Changes to the Labuan tax regime

In line with the Base Erosion and Profit Shifting (BEPS) Action 5 initiatives, Malaysia has enacted the following changes to the Labuan tax regime.

1. Substance requirements

Under the revised Section 2B(1)(b) of the Labuan Business Activity Tax Act, 1990 (LBATA), a Labuan entity must for the purpose of the Labuan business activity have an adequate number of full time employees and an adequate amount of annual operating expenditure in Labuan, as specified under the Labuan Business Activity Tax (Requirements For Labuan Business Activity) Regulations 2018 (Substance Requirements”) which took effect from 1 January 2019.

For example, a Labuan “holding company” is required to have a minimum of two full time employees in Labuan and an annual operating expenditure in Labuan of MYR 50,000, while a Labuan “leasing company” is required to have a minimum of two full time employees and an annual operating expenditure in Labuan of MYR 100,000.

Under the newly enacted Labuan Business Activity Tax (Amendment) Act 2020 (“LBATA 2020 Amendment”), where Substance Requirements are not complied with, effective from year of assessment 2020, the Labuan entity will be taxed at the rate of 24% on its net profits for that year of assessment. Therefore, the consequence of not meeting the Substance Requirements under LBATA 2020 Amendment is that capital gains and foreign source income would also be taxed at the rate of 24%.

2. Abolition of the flat tax rate

With the deletion of Section 7 of the LBATA effective from 1 January 2019, a Labuan taxpayer can no longer elect to pay tax at the fixed amount of MYR 20,000 for each year of assessment. Therefore, tax will be charged at the rate of 3% on net profits from its Labuan business activity for the basis period for the year of assessment.

3. Income from intellectual property rights

Under the amendment to Section 4(4) of the LBATA, income derived from royalty or intellectual property rights is now subject to tax under the Malaysian Income Tax Act, 1967 (ITA) rather than under the LBATA. The prevailing income tax rate for companies (non-SMEs) in Malaysia under the ITA is 24%.

4. Resident status of a Labuan entity

Prior to the LBATA 2020 Amendment, there was no provision in the LBATA which made reference to the network of double taxation.

Under the new Section 3B of the LBATA 2020 Amendment, for the purpose of the double taxation agreements under Section 132 of the ITA:

A Labuan entity carrying on a business is resident in Malaysia for a YA if at any time during the basis year the management and control of its business is exercised in Malaysia; and
Any other Labuan entity is resident in Malaysia for a YA if at any time during that basis year the management and control of its affairs are exercised in Malaysia by its directors, partners, trustees or other controlling authority.

5. Restriction of tax deductions for payments made to a Labuan company by Malaysian taxpayer

Prior to this amendment, a Malaysian taxpayer could claim a full deduction for payments made to a Labuan entity under Section 33 of the ITA.

However, due to the insertion of the new Section 39(1)(r) of the ITA, payments made to a Labuan company by a Malaysian taxpayer will be disallowed under Section 33 of the ITA unless otherwise prescribed by the Ministry of Finance. Under the Income Tax (Deductions Not Allowed for Payment Made to Labuan Company by Resident Rules 2018) (“Disallowance Rules”), the prescribed amounts prohibited from deduction for the following types of payments made to Labuan company are as follows:

Types of payment	Amount not allowed for deduction
Interest payment	33%
Lease rental	33%
Other payments	97%

In view of the significance of the above LBATA amendments, international organisations with Labuan entities within the group are advised to review their tax position on an urgent basis, to manage any tax exposure arising from the above amendments. BDO’s team of experienced tax advisory professionals in Malaysia will be pleased to help.

David Lai
davidlai@bdo.my