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International taxation: Evolution of the tax regime in Labuan IBFC

Over the past few years, there have been significant changes to the global tax landscape as jurisdictions comply with international standards to reduce tax leakages, especially standards imposed by the Organisation for Economic Corporation and Development (OECD) and the European Union (EU)’s Code of Conduct Group (Business Taxation) (EU COCG).

Malaysia is a member of the OECD’s Inclusive Framework on Base Erosion and Profit Shifting (BEPS) (henceforth referred to as the “Inclusive Framework”) and as such, Labuan International Business and Financial Centre (Labuan IBFC) being a Federal territory of Malaysia, is also required to comply with Malaysia’s commitments to the minimum prescribed BEPS standards, especially those under BEPS Action 5 which focuses on harmful tax practices. The OECD monitors compliance with BEPS Action 5 through a peer review process.

Apart from the OECD’s Inclusive Framework, the EU COCG was also established by the EU Council to curb harmful tax competition. The EU COCG monitors jurisdictions to ensure that they comply with commitments to reduce harmful tax practices. These commitments were introduced to ensure that countries do not offer preferential tax regimes unless substantial activities are undertaken within the countries. Countries failing to make sufficient commitments in response to the EU COCG’s concerns will be included in the list of non-cooperative jurisdictions (or “blacklist”), which is reviewed on a biannual basis. During a European Parliament sitting in January 2021, there were calls for the tax haven blacklist to be strengthened even further.

Introduction of substance requirements in Labuan IBFC

Against this backdrop, Economic Substance Requirements (ESR) were introduced for Labuan entities with effect from 1 January 2019. As a result, Labuan IBFC and, by extension, Malaysia were able to meet commitments to international standards. Notably, Labuan IBFC has not been included in any sanctions list or blacklist maintained by either the OECD or EU COCG to date. This should be an attractive consideration for any investor with global reach.
The relevant authorities are committed to enhancing Labuan IBFC’s position as a business-friendly and internationally compliant jurisdiction. The Labuan Investment Committee (LIC), comprising representatives from the Ministry of Finance, Inland Revenue Board of Malaysia (IRB) and Labuan Financial Services Authority (Labuan FSA), was formed to establish, monitor and improve the ESR in Labuan IBFC.

Through the careful balancing of meeting international commitments on the one hand and ensuring business continuity on the other, the LIC has introduced some welcomed changes to ESR in the past year. These include:

Entities that undertake pure equity holding are subject to less stringent requirements of “management and control” in Labuan IBFC
Entities in the captive insurance and leasing sectors are allowed to fulfill ESR on a group basis
Unlike the implementation of ESR in other jurisdictions similar to Labuan IBFC, such requirements have been prescribed to Labuan entities based on the business activity carried out. A detailed table is provided in a statutory Gazette Order issued by the Government of Malaysia, which sets out the ESR requirements, i.e. the number of full-time employees and amount of minimum operating expenditure, for various types of businesses or license holders to comply with.

Should a Labuan entity not adhere to the ESR in Labuan IBFC, its legal status does not come into question; all that is affected is its tax treatment, i.e. if it fails to comply with ESR, the Labuan entity would be subject to tax at the same corporate headline tax rate, currently at 24%, as other Malaysian companies.

Looking further to the horizon is the global rollout of OECD’s BEPS 2.0, consisting of Pillar 1 and Pillar 2, which aim to address tax challenges arising from the digitalized economy. Notably, Pillar 2 proposes to introduce a global minimum tax rule for large multinational groups – a concept which has been brought into the spotlight recently due to press statements made by the United States of America’s Treasury Secretary.

In view of the changes to the legal and regulatory landscape that are moving at an ever-faster pace, companies are encouraged to take stock of their global structures and consider the effects of international developments on such structures. Careful planning and review of the global Group structure are needed to ensure compliance with evolving tax regulations and practices. Companies need to ensure that their activities, including holding and financing activities, are carried out in jurisdictions that comply with and adapt to international standards.

Labuan IBFC’s value proposition

Labuan IBFC, located in the centre of Asia, provides a conducive environment that makes it a substance-enabling location for both global businesses looking at penetrating Asia and Asian entities aiming to go global with a competitive edge.

Offering a wide range of business structures and investment solutions catered to cross-border transactions and international business dealings, including fintech-related solutions, Labuan IBFC provides services and solutions in niche areas such as risk management, commodity trading, wealth management, international business companies, Islamic financial services and digital financial services.

Labuan IBFC offers competitive tax rates where substance requirements are complied with. Furthermore, various exemptions are available to Labuan entities for indirect taxes, stamp duty and withholding tax. In fact, the Labuan FSA recently announced the extension of a tax exemption until 2025 on director’s fees received by non-citizens. At the same time, certain long-standing exemptions have been phased out in order to keep the regime focused and relevant.

That being said, for Labuan IBFC to continue to be relevant and successful, it is important that the relevant authorities provide clarity on contentious issues on a timely basis and that the solutions provided are business-friendly and practical. The role of the LIC could be enhanced to cater to this.

With the continued support of the relevant authorities, Labuan IBFC has the potential to be a hub for both outbound and inbound investment into this fast-growing region.

Anil Kumar Puri is a partner in the International Tax and Transactions practice of Ernst & Young Tax Consultants Sdn. Bhd. The views reflected above are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Member firms of the global EY organization cannot accept responsibility for loss to any person relying on this article.

About The Author

Anil Kumar Puri

Anil has 20 years of tax compliance and consulting experience and leads EY Malaysia’s International Corporate Tax Advisory and Tax Technical teams. He has advised on the tax and regulatory issues of many cross border transactions (both inbound and outbound). His experience includes advising on the impact of the OECD’s Base Erosion & Profit Shifting Action Plans on holding and transactional structures, regulatory approvals, withholding taxes, tax incentives, structuring of operations in a business-focused and tax efficient manner and exit strategies.

Anil has advised on a number of restructuring exercises, including pre-IPO restructuring and pre-divestment restructuring. He has also led various tax buy-side and sell-side due diligence projects, including multi-country projects, involving various industries such as retail, education, oil & gas and healthcare.

Anil has spoken at EY’s tax conferences, client events, and industry events in Malaysia and abroad. In addition, Anil has also regularly spoken at events organized by the Labuan IBFC. He also regularly conducts training sessions for clients and senior EY personnel on various matters.

Anil is a graduate from the Monash University, Australia. He completed his Bachelor of Business (Accounting). In addition, he is also a Fellow Member of CPA Australia, Member of the Malaysian Institute of Accountants and Associate Member of the Chartered Tax Institute of Malaysia.

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Access a wealth of information from Labuan IBFC from reports on forward-thinking research to insightful articles.
Get in touch
Interested to setup your business in Labuan? Speak to our dedicated advisors to find out more.
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