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by the Investors Offshore Editorial Team, September 2012, 14 September, 2012
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 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 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 However, these are fast being superseded by financial services, and tourism is also a growing industry given the island’s year-round tropical climate, coral reefs and sandy beaches.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 2011 included 60 banks, 181 insurance and insurance-related companies, 223 leasing companies and 23 trust management companies.
Despite the challenging global economic environment, the Labuan IBFC has recorded healthy growth over the past few years, particularly in the banking, insurance and leasing sectors. 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.
Releasing its 2011 Annual Report on June 7, 2012, the Labuan FSA said that a total of 651 new companies were incorporated in Labuan in 2011, representing an increase of 8.1% over 2010. By the end of the year, out of the total of 8,655 Labuan companies, 72% were from the Asia-Pacific and Far East region, followed by 13% from Europe and the 10% from the Americas.
Of note in 2010 were new laws which have substantially improved the regulation and development of Labuan’s international financial markets. 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.
Furthermore, 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.
In 2011, the Global Incentives for Trading (GIFT) scheme was launched, enabling Labuan International Trading Commodity (LICT) companies to benefit from incentives under the programme. This scheme is designed to facilitate oil and gas trading companies to establish in Labuan and is intended to diversify further the jurisdiction's offshore sector.
As part of the strategy to further facilitate the use of Labuan as the platform for investment into Malaysia and the region, LOFSA has also simplified the procedures for Labuan companies to deal with residents and invest into a domestic company. With effect from June 1, 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.
Ongoing robust regulation of the LIBFC by the Labuan FSA should ensure its continued development as a regional platform for international investments. In 2011, the FSA also continued to improve the jurisdiction's anti-money laundering regime, something which FSA Chairman Zeti Akhtar Aziz said "represents a key component of the regulatory and supervisory system in the Labuan IBFC".
"This has contributed to sustained confidence in the integrity of the financial sector in the Labuan IBFC," she says in the 2012 report. "Building on this foundation, the Authority has outlined plans in the Financial Sector Blueprint to implement an enhanced framework for prudential and conduct regulation and supervision that is consistent with the current international standards and that will support the orderly future development of the Labuan IBFC. This work will include existing regulations implementing improved supervisory methodologies and practices, establishing enhanced arrangements for supervisory cooperation with both domestic and foreign supervisory authorities and substantially upskilling Authority's supervisory resources and capacity to deal with the increasing complexity of the global financial system."
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.
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.
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 RM100,000 per year (US$32,400), 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 Sectors
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 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.
The leasing sector was one of the most vibrant sectors in Labuan last year. The number of leasing companies rose to 227 and accumulated assets leased reached USD27.6bn. The focus of the leasing companies in the highly specialized areas in aviation and oil and gas provides strong support for the growth and development of the oil and gas sector in Labuan.
The insurance sector in the IBFC remained resilient in 2011 despite various natural disasters within the region during the year. For the insurance industry, 22 new licenses were issued, bringing the total of Labuan insurance and insurance-related companies to 181 (2010: 169). The sector registered a pre-tax profit of USD111.8m and total assets increased by 16.1% to USD3.6bn (2010: USD3.1 billion). Total earned premium income for the sector also grew by 45.1%.
The attractions of the Labuan IBFC for captive insurance companies are increasingly being recognized, and the sector is expected to expand significantly. In October 2011, it was reported that 34 captive companies were established within the IBFC, of which 14 were Malaysian companies. The sector had total assets of over US33bn in 2010, with total gross premiums of US1.2bn.
IBFC Chief Executive Officer David Kinloch pointed out that, while there is a large untapped market in Malaysian companies that have significant insurance needs, Labuan is also now attracting European and Asian multinational companies away from other captive insurance destinations in the region, such as Singapore. As the IBFC has been operating captive insurance only for some five years, and the period for developing such products, and for companies to take decisions, is substantial, Kinloch disclosed that he expects the recent emphasis put into the sector by Labuan to mean that there will be a substantial influx of captive insurance business in 2012.
He pointed to the Labuan IBFC’s advantages. For example, it is possible to operate structures such as limited liability partnerships and protected cell companies, and there are also significant tax advantages, including a stamp duty exemption on all documentation, no tax on non-trading activities (such as the holding of investments), and a 3% tax on net profits per audited accounts, or MYR20,000 (USD6,420) upon election.
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.
In addition, 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 Labuan banking sector also reported a steady increase in total assets in 2011, which grew by 13% to USD38.3bn by the end of December that year. The capital position of Labuan banks remained resilient with the industry's risk weighted capital ratio and core capital ratio at 22.1% and 23.0%, respectively whilst the ratio of gross non-performing loans improved to 1.5% in 2011. Two new banks from Australia and Ghana obtained licences to operate in Labuan, bringing the total number of Labuan banks to 57.
Trusts and Foundations
The trust sector also continued to grow in 2011 with seven new Labuan trust companies established, of which five were foreign-owned. Aggregate operating income grew to USD18.6m, from USD15.4m in 2010.
Since the introduction of the Labuan Foundations Act in 2010, 35 new Labuan foundations were registered in 2011, bringing the total number of Labuan foundations to 40 from just five in 2010.
Oil and Gas Trading
At the launch of the GIFT) programme and the newly-formed Labuan International Trading Commodity Company in November 2011, the Director-General of Labuan Financial Services Authority (FSA) Encik Ahmad Hizzad Baharuddin announced that a range of incentives have been initiated to attract oil and gas traders to Malaysia.
Ahmad Hizzad said that, over the years, the oil, gas and energy sector has contributed significantly to the growth of the country and now accounts for about 20% of the Malaysia’s gross national product. The government has earmarked the sector as one of the country’s key economic growth areas. In addition, he pointed out that, “while Malaysia has thriving up-stream activities in the oil and gas sector, more activities could be initiated at the various levels in the business value chain, particularly in the trading of petroleum and its related products. … This offers a huge potential for Malaysia to tap into the oil trading market, as it would not only generate revenue for the country, but would also increase the pool of expertise and talent, and improve the transfer of technology.”
At this initial stage, one of the main objectives of the GIFT programme, Ahmad Hizzad disclosed, is to attract major international oil trading companies, such that they would consider locating part of their operations in Malaysia. In attracting these international companies, the programme offers a set of incentives through the establishment of the LITC.
The key incentives offered through the LITC under the GIFT programme include a flat corporate tax rate of 3% of chargeable income, a 100% exemption on directors fees paid to non-Malaysian directors, and a 50% exemption on gross employment income for non-Malaysian professional traders and managers of LITC companies.
There is also an exemption of stamp duties on documentation for such business activities, a tax exemption on dividends received by or paid from LITC companies, and all of the other fiscal incentives that are attached to operating a Labuan entity.
Ahmad Hizzad also emphasized that the attractiveness of using the Labuan IBFC as a base for oil trading business in Malaysia extends beyond fiscal incentives. The IBFC hosts to over 400 international financial institutions, and is an ideal location as it provides the oil and gas trading companies with a comprehensive range of financial products and services, both under conventional and Shariah-based principles.
The Labuan FSA, he said, is pleased to note that the banks and insurance companies in Malaysia, including Labuan, are already gearing up towards providing the specialized financial services in their oil trading desks that will needed by the trading companies.
As of June 2012, five trading licences have been issued under the Global Incentives for Trading (GIFT) Programme.
Labuan Financial Exchange
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 August 31, 2012 stood at USD18bn, with a total of 29 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.
Total Islamic assets registered growth of 15.4% to USD1.5bn in 2011 (USD1.29 billion in 2010), reflecting the strong interest in Islamic finance. Total Islamic bank financing increased significantly to USD294.6m as at end-2011, with larger demand from non-residents. The figures also reflect the growing number of international banks establishing Islamic businesses in Labuan.
The takaful and re-takaful sectors also recorded a double-digit growth (54.6%) for the fifth consecutive year, total gross contributions of the sectors reaching USD459.5m USD297.3m in 2010).
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.
The Labuan International Business and Financial Centre (LIBFC) said in July, 2009, that it was developing guidelines on shariah-compliant captive insurance for completion by early 2010. 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.
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.
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.
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.