Exemption from Labuan Tax

Introduction

Labuan is renowned for its tax friendly regime. The standard income tax rate for Labuan entities is competitively set at 3% of audited net profits, provided they meet the economic substance requirements. This makes Labuan an attractive destination for businesses seeking a tax-efficient environment. Labuan entities which are eligible for the 3% tax rate must be engaged in Labuan trading business activities which include banking, insurance, international trading, fund management, leasing, shipping operations, and provision of legal, accounting, payroll, backroom processing services, etc. 

Recently, the Labuan tax regime introduced a tax exemption for financial services sector adhering to Syariah principles for the years of assessment 2024 to 2028, pursuant to the newly gazetted Labuan Business Activity Tax (Exemption) Order 2024 (“2024 Exemption”) issued on 10 May 2024. Eligible companies have to meet the substance requirements below.

Substance Requirements

Labuan implemented substance requirements to ensure that Labuan entities operating within the jurisdiction have a meaningful presence and conduct genuine business activities. These requirements align with international standards and address concerns related to Base Erosion and Profit Shifting (BEPS).

Effective from Year of Assessment (YA) 2019, a Labuan entity must ensure it qualifies as a Labuan entity under Section 2B of the Labuan Business Activity Tax Act 1990 (LBATA) to benefit from the 3% tax rate on chargeable audited net profits. To qualify, the entity must:

• Employ an adequate number of full-time employees in Labuan.
• Incur an adequate amount of annual operating expenditure in Labuan,

The minimum number of employees and annual operating expenditure shall be those as prescribed by the Minister under Section 21 of LBATA.

As a result, the Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2021 (“Substance Regulations 2021”) were gazetted on 19 November 2021 and came into operation on 1 January 2019. These regulations specify the minimum number of employees and the minimum annual operating expenditure for 20 types of trading activities and 2 types of non-trading activities, as detailed in Schedules 1 and 2 of the Substance Regulations 2021. Labuan entities must maintain proper documentation and records, including meeting minutes, financial records, and other relevant documents, to support their compliance with substance requirements.

Entities that fail to meet the substance requirements may risk losing the benefits of Labuan's preferential tax regime and subject to corporate tax rate at 24%. Hence, it is crucial for businesses operating in Labuan to fulfill the substance requirements to ensure regulatory compliance.

Tax Filing Requirements

Despite the tax exemption, Labuan entities must continue to file annual tax returns. The exemption does not absolve them from complying with any requirements to submit returns, statements of bank accounts, or other information under LBATA. If the Labuan entity has income other than the exempted income, each activity or business must be treated as a separate source, with separate accounts maintained for each, to ensure compliance during tax audits.