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Direct Taxes and Indirect Taxes - A Comparison Between Entities in Malaysia and Labuan
The comprehensive range of tax benefits available in Labuan IBFC makes it a very attractive jurisdiction for a variety of business and financial activities. In this article, Goh Ka Im, Partner and Head of Tax and Revenue Practice Group, Messrs Shearn Delamore & Co, compares the different tax treatments that apply to Malaysian and Labuan entities.

Introduction

Much has been written about the beneficial tax treatment currently enjoyed by Labuan entities in the Labuan International Business and Financial Centre (Labuan IBFC), particularly under the Labuan Business Activity Tax Act 1990 (LBATA).

Such beneficial tax treatment is in relation to the direct tax on profits imposed on Labuan entities. However, there are other beneficial tax treatments relating to indirect taxes that are also made available to Labuan entities, which will be highlighted in this article together with a comparison of the different tax treatments for Labuan entities and Malaysian entities.

Labuan Business Activity Tax Act 1990 (LBATA)

Under the LBATA, a Labuan entity carrying on a Labuan trading activity is charged tax at a rate of 3% on the net audited profits reflected in the audited accounts of the Labuan entity for each year of assessment. However, a Labuan entity carrying on a Labuan trading activity has the option of electing to be charged tax at a fixed rate of MYR20,000 for each year of assessment. Once this option has been exercised, a Labuan entity would not be subject to the 3% tax charge.

In the case of a Labuan entity carrying on a Labuan non-trading activity (which would basically include all investment activities), there is no charge to tax.

Income Tax Act 1967 (ITA)

Other Malaysian non-Labuan entities deriving income from Malaysia are subject to tax under the ITA where the usual rate of tax applicable to companies is currently 25%. However, it has been proposed that the rate be reduced to 24% from the year of assessment 2016.

For Labuan entities that prefer to enjoy benefits under a Malaysian double tax treaty rather than the tax benefits under the LBATA, they may opt to make an irrevocable election for their profits to be taxed under the ITA instead of the LBATA. With such an election, all of the Labuan entity’s profits, whether arising from a Labuan trading activity or a Labuan non-trading activity, would be subject to tax at the usual rate of 25% under the ITA.

Exemption Orders Under the ITA

Ordinarily, payments of interest, royalties, technical fees and other gains or profits not coming within the specified classes of income, which are derived from Malaysia and paid to non-residents, would be subject to withholding tax in Malaysia.

However, Labuan entities are exempted from withholding tax on those specified payments made to non-residents.

Under the Income Tax (Exemption) (No. 22) Order 2007 (2007 Exemption Order), due to the terminology used which refers to “offshore company” instead of “Labuan entity”, Labuan companies and Labuan trusts are amongst the types of entities specified as being exempted from withholding tax on interest, royalties and technical fees paid to non-residents. This exemption, however, does not apply to Labuan foundations.

As such, a new exemption order known as the Income Tax (Exemption) (No. 4) Order 2012, which was gazetted in 2012, used the term “Labuan entity” in relation to exemption from withholding tax on other gains or profits not coming within the specified classes of income so that where those payments are concerned, the exemption from withholding tax is made available to all Labuan entities as defined, including Labuan foundations, Labuan companies and Labuan trusts. The anomaly affecting the 2007 Exemption Order is known to the Labuan authorities and should hopefully be resolved soon.

Double Tax Treaties

Some countries that have entered into double tax treaties with Malaysia have specifically excluded Labuan entities from enjoying the benefits provided under their double tax treaties.

One of the latest examples is the double tax treaty between Malaysia and India known as the Double Taxation Relief (The Government of the Republic of India) Order 2012 (India Order). The Protocol to the India Order specifies that persons who are entitled to tax benefits under the LBATA are not entitled to benefits under the India Order but an exception is made for Labuan companies which have made an irrevocable election to be charged tax in accordance with the ITA.

In contrast, other countries which have excluded Labuan entities from enjoying the benefits under their double tax treaties do not make any exceptions for Labuan entities which elect to be taxed under the ITA instead of the LBATA.

One such example is the double tax treaty between Malaysia and South Africa known as the Double Taxation Relief (The Government of the Republic of South Africa) Order 2005 (South Africa Order), which specifies that the benefits of the South Africa Order shall not be made available in relation to the carrying on of any offshore business activities (as defined in the LBATA as at 26 July 2005).

As no exception was provided in the South Africa Order, Labuan entities wishing to enjoy benefits under the South Africa Order or other similar double tax treaties without provisions for an exception, should be aware that electing to be taxed under the ITA instead of the LBATA may not necessarily enable them to enjoy treaty benefits.

Inheritance Tax and Gift Tax

There is no inheritance tax or estate duty in Malaysia, including Labuan, so any estate planning does not have to take into account such taxes.

There is also no gift tax per se in Malaysia, including Labuan, but if the gift involves real property or shares in a real property company, the Real Property Gains Tax Act 1976 may need to be considered.

Stamp Duty

Stamp duty is imposed on certain types of instruments in Malaysia as specified in the Stamp Act 1949. Common instruments which are subject to stamp duty would be conveyances or transfers on sale of property such as shares and real estate. For such instruments, the rate of stamp duty is imposed on the value of the property in question so the total stamp duty payable could be quite substantial depending on the value of the property.

For Labuan entities, an exemption order known as the Stamp Duty (Exemption) (No. 3) Order 2012 (Stamp Order) is in force which exempts all instruments executed by a Labuan entity in connection with a Labuan business activity from stamp duty.

In addition, under the Stamp Order, all instruments of transfer of shares in a Labuan entity, as well as the constituent documents for the establishment of a Labuan entity, are exempted from stamp duty.

Customs Duties

Customs duties, the most common of which are import duty and export duty, are imposed on certain goods imported into or exported from Malaysia.

However, once again there is special treatment in relation to Labuan; as stated in the Customs Act 1967, the “principal customs area” in Malaysia is defined to exclude Labuan so that no export duty is payable on any goods exported from Labuan and generally no import duty is payable on goods imported into Labuan.

Sales Tax

Sales tax is imposed on specified goods which are manufactured in Malaysia or imported into Malaysia for home consumption but Labuan enjoys special treatment as it is excluded from the definition of “principal customs area” for purposes of the Sales Tax Act 1972.

Generally, no sales tax would be payable on any taxable goods imported or transported to Labuan from the principal customs area of Malaysia.

Service Tax

Service tax is imposed on prescribed taxable services provided by prescribed taxable persons in Malaysia. Common examples of taxable services include legal services and accounting services, while common examples of taxable persons include advocates and solicitors as well as public accountants.

The Service Tax Act 1975 is specified as not applying to Labuan. Additionally, the Minister of Finance had exercised his powers to exempt all taxable services provided by persons in the principal customs area in relation to matters in Labuan from service tax. The Minister further specified that all taxable services provided by persons in the principal customs area to persons in Labuan are not subject to service tax.

The exemption from, and non-application of, service tax in relation to Labuan as described above would remain until the introduction of the goods and services tax (GST).

Goods and Services Tax (GST)

It was announced in the Malaysian Budget 2014 that the goods and services tax (GST) will come into force in Malaysia effective 1 April 2015. To facilitate this, the Goods and Services Tax Bill 2014 (GST Bill) was passed by the Malaysian Parliament in April 2014.

Pursuant to the GST Bill, GST would be levied on any supply of goods or services made in Malaysia, including any importation of goods into Malaysia. With the introduction of GST, the Sales Tax Act 1972 as well as the Service Tax Act 1975 would be repealed so that sales tax and service tax would no longer be chargeable.

Also, GST shall not apply to any importation of goods or supply of imported services into Labuan unless specifically prescribed by the Minister of Finance by an order laid before Parliament. However, GST is chargeable on all goods supplied from Labuan to Malaysia or taxable services made by a taxable person in Labuan to Malaysia.

Conclusion

There is a comprehensive range of tax benefits both in relation to direct taxes and indirect taxes available to Labuan entities, which makes Labuan IBFC a very attractive jurisdiction for a variety of business and financial activities. Strategically located in the heart of Asia Pacific, Labuan IBFC is well positioned to tap into one of the fastest growing regions in the world, presenting the perfect opportunity for businesses seeking to connect with Asia’s economies and beyond.

This article was first published in Labuan IBFC's Q Report, Issue 1 (2013)


About Author

goh ka im

Goh Ka Im is a Partner and Head of Tax and Revenue Practice Group at Messrs Shearn Delamore & Co. She joined the firm in 1988 and became a partner in 1997. She is currently a member of the Inter-Pacific Bar Association, where she was previously the Chairperson of the Tax Committee; the International Bar Association; the International Fiscal Association; and the International Tax Planning Association (ITPA), where she is also its Malaysian Jurisdiction Editor (Labuan).

Ms Goh’s main practice areas include all aspects of tax and revenue law, such as income tax, corporate tax, real property gains tax, customs duties, sales tax, service tax, double taxation treaties, Labuan business activity tax, Labuan entities, Labuan trusts and foundations, stamp duty, tax incentives for investments, personal trusts, charitable trusts and tax litigation.

She also has extensive experience in advising on tax and revenue matters and appears regularly in court on such matters. Due to her vast experience in tax and revenue law, she has been invited to speak at numerous local and international revenue law conferences and seminars, and has actively written and contributed a number of articles to the ITPA and other publications.

Ms Goh graduated with an LLB (Hons) degree from the University of Bristol, UK in 1986. She was called to the Bar of England and Wales in 1987 and was admitted as an Advocate and Solicitor of the High Court of Malaya in 1988.


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