Labuan Updates: Tax Exemption from 2023 to 2027

Labuan Updates: Tax Exemptions from 2023 to 2027

Introduction

Labuan entities, such as companies, trusts and foundations, benefit from a low tax environment, being taxed at a flat rate of 3% on audited net profits. In contrast, Labuan entities engaging in non-trading activities are generally exempt from tax (Nil tax). Non-trading activities typically include holding investments in securities, stocks, shares, loans, deposits, or any other properties situated in Labuan by a Labuan entity on its own behalf. The tax treatments for Labuan entities are governed by the Labuan Business Tax Act 1990 (LBATA) and specific statutory exemption orders or PUs issued by the Government.

Economic Substance Requirements – Effective 1 January 2019

Labuan entities have to comply with substance requirements to benefit from the low tax regime. This is to ensure that entities conducting business in Labuan have a genuine presence and economic activity there. The requirements which became effective on 1 January 2019, compel Labuan entities to meet certain criteria, such as maintaining a minimum number of full-time employees in Labuan and incurring a minimum amount of annual operating expenditure in Labuan. Failure to meet these requirements will result in the Labuan entity being subject to tax at the standard corporate tax rate of 24% instead of the preferential rates or exemptions.

Income Tax (Exemption) Order 2025 [P.U. (A) 59/2025] – Effective YA2023 to YA2027

The latest changes to the tax treatments concerning various stakeholders in a Labuan entity have been incorporated in the Income Tax (Exemption) Order 2025 [P.U. (A) 59/2025], issued on 24 January 2025 (“2025 Exemption Order”). This new exemption order supersedes the Income Tax (Exemption) (No. 22) Order 2007 [P.U. (A) 437/2007] (“2007 Exemption Order”), issued on 18 December 2007. The latest exemption order covers various types of income received by a Labuan entity as well as income received by individuals, companies, residents, non-residents, and other parties from a Labuan entity.

By and large, the new exemption order and its predecessor exemption order provide almost similar tax benefits to taxpayers engaging with Labuan entities, with slight exceptions as highlighted below:

Unlike the previous exemptions, which were issued with open-ended or indefinite effective dates, the validity of these exemptions is confined to the period from YA2023 to YA2027.
In addition, the new exemption order introduces new exemptions for income received by:
1. members of Labuan Foundations (i.e. Labuan Foundation or Labuan Islamic Foundation);
2. partners of Labuan Partnerships (i.e. Labuan Limited Partnership, Labuan Limited Liability Partnership, Labuan Islamic Limited Partnership and Labuan Islamic Limited Liability Partnership).

Below is a detailed explanation of the tax treatments for different scenarios.

A. Income Received by a Labuan Company (“Labuan Company” means a company incorporated under the Labuan Companies Act 1990)

Dividends: When dividends are paid to a Labuan Company by any entity, the recipient Labuan Company is exempted from income tax. This exemption encourages investment and the flow of dividends into Labuan entities.
Interest Received: Interest payments made by one Labuan Company to another are also exempted from income tax. This exemption facilitates financing and liquidity management within Labuan entities.
Royalties Received: Royalties received by a Labuan Company from another Labuan Company are exempted from income tax. This provision supports the use of intellectual property and other intangible assets within Labuan.
Service fees under Section 4A (i) and (ii), Income Tax Act 1967: The service income categorized under Section 4A (i) and (ii) of the Income Tax Act 1967, received by a Labuan Company from another Labuan Company are exempted from income tax. The provisions under Section 4A are designed to tax certain types of income earned by non-residents such as equipment installation fees and technical fees paid by Malaysian entities to non-residents, including a Labuan entity.

B. Income of a non-Labuan party receiving income from a Labuan Entity (Labuan Company, Labuan trust, etc.)

Dividends: Dividends paid by a Labuan Company to any person are exempted from income tax, subject to certain conditions. This exemption aims to attract investors by providing tax-free returns on their investments.
Interest: Interest payments made by a Labuan Company to non-residents and residents are exempted from income tax. This exemption encourages both local and foreign entities to engage in financial transactions with Labuan Companies.
Royalties: Royalties paid by a Labuan Company to non-residents are exempted from income tax. This provision supports the use of foreign intellectual property and other intangible assets by Labuan companies.
Service fees under Section 4A (i) and (ii), Income Tax Act 1967: Payments categorized under 4A (i) and (ii) (i.e. fees from services such as equipment installation fees and technical fees) made by a Labuan Company to non-residents for the services acquired are exempt from income tax.
Distributions by -
- Labuan trust (i.e. Labuan trust and Labuan Islamic trust).
- Labuan Partnership (i.e. Labuan Limited Partnership, Labuan Limited Liability Partnership, Labuan Islamic Limited Partnership and Labuan Islamic Limited Liability Partnership).
- Labuan Foundation (i.e. Labuan Foundation or Labuan Islamic Foundation).
Distributions made by a Labuan trust to its beneficiaries are exempted from income tax. Similarly, distributions of profits after tax (PAT) made by a Labuan Partnership to its partners and distributions by a Labuan Foundation to its members are exempt from income tax. However, the Labuan Foundations Act 2010 does not have the term “members”. As such, the government will need to provide guidelines on the interpretation of this term or amend the exemption order to better reflect the party which should enjoy exemption i.e the beneficiaries of the Labuan Foundation.
The above exemption benefits the recipient parties and support the use of these structures in Labuan for various business and other undertakings.

Applicability of withholding tax under Section 109, Section 109B and Section 109C of the ITA

The exemption order also addresses the applicability of the relevant withholding tax provisions under Section 109 (interest and royalties paid to non-residents), Section 109B (payments under Section 4A(i) and (ii) to non-residents), and Section 109C (interest paid to individual residents). According to Paragraph 4 of PU(A) 59/2025, a person granted an exemption shall not be allowed any deduction of withholding tax under the relevant provisions, i.e., Section 109, Section 109B, and Section 109C.

In the previous PU(A) 437/2007, Paragraph 5 explicitly states that the relevant withholding tax provisions under Section 109, Section 109B and Section 109C shall not be applicable to the income exempted under the exemption order. The present PU(A)59 basically reiterates the same prohibitions. Although there appears to be some ambiguity in the wording used in the PU(A) 59 exemption order compared to the clear position stated in its predecessor exemption order PU(A) 437, it is believed that they convey the same meaning, that is, the payer is not required to deduct the relevant withholding tax on payments made to a person where the income is exempted under the latest exemption order.

Summary Table

The summary table below highlights the various scenarios and their respective tax treatments for easy reference.

Ref in PU(A) 59	Paid by	Paid to	Nature of Payment	Tax Treatment
Para 2(a)	Anybody	Labuan Co	Dividends	Recipient exempted from income tax
Para 2(d)	Labuan Co	Labuan Co	Interest received	Recipient exempted from income tax
Para 2(g)	Labuan Co	Labuan Co	Royalties received	Recipient exempted from income tax
Para 2(l)	Labuan Co	Labuan Co	4A (i) and (ii) payments	Recipient exempted from income tax
Para 2(b)	Labuan Co	Any person	Dividends	Recipients exempted from income tax. Conditions apply.
Para 2(c)	Labuan Co	Non-resident	Interest	Recipients exempted from income tax. Conditions apply.
Para 2(e)	Labuan Co	Resident	Interest	Recipients exempted from income tax. Conditions apply.
Para 2(f)	Labuan Co	Non-resident	Royalties	Recipient exempted from income tax
Para 2(h)	Labuan Trust	Beneficiary	Distributions	Beneficiary exempted from income tax
Para 2(i)	Labuan Partnership	Partner	Distribution of PAT	Partner exempted from income tax
Para 2(j)	Labuan Foundation	Member	Distribution of PAT	Member exempted from income tax
Para 2(k)	Labuan Co	Non-resident	4A (i) and (ii) payments	Non-resident is exempted from income tax

Closing Remarks

The 2025 exemption order PU(A) 59 is an update of the 2007 exemption order PU(A) 437, both serving the objective to promote the use of Labuan as an international business and financial centre. It is important to note that any income not specified in the 2025 exemption order will be subject to the normal tax treatments stipulated under the LBATA (Nil tax or 3% tax if the recipient meets the conditions) or the Malaysian Income Tax Act 1967 (if the recipient does not meet the conditions). Furthermore, the exemptions provided under the 2025 exemption order are only applicable for a specific period, namely from YA2023 to YA2027. This limited timeframe for the tax benefits underscores the temporary nature of the exemptions and highlights the need for stakeholders to plan accordingly. The confined period of validity means that any income received outside of this timeframe will not be eligible for the exemptions, hence, stakeholders must be aware of this to optimize their tax planning strategies. The temporary nature of these exemptions also suggests that the government may review and potentially revise these provisions in the future, depending on the economic and regulatory landscape.

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