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by the Investors Offshore Editorial Team, September 2011, 30 September, 2011
When we think of the word ‘offshore,’ the names ‘Bermuda’, ‘Cayman Islands’, or perhaps ‘Switzerland’, are the ones that would probably come to mind before ‘Labuan’.
In a way that is unsurprising, as Labuan, situated a few miles off the northern coast of Borneo in Malaysia and just 60-odd square miles in size, is one of the newer additions to the list of the world’s offshore jurisdictions.
Situated in the heart of the fast growing South Eastern Asian region, and close to a number of major cities and economic hubs such as Singapore, Hong Kong, Kuala Lumpur and Jakarta, Labuan is currently (2011) home to a population of around 90,000, benefits from a benign income tax regime, a well regulated financial regime, a deep water port and a well developed supporting infrastructure, including internet communications, and could well soon be giving other more established financial jurisdictions a run for their money, particularly in the field of Islamic finance.
Used by the British as a coaling station in the days of empire, Labuan’s economic existence has traditionally depended on its deep water port and position at the confluence of Eastern Asian’s trade routes. Latterly, oil and gas exploration and their supporting industries were the main contributors to the island’s economy. However, these are fast being superseded by financial services, and tourism is also a growing industry given the island’s year-round tropical climate, coral reefs and sandy beaches.
The Labuan International Business and Finance Centre (IBFC)
The financial services industry in Labuan has taken root thanks to the creation of the Labuan International Offshore Financial Centre in 1990, along with the passing of a batch of ‘offshore’ laws and the creation of LOFSA (Labuan Offshore Financial Services Authority). With the passage of new laws to govern its business environment in 2010, LOFSA has re-branded itself as Labuan FSA (Labuan Financial Services Authority), and the centre itself as IBFC (Labuan International Business and Finance Centre).
The offshore companies established on Labuan in 2009 included 61 banks, 169 insurance companies, 176 leasing companies and 23 trust management companies. Moreover, the island has quickly grown as a major conduit for Foreign Direct Investment into a number of local countries, particularly South Korea and Malaysia itself.
In 2010, Labuan IBFC maintained positive growth across all key business sectors, but particularly banking, leasing and insurance, despite the more challenging global environment, and new measures have been implemented recently to improve the flexibility and business-friendliness of its tax and legal framework, becoming effective in 2009 and beyond.
According to the Labuan FSA's 2011 Annual Report, in 2010, the number of Labuan companies registered under the Labuan Companies Act 1990 recorded growth of 7.8%, increasing to 8,004, compared to 7,423 companies in 2009. These originate from close to 100 countries, of which about 60% are from the Asia Pacific region, mainly for investment holding purposes, special purpose vehicles, international financial activities and trading activities. The reduction in annual fees from RM2,600 to RM1,500 and the upgrading of the online registration system and business approval process have facilitated this growth.
Of note in 2010 were the new laws which have substantially improved the regulation and development of Labuan’s international financial markets. An additional clause to the Labuan Offshore Business Activity Tax Act, which is now known as the Labuan Business Activity Tax Act, has enabled the adoption of the Organization for Economic Cooperation and Development standard for the exchange of information for tax purposes in double taxation agreements.
The new laws allow for the creation of Labuan foundations, limited liability partnerships, protected cell companies (insurance and mutual funds), shipping operations, Labuan special trusts and financial planning activities. These complement the existing available range of products and services and aim to provide investors with a wider choice of financial products to maximise investment opportunities.
Ongoing robust regulation of the LIBFC by the Labuan FSA should ensure its continued development as a regional platform for international investments.
In order to enhance LOFSA’s regulatory function and corporate governance, a separate marketing entity, Labuan IBFC Incorporated Sdn Bhd was established in 2009 to undertake more focused marketing activities for the Labuan IBFC.
As part of the strategy to further facilitate the use of Labuan as the platform for investment into Malaysia and the region, LOFSA simplified the procedures for Labuan companies to deal with residents and invest into a domestic company.
With effect from 1 June 2009, Labuan holding companies have been accorded the extra flexibility to have a physical presence in Kuala Lumpur. Similarly, Labuan banking institutions and insurance companies that meet the predetermined criteria will also be allowed to have a physical presence onshore from 2010 and 2011, respectively.
In 2010, the Labuan FSA continued to undertake various initiatives to promote the development of Labuan IBFC as a premier jurisdiction for international business and finance. Amongst the initiatives were the establishment of a representative office in Hong Kong to further strengthen the connectivity and linkages with the Asia Pacific countries. In April that year, the Labuan FSA also signed a Memorandum of Understanding on Cooperation and Mutual Assistance with the Financial Services Commission of Mauritius. The agreement is aimed at establishing an enhanced cooperation between the authorities in regulating and supervising cross-border financial activities.
Looking ahead, the Labuan FSA's 2011 Annual Report revealed that several key strategies have been identified to advance Labuan as an international business and financial centre of choice in the region. In the pipeline are several key initiatives under the Malaysian Financial Sector Blueprint to be unveiled by Bank Negara Malaysia which aims to provide a holistic approach for the development of the Malaysian financial sector for the next 10 years.
For income tax purposes, Labuan is considered part of Malaysia and therefore Malaysian tax rules apply to individuals working in Labuan, although there are many exemptions available to individuals and companies. Individuals are resident for tax purposes under the following circumstances:
Individual income tax for residents in Malaysia is charged at progressive rates up to a maximum of 26% on income over RM250,000 per year (US$65,800), with the first RM2,500 of income exempt from taxation.
A non-resident individual is liable to tax at the rate of 26% although they are not entitled to any tax reliefs. However, non-residents can claim rebates in respect of levies paid to the government for the issuance of an employment work permit.
Companies established in Malaysia, regardless of whether they are domestic or foreign in origin, will be faced with a corporate tax charged at a flat rate of 25% (SMEs pay a reduced rate of 20% on the first RM500,000 of income). While this is somewhat higher than other economic centres in the region such as Hong Kong and Singapore, one major advantage of the Malaysian income tax system is that it is territorial, so only income accrued in, derived from or remitted to Malaysia is liable for tax.
Labuan companies can now elect to be taxed under the Income Tax Act 1967 or the Labuan Offshore Business Activity Tax Act 1990, to reinforce the business-friendliness and flexibility of Labuan IBFC. The tax system is also favourable for companies carrying on offshore trading activities in Labuan, and firms can opt to pay tax each year at the rate of 3% of their net audited profits on trading activities, or a fixed sum of RM20,000. Non-trading activities are exempt from tax.
Individuals and corporate entities doing business in Labuan are entitled to a number of tax privileges and deductions as a result of the offshore regime. The following income is exempt from tax in the hands of a Malaysian or foreign recipient:
To encourage the development of the offshore centre, a liberal immigration policy has been adopted by Labuan, and multiple entry visas are issued to expatriates who have been granted employment permits to work with offshore companies.
By comparison, the immigration procedures of mainland Malaysia are tougher. Foreign nationals may not obtain residence permits in Malaysia, which only grants temporary visas to tourists, students and foreign nationals attending business conferences. Those wishing to enter the country to work for a Malaysian firm must apply to the Department of Immigration through their employer, which will usually issue a visa for a period of two to three years, renewable for a similar duration.
These employment visas are issued on a case-by-case basis and can take up to one month to be approved.
Offshore Business Sector
Labuan offers a range of financial services including offshore banking, insurance, trust business, fund management, investment holding and investment banking, all overseen by the LFSA.
From the banking and trust perspective, strong confidentiality rules are enshrined in the original legislation creating the Labuan IOFC, giving the jurisdiction something of a competitive edge over other financial centres in the market for high-net-worth and offshore investors.
Whilst Labuan has been ostensibly an offshore centre since 1990, it has only been in the last ten years or so that there has really been significant growth in the number of offshore firms registered in the jurisdiction. The year 2002 was particularly significant. After conducting some well-targeted roadshows in Hong Kong, mainland China and other regional business hubs, company registration grew by 30%. It was also a year in which the Labuan International Financial Exchange (LFX) emerged as a regional force and Labuan began to be talked about as a major global Islamic Finance centre.
There has been sustained growth in the number of companies registering under the Labuan Companies Act 1990. In 2010, there were 581 new company registrations, almost 8% more than there were in 2009.
Leasing out of the Labuan International Business and Financial Centre (LIBFC) has become a particularly successful business sector for Labuan In 2010, the number of companies increased by 29.4% while the amount of assets leased grew by 14.2% to USD25bn compared to USD21.9bn in 2009. The leasing sector was primarily driven by leasing transactions in the oil and gas, shipping, aviation and telecommunication sectors.
The insurance sector also continued to expand in 2010. During the year, 22 new licences were approved, comprising nine insurance brokers, seven
underwriting managers, three reinsurers, two captive insurers and one general insurer. The gross premiums of the insurance sector surpassed the USD1.0bn mark for the third consecutive year. The solvency margin remained strong at five times above the minimum regulatory requirements. Captive insurance, a recognised niche business, saw premiums increase by 47% to USD186.9m in 2008.
Under an exemption from subsection 140(1) of the Insurance Act, any marine and aviation risks, including goods in international transit, can now be handled by Labuan-based insurance companies, whereas before April 1, 2009, the risks had to be insured through a local onshore insurance company.
The total assets of the banking industry increased by 13.2% to USD33.9bn in 2010, driven by higher loans and advances which amounted to USD19.9bn as compared to USD18.5bn in 2009. According to the Labuan FAS, the industry continued to exercise prudent and sound credit risk management. Gross non-performing loans remained low at 2.2% in 2010. The capital position of the Labuan banking sector remained strong with a risk-weighted capital ratio at 20.5%.
The Labuan Financial Exchange was officially launched in October 2000. It is an offshore exchange wholly owned by the Kuala Lumpur Stock Exchange and trades in financial instruments such as equities, investment funds, debt instruments and insurance-related instruments. The LFX has no restrictions on the type of financial instruments and no pre-determined minimum quantity for listing. There is also no requirement for participants to have a physical presence in Labuan, and trading is conducted using an electronic bulletin board in which trading agents place their interests to buy or sell on the board and then undertake their own negotiations.
The exchange is seen as one of the key components in promoting Labuan as an offshore financial centre, and also holds the key to Labuan’s development as an engine in the world’s growing Islamic capital market. The market capitalisation of LFX as at 31 December 2010 stood at USD19.2bn, with a total of 28 listings.
Whilst Labuan has succeeded in attracting conventional business interest from all over the globe, its most exciting potential area of future growth is in catering for the growing demand for Islamic finance products. The Islamic banking sector, comprising 6 Islamic banks and 9 banks with Islamic windows, saw total deposits grow 63.6% to reach USD1.3bn as compared to USD794.7 million in 2009. This represents 3.8% of the total assets of the Islamic banking industry. It is believed that as of 2011, global Islamic assets are worth in the region of USD1 trillion, the industry having grown at an annual rate of about 20% in recent years.
In a bid to extend its reach into the Islamic finance arena, in January 2004 the LFX signed a Memorandum of Understanding with the Bahrain-based Islamic International Financial Market, allowing Labuan to tap into the vast Middle Eastern market. The MoU promotes the development of channels of communications and exchange of information in addition to fostering collaboration in the listing and active secondary trading of Islamic financial instruments.
Subsequently, the LFX has gone on to list the first governmental Sukuk of Qatar, in addition to the first Sukuk of the Kingdom of Bahrain, further strengthening its position as a facilitator of the Islamic capital markets.
In 2010 the takaful and retakaful industry also continued its upward trend of double digit growth. The industry gross contributions increased by 27.0% to USD297.3m, which reflected the enhanced interest and confidence on Labuan takaful and retakaful business. As at 31 December 2010, there were 7 full-fledged retakaful companies and 9 retakaful windows conducting business in Labuan IBFC.
The Labuan International Business and Financial Centre (LIBFC) said in July, 2009, that it was developing guidelines on shariah-compliant captive insurance for completion in the next 6-9 months. Further Labuan initiatives include provision for protected cell companies and amendments to the 1996 Insurance Act to allow for marine and aviation captive insurance companies.
Speaking at an industry briefing in Kuala Lumpur, Labuan IBFC chief executive officer Martin Crawford said guidelines on Islamic captive insurance are non-existent now, as very few jurisdictions have a legal framework to accommodate Islamic finance with the necessary physical infrastructure. Crawford considers that Malaysia's shariah traditions and the comparatively low-cost nature of doing business in Labuan augur well. The Labuan IBFC already has 32 captive and four rent-a-captive companies in operation and may be the home of 40 captive insurance companies by the end of the year. This compares with 50 captives in the captive insurance market of Singapore.
In August, 2009, Petronas issued a landmark dual-tranche USD4.5bn bond/sukuk, domiciled in Labuan and managed by Bank Negara Malaysia.
The Malaysian national oil company’s issue consists of a USD3bn 10-year fixed-interest USD bond and USD1.5bn five-year sukuk (sharia-compliant bonds). Foreign-currency issues out of the Labuan International Business and Financial Centre (LIBFC) have now been named “Emas”, in an attempt to provide added exposure for the LIBFC and Malaysia as a means of attracting funds.
It was announced that the Petronas issue was very successful, having generated interest from a wide investor base and being five times oversubscribed. The sukuk was sold mainly to investors in Asia and Europe, while the USD bond was also sold in the US. The issue is expected to be listed on the Labuan International Financial Exchange and the Bursa Malaysia, and also on the Luxembourg Stock Exchange.
It was hoped that the issue’s success would show that Malaysia could be utilized not only for the origination of domestic ringgit bonds and sukuk, but also for foreign-currency denominated bonds and sukuk. The issuance of sukuk is becoming of increasing importance worldwide.
The larger goals are now said to be to offer a wider range of services in the LIBFC through an amended Labuan Financial Services Authority Act, and to become an Islamic financial centre through a Labuan Islamic Financial Services and Securities Act. Both laws are currently before parliament.
Legislation for protected cell companies (PCC) became effective in law in the first quarter of 2010. A PCC is structured with core capital, cellular capital, cellular assets and liabilities, and core assets and liabilities. The various businesses within each 'cell' are ring-fenced and insolvency of one cell should not affect the solvency of the whole entity or the performance of the other cells. For any contract the PCC discloses which cell is contracting or whether it is a 'core' contract. 'Cellular' or 'non-cellular' shares may be issued, depending on whether they represent an equity interest in a specific business cell or in the core assets. The entity keeps accounts showing the corresponding patrimonial divisions among the segregated cells and the core cell.
So, in summary, Labuan could be said to be something of a hidden gem for the offshore investor, both on the individual and corporate level. With its benign tax regime, strong confidentiality rules and strategic location at the heart of the fast growing South East Asian economies, in addition to easy access to several major cities, a well developed infrastructure and the Malaysian government committed to the island’s economic success, Labuan may not be Asia’s best-kept secret for much longer.