We would like to examine the Impact of the Proposed New Labuan Tax measure that allows a Labuan Company to transact with Malaysia Resident but with limited to 3% of the allowable expenditure.
To recap the new Pakatan Harapan government first Budget 2019 announced on 02 November 2018 that it will continue to enhance Labuan’s competitiveness by removing restrictions on trade in ringgit, transactions between Labuan and Malaysian residents as well as maintaining the current tax rate of 3%. The tax ceiling of RM20,000 under the Labuan Business Activity Tax Act 1990 will be removed.
It was also announced that commencing Jan 1, 2019 Malaysian Resident or Malaysian Companies which transact with a Labuan Company is entitled to tax deduction on expenditure incurred, limited to 3% of the allowable expenditure.
But what does this 3% allowable expenditure mean?
Unlike Labuan company which is tax based on audited net profit, For Malaysia Company the audited net profit is Not the taxable profit. In order to derive the taxable profit Malaysian Company has to produce another set of Tax Computation to add back to their audited profit those expenses which are Not allowable to be deducted such as Entertainment, Travelling and those other expenses which are Not incurred wholly and exclusively for the purpose of trade. The Inland Revenue of Malaysia may allow certain percentage of this expense to be deductible for example 50%; but Not allowable 100% deductible.
In this case based on the proposed Budget 2019 on 3% allowable expenditure means of the 100% expenses paid by the Malaysian Company only 3% is allowable as tax deductions and the 97% is Not allowable.
Obviously, this come as a very strong objection from especially Malaysia Company that have business transaction with Labuan Company such as
- Labuan Leasing Company
- Labuan Bank include Labuan Investment Bank
- Labuan Insurance Company
- Labuan Trading Company
- Labuan Trust Company
The implication of the above amendment is that it has the very adverse effect by discouraging those Malaysia Company who at present carrying on business with Labuan company.
In our case study we would like to use the example of a Labuan Leasing business
Labuan leasing company means the business of letting or sub-letting property on hire for the purpose of the use of such property by the hirer, regardless whether the letting is with or without an option to purchase the property. These leasing structures are particular very famous for Malaysian vessel owners such as Tug Boat, Anchor Handling Tug, Platform Supply Vessel and many more specialized marine vessels especially those in the Oil and Gas industry. These charters of ships must be bareboat charters only and does not include the transportation of passengers, cargo by sea or the charter of ships on a voyage or time charter basis. Under the Labuan Leasing license, the Malaysian government allows a Malaysian Company to rent the lease asset from a Labuan Company.
If a Malaysian company which lease an asset say a tug boat from a Labuan Leasing Company which makes payments for lease rental of USD 1,000,000 per year. Of the USD 1,000,000 of rental paid, only USD 30,000 (ie 3% X USD 1,000,000) is allowed as deduction against the chargeable income of the Malaysian Company for tax computation purposes. So by disallowing USD 970,000 (ie USD 1,000,000 less USD 30,000) of the lease payment, the Malaysian Company would have to pay tax of 20% or 24% based on the Malaysia Company tax bracket
- If the Malaysia Company tax bracket is 20% then on this amount of USD 1,000,000, the amount payable to the Inland Revenue of Malaysia comes to USD 194,000 (20% of USD 970,000 ie USD 1,000,000 less USD 30,000).Thus in this example, the Malaysian Company would have to pay USD 1,000,000 of lease rental to the Labuan Company plus USD 194,000 to Inland Revenue which sum up to USD 1,194,000 when making a payment of USD 1,000,000 lease rental
- If the Malaysia Company tax bracket is 24% then on this amount of USD 1,000,000 the amount payable to the Inland Revenue of Malaysia comes to USD 232,800 (24% of USD 970,000 ie USD 1,000,000 less USD 30,000).Thus in this second example, the Malaysian Company would have to pay USD 1,000,000 of lease rental plus USD 232,800 to Inland Revenue which sum up to USD 1,232,800 when making a payment of USD 1,000,000 lease rental
The above example means the Malaysian Company will be heavily tax by the Inland revenue of Malaysia.
The new proposal also means Malaysia Company dealing with Labuan Company much worse than those dealing with foreign companies cause under the same business with a foreign company, the Malaysian Company could deduct 100% expense, subject to withholding tax of 10%
Using the same example as above that a Malaysian company which lease the asset from a Singapore Company for lease rental of USD 1,000,000 per year. Of the USD 1,000,000 of rental paid the withholding tax is USD 100,000 (ie USD 10% X USD 1,000,000)
This means the Malaysia Company which lease from a Singapore Company will gained more in terms of Tax Savings in which it has to pay USD 100,000 in withholding tax compared to Computations in A in which the Malaysia company that leased the assets from a Labuan company has to pay tax of USD 194,000. The tax savings is USD 94,000 (ie USD 194,000 less USD 100,000)
In Computation B above, the Malaysia Company which lease from a Singapore Company will gained in terms of Tax Savings in which it has to pay USD 100,000 in withholding tax compared the Malaysia company that leased the assets from a Labuan company has to pay tax of USD 232,800. The tax savings is whopping USD 132,800 (ie USD 232,800 less USD 100,000)
In conclusion if the Malaysian government goes ahead with this proposed Budget which requires Malaysian Resident or Malaysian Companies which transact with a Labuan Company to entitle tax deduction on expenditure incurred, limited to 3% of the allowable expenditure, this will cause many existing Labuan Leasing Company to unwind their current structure, surrender their existing license, close the business in Labuan and look for alternative jurisdiction such as Singapore and Hong Kong. At the time of writing there are 365 Labuan Leasing Companies listed on the Regulator website dated 02 November 2018.
About the Author
Clament Chua was born in Labuan and one of the first local to start his Trust Company in Labuan. Clament started his career with Ernst & Young and is a member of The Malaysia Institute of Accountants and The Chartered Tax Institute of Malaysia.
For more Information Please contact:
Corporate Services Trust Co Ltd
Unit B, Lot 49, 1st Floor, Block F,
P O Box 80192
87000 Federal Territory of Labuan,
Tel: 6 087 419000 or 419100
Fax: 6 087 419 200