IMPORTANT WARNING: The contents of this report have been compiled in good faith by Investorsoffshore.com to provide assistance to investors, but do not constitute investment advice or recommendations. Investors should not rely upon the information given in order to choose types or routes of investment but should make their own independent enquiries before making choices. Investorsoffshore.com has taken reasonable care in researching and presenting the information herein but makes no representations as to its accuracy and accepts no liability for actions taken or not taken as a result.

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, Labaun, currently home to a population of around 75,000, 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 However, these are fast being superseded by financial services, and tourism is also a growing industry given the island’s year-round tropical climate, coral reefs and sandy beaches.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 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. The offshore companies established on Labuan in 2006 included 60 banks, 112 insurance companies, 68 leasing companies and 30 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.

Tax

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. One becomes a resident of Malaysia for taxation purposes after having physically spent 182 or more days in the country for one calendar year. Individuals will also be resident for tax purposes under the following circumstances:

• They are physically present in Malaysia for less than 182 days during a calendar year, but that time is connected to physical presence of at least 182 consecutive days in either the preceding or succeeding calendar year. (Periods of temporary absence are considered part of a period of consecutive presence if the absence is related to the individual's service in Malaysia, personal illness, illness of an immediate family member or personal trips of 14 days or less.)
• They are in Malaysia during the calendar year for at least 90 days and have been resident or present in Malaysia for at least 90 days in any three of the four preceding years.
• They have been resident for the three preceding calendar years and will be resident in the following calendar year. This is the only case in which an individual is considered resident though not physically present in Malaysia.

Individual income tax for residents in Malaysia is charged at a rate of 28% on income over RM250,000 per year (US$65,800), with the first RM2,500 of income exempt from taxation. In between there are several tax brackets which are as follows:

• to RM 5,000, 1%
• to RM 20,000, 3%
• to RM 35,000, 7%
• to RM 50,000, 13%
• to RM 70,000, 19%
• to RM 100,000, 24%
• to RM 250,000, 27%
• 0ver RM 250,000, 28%

A non-resident individual is liable to tax at the rate of 28% 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.

Meanwhile, 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 28%. 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.

However, 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:

• Dividends received by, or received from an offshore company;
• Distributions received from an offshore trust by the beneficiaries;
• Royalties received by a non-resident;
• Certain interest payments received from an offshore company including those from an offshore company for providing services.
• 65% of income from offshore entities from the rendering of legal, accounting, financial or secretarial services
• Income earned from renting a "qualifying asset" to an offshore company in Labuan is exempt from tax for an amount of up to 50% of the income received for a period of 5 years.
• 50% of the housing and regional allowances given to residents working in the public sector and offshore companies in Labuan
• Second tier dividends declared out of dividends received from an offshore company by a domestic company
• Royalties paid by an offshore company to a non-resident person
• Interest paid by an offshore company to a non-resident person
• Interest paid by an offshore company to a resident person (except those engaged in banking, finance or insurance in Malaysia)
• Technical or management fees

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, or a fixed sum of RM20,000.

Entry

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 LOFSA, the Labuan Offshore Financial Services Authority, which was established in 1996 as a single regulatory agency and a one-stop agency for the offshore centre.

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 two 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.

LFX

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.

Islamic Finance

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, and the jurisdiction has already made significant strides in this area. Setting a global precedent, in 2002 Malaysia's US$600 million Global Islamic Trust Certificates (Sukuk), was listed on the LFX and the Luxembourg Stock Exchange. The five-year Sukuk maturing in 2007 attracted wide participation from investors in Asia, the Middle East, the United States and Europe.

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.

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.