Understanding Labuan Business Activity Tax in Malaysia

Labuan, an island in the South China Sea off the coast of Sabah in East Malaysia, was established as an international offshore financial centre (IOFC) in 1990 to attract international financial activities. Renamed Labuan IBFC, it has become popular due to its tax benefits, offering tax rates ranging from 0% to 3% for most business activities.

This blog provides a comprehensive overview of the Labuan Business Activity Tax, covering laws, amendments, scope, chargeability, tax rates, and more.

Legislative Framework for Labuan Business Activity Tax

Labuan Business Activity Tax Act 1990 (LBATA): Governs the taxation of Labuan business activities. Click here
Additional Legislation: There are additional laws that Include laws governing companies, trusts, foundations, limited liability partnerships, financial services, securities, and Islamic financial services. Click here to read the additional legislation
Amendments: In 2018/2019, significant amendments were introduced to the Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2018 and the Labuan Business Activity Tax (Amendment) Act 2020, effective from 1 January 2019 or the year of assessment 2020.

Labuan Business Activity

As of January 1, 2019, 'Labuan business activity' includes both trading and non-trading activities conducted in, from, or through Labuan, except those activities prohibited by law.

This is a shift from previous rules that restricted trading to foreign currencies, non-residents, or other Labuan entities. This change aligns the Labuan tax regime with the base erosion and profit shifting (BPES) minimum standards.

Trading Activities: Trading activities for Labuan entities encompass a variety of business operations that involve the buying and selling of goods, services, or assets. According to the Labuan Business Activity Tax Act (LBATA), trading activities include Banking, Insurance, Trading, Management, Licensing, Shipping operations, and all other activities not classified as non-trading.

Non-Trading Activities: Holding investments in securities, stocks, shares, loans, deposits, or other properties situated in Labuan by a Labuan entity on its own behalf. In essence, non-trading activities focus on investment holdings and do not involve active trading or business operations like those classified under trading activities.

What is Labuan Business Activity Tax (LBAT)?

The Labuan Business Activity Tax (LBAT) is a tax regime designed for entities operating within Malaysia's Labuan International Business and Financial Centre (IBFC). This tax framework provides favourable tax rates for qualifying business activities conducted in, from, or through Labuan.

Scope of Charge: Labuan entities are taxed under the Labuan Business Activity Tax Act (LBATA) for Labuan business activities.

*Labuan Entity: Includes Labuan companies, foundations, partnerships, trusts, Malaysian Islamic bank licensees, Labuan financial institutions, and any person declared by the Minister.

Eligibility and Compliance

Labuan entities must engage in specified business activities listed in the Substance Requirements Order to qualify under LBAT for Non-Trading activities.
Must fulfill economic substance requirements as outlined in the Labuan Business Activity Tax (Requirement for Labuan Business Activity) Regulations 2018.
Entities that do not meet the above requirements would not qualify for Labuan Business Activity Tax and would be taxed at the normal tax rate of 24%.

Tax Rate of Labuan Business Activity

Category

Description

Tax Treatment

Trading Activities

Activities such as banking, insurance, trading, management, licensing, and shipping operations.

3% on chargeable income (net profit

Non-Trading Activities

Holding investments in securities, stocks, shares, loans, deposits, or other properties on own behalf.

Trading + Non-Trading Activities

Engaging in both trading and non-trading activities.

3% on trading income, 0% on non-trading income

Intellectual Property Income

Income derived from intellectual property rights such as patents, trademarks, copyrights, etc.

Not eligible for LBATA preferential rates.

Taxed under the Income Tax Act 1967 at 24%.

Failure to Meet Substance Requirements

Non-compliance with substantial activity requirements (employees and expenditure).

24% on chargeable profits for the year of assessment.

Activities Not Qualifying for Labuan Business Activity

Activities not listed in the Substance Requirements order or constituting an offence under any written law.

No benefit from LBATA preferential tax treatment.

Objectives of Labuan Tax

The Malaysian government offers preferential tax rates for Labuan business entities to achieve the following objectives:

Attract International Businesses: The tax incentives are designed to draw global businesses to establish operations in Labuan.
Compliance with International Standards: The revised tax regime aligns Labuan with the Base Erosion and Profit Shifting (BEPS) minimum standards, promoting transparency and reducing harmful tax practices.
Facilitate Economic Growth: The Labuan Business Activity Tax (LBAT) provides a favourable tax environment to stimulate economic activity and growth within the Labuan International Business and Financial Centre (IBFC).

Exemptions, Incentives, and Other Specific Provisions

Besides preferential income tax rate for Labuan entities for business activity, there are numerous other Tax exemptions, incentives and rebates

No Indirect Taxes: Exempt from sales and service tax due to free-port status.
Stamp Duty : Exempt on instruments executed by Labuan entities in connection with Labuan business activity.
Exchange Control: Labuan entities are not subject to exchange control restrictions.
Income Payments: Dividends, interest, royalties, and technical services payments made by Labuan entities to non-residents are exempt from withholding tax .
Selection for Mainstream Tax System: Labuan entities can elect to be taxed under the Income Tax Act 1967, enabling access to treaty benefits. The election is irrevocable and must be made within three months of the beginning of the basis period for a year of assessment.
Zakat Tax Rebate: Zakat payments to Labuan Islamic religious authorities can be rebated up to the amount of tax charged.
Non-deduction of Payments: Payments by Malaysian residents to Labuan entities are subject to significant non-deduction rules and have limited tax deductibility.

Conclusion

The Labuan Business Activity Tax, governed by the Labuan Business Activity Tax Act 1990, offers preferential tax rates of 3% for trading activities and 0% for non-trading activities for Labuan entities engaged in Labuan business activities.

While Labuan is widely recognised as a low-tax regime, it complies with international regulations, ensuring adherence to global tax standards. The regulatory framework is periodically reviewed and amended to maintain compliance and enhance its attractiveness as an international business and financial centre.

Frequently Asked Questions

What is the Labuan Business Activity Tax (LBATA)?

The Labuan Business Activity Tax (LBATA) is a tax regime established under the Labuan Business Activity Tax Act 1990, specifically for Labuan entities engaged in Labuan business activities. It provides a preferential tax structure to encourage international financial activities in Labuan, Malaysia.

What is the tax rate under LBATA?

The tax rate under LBATA is 3% on net profits from Labuan trading activities. Labuan non-trading activities, such as holding investments, are not subject to tax, effectively enjoying a 0% tax rate. However, if a Labuan entity fails to meet the substance requirements, it will be taxed at a higher rate of 24%.

What are the Labuan substance requirements?

All Labuan entities must meet certain requirements related to employees and operating expenses so that shell companies solely for the purpose of tax evasion can be avoided. These conditions are outlined in Labuan Business Activity Tax (Requirement for Labuan Business Activity) Regulations 2018

Can I claim any exemptions or rebates on LBATA?

Yes, various exemptions and rebates are available under LBATA:

Labuan entities enjoy exemptions from indirect taxes, stamp duty, and exchange control restrictions.
Zakat paid to a Labuan Islamic religious authority may be given as a rebate up to the amount of tax charged.
Certain payments made by Labuan entities to non-residents, such as royalties, interest, and technical service fees, are exempt from withholding tax.

Can a Labuan company choose to be taxed under the regular Malaysian Income Tax Act?

Yes, a Labuan company can irrevocably elect to be taxed under the regular Malaysian Income Tax Act 1967 instead of LBATA. This election must be made within three months of the beginning of the basis period for a year of assessment and will subject the company to all the tax provisions under the Income Tax Act, including the cessation of exemptions available under LBATA.