Part eight of the Jurisdiction Spotlight series will focus on Labuan, which has grown significantly in the last couple of years.

Labuan is a rather complex offshore jurisdiction with cleverly written laws and tax codes. This post is by no means exhaustive, but should serve as a good primer on what is going on in Labuan.

First up, a brief history lesson.

History

Labuan enters history books in the 14th century when the Majapahit Empire fell and Labuan became a part of the Sultanate of Brunei.

Not a lot happened until 1846, when the British gained control over Labuan. The conditions for this cession are not well recorded, with some sources claiming it was an amicable exchange and others claiming the sultan of Brunei was under threat from the British.

The island was named Victoria under British rule and served as a naval base for combating piracy in the region. With coal exploitation proving successful in Labuan, the British saw potential in Labuan becoming an important hub similar to Singapore.

Although it never reached the size and importance of Singapore, Labuan remained a valuable asset under British rule, except for 1890 — 1906 when it was ruled by the North Borneo Company. In 1907 it became a part of the Straits Settlments, where it remained until it was captured by the Japanese Empire. The island changed name to Maida Island.

British and Australian forces liberated Labuan in June of 1945. The island remained under British military rule until 1946 when it became a colony.

The free port of Labuan opened in 1956, making the island duty free.

Labuan was granted independence in 1963. It then became a part of Sabah and joined Malaysia. This lasted until 1984 when Sabah ceded Labuan, which pronounced itself a federal territory of Malaysia, gaining greater independence.

On the 1st of October 1990, Labuan launched itself as an offshore financial center and free trade zone (FTZ).

Today, Labuan is a tourist attraction and growing financial center.

Overview Data

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Labuan Companies

There are two types of offshore companies in Labuan: trading company and non-trading (holding) company.

Both forms of companies are registered under the same law but different taxes, fees, and requirements apply depending on what the company is effectively doing; whether it’s just holding or if it’s actively trading.

There is a third category, called Labuan Charged Company. This is a company which opts to be taxed under federal Malaysian law, which grants access to Malaysia’s as of writing 73 DTAs; a rather impressive range, with good coverage of Europe and Asia.

Gradually, Labuan is becoming a favoured tax haven in Asia, for its combination of tax efficiency and reputability, owing to compliance with international standards on due diligence and transparency. Over 50% of all Labuan companies have owners from Southeast Asia and the Pacific, followed by 16% Far East, and then 13% European. The remaining is made up of owners from the Americas, Caribbean, Middle East, and Africa.

There are no public records of Labuan companies and the OECD in 2011 criticized Malaysia for time to time being unable to extract information from Labuan. This is likely to improve, since Malaysia seems to want Labuan to be a reputable offshore financial center.

Labuan Trading Company

Under the Labuan Business Activity Tax Act 1990, Labuan trading companies pay a tax of 3%, which is capped at 20,000 MYR per year. (As of writing, 100 MYR ≈ 23 EUR, 31 USD, 18 GBP.)  However, companies  cannot trade in the MYR currency. Share capital cannot be in MYR either. Any other currency is permitted, with USD being the by far most common.

Labuan companies are also limited in their trade with Malaysian resident persons and companies. A Labuan company cannot trade wholly with Malaysian residents, nor is it entirely prohibited from doing so. Trade with Malaysian residents must be reported to the Labuan FSA, but reporting need only be done after the transaction has taken place.

Annual fees are higher than most offshore jurisdiction. A foreign-owned Labuan company pays 5,300 MYR per year, whereas a locally controlled Labuan company only pays 2,600 MYR. In the grand scheme of things, this is not a particularly high amount. It does, however, prevent small or poorly funded companies from forming in Labuan. This is an intentional strategic move.

Trading companies must also have what’s called commercial substance physically in Labuan. This requirement can be fulfilled quite easily, by simply having a Labuan bank account, staff in Labuan, or annual board meeting in Labuan. It’s not a very difficult requirement to live up to and its purpose is likely to further filter out only the most serious entrepreneurs from setting up shop in Labuan. I know of companies that pass this requirement by utilizing a virtual office in Labuan to have a

Hiring staff to work for Labuan companies has an interesting quirk: employees must be at least 21 years old for IT positions and 27 years old for management positions.

Employees working for a Labuan trading company enjoy a significant tax reduction on their income of up to 50%.

Labuan companies must have at least one director and one resident secretary. While nearly always limited by shares, companies can opt to be limited by guarantee.

Companies are required to keep accounts and file annual returns. Audits, while not required, are commonly used, as they may be required to access certain tax benefits.

Labuan Non-Trading Company

Under Section 2 of the aforementioned Labuan Business Activity Tax Act 1990, Labuan non-trading company is a company which engages “an activity relating to the holding of investments in securities, stock, shares, loans, deposits or any other properties by a Labuan entity on its own behalf” – effectively a holding company.

Section 9 states that “a Labuan entity carrying on a Labuan business activity which is a Labuan non-trading activity for the basis period for a year of assessment shall not be charged to tax for that year of assessment.”

If a a company engages in both trading and non-trading, it is considered a trading company. In such a situation, it would be wise to divide trading from non-trading into separate legal entities.

Labuan non-trading companies are otherwise nearly indistinguishable from trading companies.

Labuan Limited Liability Partnership

In February 2010, Labuan enacted a law which made Limited Liability Partnerships (LLP) possible.

The fees for forming an LLP are much lower than forming a company limited by shares.

At least two partners are required.

Labuan Trusts

Labuan trusts require a resident settlor, whose powers may be uncomfortably wide for some. The settlor is authorized to revoke, amend,  the trust.

The beneficiary must also be a Labuan person, but this can be a foreign-owned legal entity.

Trusts can be for a limited time or, if no time is stated, perpetual.

There is not much that separates Labuan trusts from trusts in other jurisdictions. It does not have the ironclad asset protection properties of for example Cook Island trusts.

They are commonly used for asset protection, wealth management, or as vehicles in tax structures.

Other Activities

There is a plethora of Other Activities available in Labuan.

• Labuan leasing
• Labuan foundation
• Protected Cell Companies
• Money brokering
• Ship registry

Chances are that whatever your offshore financial itch is, Labuan has something to scratch it.

The Labuan FSA also issues licenses for a wide range of activities, such as banking and insurance.

Banking in Labuan

So far, although many hold bank accounts in Labuan to achieve commercial substance (see above) in Labuan, many if not most offshore companies in Labuan bank elsewhere; typically Hong Kong or Singapore.

There are presently 58 banks licensed in Labuan, of which many are either local Malaysians bank or investment banks. A large number of the banks are just branches of other banks with very little actual presence in Labuan. These banks mostly just open up a Labuan branch to offer Labuan-based services to their customers elsewhere.

Generally, banking in Labuan is quite poor due to the limited availability of banks. Things have however improved massively.

CIMB Bank Offshore, Maybank Offshore, KFH Offshore, and HSBC are some of the major banks active in the local markets.

Labuan banks are typically not interested in non-Labuan companies, although exceptions are sometimes made for companies from Hong Kong and Singapore.

Banking secrecy in Labuan is strict for now since the Malaysian federal government cannot access information. This may change in the future, but in general, Malaysia has quite rigorous banking secrecy.

Living in Labuan

Labuan is a small island yet well-connected to mainland Malaysia. There are also ferries, which connect Labuan with not only Malaysia but also Brunei.

While the island lacks sales tax (duty free), it is still quite expensive. An average Malaysian salary will not be enough to live comfortably in Labuan.

Forming a Labuan company can be an effective way to gain Malaysian residence permit. These programs tend to change from time to time, so check the Labuan or Malaysian government websites for up to date information.

Personal income tax is the same as in Malaysia and goes from 0% to 26%. However, as mentioned earlier, special provisions are made for personal income from Labuan companies.

Labuan is a very safe island, with little to no violent crime. Weather can be rough, as is typical for the region.

Final Words

If you are a serious entrepreneur with the capital to show it, looking to form a tax efficient trading or non-trading company, Labuan just be the right move for you, especially if you trade across Asia.

Banking is getting better all the time. With English being so well-spoken and commonly used, Labuan stands to take a strong third position in Asia for banking after Hong Kong and Singapore. The banks need to become more easy-going first.

It is a beautiful island, well worth a visit and – if you like it – stick around for a few years. I did get a bit of a claustrophobic feeling in Labuan, though, with only domestic flights. To get out of the country – other than by boat to Brunei – you have to fly via Malaysia.

Click here to see other posts in the Jurisdiction Spotlight series.

Further Reading

• OECD Peer Review of Malaysia (also has a list of TIEA and DTA)
• Financial Secrecy Index Malaysia (Labuan)
• FATF Evaluation (2007)