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 is currently (2009) home to a population of around 78,000, 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 However, these are fast being superseded by financial services, and tourism is also a growing industry given the island’s year-round tropical climate, coral reefs and sandy beaches.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 (LOFSA) in 1990, along with the passing of a batch of ‘offshore’ laws. The offshore companies established on Labuan in 2009 included 60 banks, 140 insurance companies, 121 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 2008, Labuan IBFC maintained positive growth across all key business sectors, despite the more challenging global environment, and new measures were recorded to improve the flexibility and business-friendliness of its tax and legal framework, becoming effective in 2009 and beyond.

In 2008, company incorporation in the Labuan IBFC grew by 9.1% to 6,868 originating from a total of 85 countries, of which about 60% are from Asia Pacific region, mainly for investment holding purposes, special purpose vehicles, international financial activities and trading activities. The number is expected to increase further with the enhancement of its delivery process, reduction of annual fees from RM2,600 to RM1,500 and the upgrading of the online registration system and business approval process.

In order to enhance LOFSA’s regulatory function and corporate governance, a separate marketing entity, Labuan IBFC Incorporated Sdn Bhd was established 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 has also simplified the procedures for Labuan companies to deal with residents and invest into a domestic company.

LOFSA is committed to maintaining Labuan IBFC as a preferred international business and financial centre of high integrity and repute and improving the facilitative environment.

Legislation for a new improved legal framework is expected to be tabled in the coming Parliament session. LOFSA will complete upgrading the on-line company registration system in 2009 improving its speed and user-friendliness.

With effect from 1 June 2009, Labuan holding companies will be 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.

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. Individuals are 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 (2009) at a rate of 27% 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 20,000, 1%
• to RM 30,000, 2%
• to RM 35,000, 7%
• to RM 50,000, 12%
• to RM 70,000, 19%
• to RM 100,000, 24%
• over RM 250,000, 27%

A non-resident individual is liable to tax at the rate of 27% 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%. 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:

• Dividends received from an offshore company;
• 65% of income from offshore entities from the rendering of legal, accounting, financial or secretarial services;
• 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.

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.

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.

Six new banking licenses were issued in 2008. The soundness of the Labuan banking industry is reflected in the quality of assets, strong capitalisation and earnings growth - the gross non-performing loans ratio reduced from 2.0% to 1.9%, an average risk-weighted capital ratio and core capital ratio at 15.9% was mainatained with total assets increasing by 7.5% to USD29.0bn; earnings grew by 28.2%.

27 new leasing companies were approved in 2008. Leased assets grew by 22.9% to USD17.4 billion, underpinned by activities in oil and gas and aviation.

During 2008, 16 new insurance licensees were approved, comprising two insurers, two reinsurers, two captives, nine insurance brokers and one underwriting manager. The insurance sector in Labuan achieved a significant growth in 2008 recording gross premiums of more than USD1bn. The net claims to earned premium income ratio of the industry improved significantly to 56.5% from 72.9% in 2007.

Foreign representation in the insurance sector continued to increase from 66.5% in 2007 to 69.5% in 2008. Similarly, the non-resident insurance business remained to have a higher share of 57% in 2008. This reflects favourably the out-out business conducted through Labuan IBFC.

The insurance industry maintained an aggregate solvency surplus of USD627.7m and margin of solvency of five times above the minimum regulatory requirement.

Captive insurance, a recognised niche business, saw premiums increase by 47% to USD186.9m. There were 32 captives insurers in Labuan IBFC as the end of 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.

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, Islamic Financial Services. The Islamic banking sector, comprising 6 Islamic banks and 3 banks with Islamic windows, saw total deposits grow to USD337.3m from USD250m in 2007.

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 2008, Retakaful gross contributions increased by 48.2% to USD162.3m, driven by four full-fledged retakaful operators and nine retakaful windows. Five new Islamic private funds were established in 2008, with an approved fund size of USD1.5bn increasing the total Islamic private funds to USD2.8bn or one-third of the total size of private funds in Labuan IBFC.

The Labuan International Business and Financial Centre (IBFC) 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) has had its first reading in Parliament and could become effective in law by 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.