Changing in Time with the Times

No matter how often pundits and philosophers remind us that change is the only constant in a transient world, we often persist in behaving as if nothing changes – until the unforeseen happens. Then, a natural disaster like an earthquake or a tsunami overwhelms us, or a financial catastrophe brings material ruin. Events like these demonstrate again and again that those who are nimble and flexible can survive, yet deliberate change is seldom embraced as a far-sighted strategy.

Change at last appears to be coming into its own since the walls came tumbling down on Lehman Brothers and forced top economic policymakers to wrestle with the many-headed Hydra that has wrought havoc in the financial landscape. Among the targets singled out as part of what of went wrong are offshore jurisdictions, and the Organisation for Economic Cooperation and Development’s (OECDs) determined push to purge non-tax paying offshore accounts has stirred much moral debate. Despite the Great Divide among believers and non-believers, though, there is grudging acknowledgement that offshore centres which are properly administered, regulated and tax compliant can actually contribute to the economic well- being of their neighbouring countries.

Labuan International Business and Financial Centre (IBFC), although relatively unknown, is regarded by those who do know it as a safe, robustly regulated jurisdiction. Labuan’s strategic location just off the north-west coast of Sabah, a Bornean state of Malaysia in the heart of South-East Asia, has much going for it. The current trend toward ‘flight to quality’, coupled with the continuing economic boom in China and India which is encouraging investments to flow eastwards, makes Labuan especially attractive at present.

Labuan, despite its tiny land mass of just 95 sq. km, has chalked up a remarkable track record since its inception in 1990 as the country’s offshore financial centre. Regulated by Labuan Offshore Financial Services Authority (LOFSA) which was set up in 1996, the jurisdiction to date is home to more than 7,000 companies; 60 banks; 140 insurance entities; 23 Trust companies and scores of service providers including lawyers, accountants, tax consultants and audit and secretarial staff.

As the island has developed, adding modern infrastructure and telecommunications technology, so has its range of products and services grown. Alongside these developments, a slew of legislation had been introduced to ensure the soundness of Labuan’s financial system. The jurisdiction maintains stringent screening measures including active membership of international watchdog groups like the Asia-Pacific Group on Anti-Money Laundering.

Recognising the value of change, the jurisdiction took a long, hard look at the future and made moves to prepare itself to meet the demands and challenges ahead. In January 2008, the sea-change began.

First, it re-named and re-positioned itself as Labuan IBFC in keeping with its goal to be the premier IBFC in the Asia-Pacific region. In line with this objective, Labuan identified five key areas of focus, namely: holding companies, Islamic finance, insurance (including captive insurance), private wealth management, and lastly, fund management.

Next, a unit dedicated to marketing and promoting Labuan was set up and this was followed by a comprehensive review of the nine Acts and accompanying guidelines. These have been amalgamated into four new Acts, and four amended Acts. The legislative refresh is expected to come into force by the end of 2009.

The following is an overview of the changes relating to some of these laws.

Labuan Islamic Financial Services and Securities Act

Since Labuan took on the mantle of ‘first mover’ in Islamic finance, starting with the establishment of the first Islamic bank in 1998, it has been steadily building up a financial storehouse. This decade has seen it issue the first global sukuk in 2002, one of the largest aircraft financing transactions using an Ijara leasing structure and most recentlyUSD1.5 billion Islamic bonds by Petroliam Nasional (Petronas), Malaysia’s national petroleum company.

It is thus timely that the ground-breaking Labuan Islamic Financial Securities and Services Act (LIFSSA) will soon make its debut, given the continuing rise of Islamic finance around the world as a viable alternative to financial services offered under conventional principles. LIFSSA will probably be the first of its kind in the world, an ‘omnibus’ piece of legislation that will clarify and streamline all the rules and guidelines issued over the years on Islamic finance.

In addition, among the chapters in LIFSSA will be some addressing Shari’a compliance in trusts and foundations as well as the appointment of a Shari’a adviser or a trustee. On the subject of Shari’a compliance, Labuan has been at the forefront in the drive towards internationally recognised and accepted Shari’a standards, setting the example with its own SAC that comprises globally acclaimed Islamic scholars.

Furthermore, Labuan has played a pivotal role in the establishment of the Malaysia International Islamic Financial Centre (MIFC), a national initiative which aims to position Malaysia as the international hub of Islamic finance and as the intellectual epicenter of the sector.

Labuan Trusts Act and Labuan Foundations Act

Amendments to the Labuan Trusts Act (LTA) and the introduction of the Foundations Act are expected to give Labuan IBFC an edge as a modern offshore centre for wealth planning. This is fortuitous as industry experts forecast that Asia’s share of the rich community is poised to grow annually by 12 to 15 per cent until 2013, making the region the largest source of high net-worth wealth investors after the U.S.A.

The LTA has taken the best from the best, drawing upon and improving features from jurisdictions such as the British Virgin Islands, the Cayman Islands, Guernsey, Jersey, Dubai and Mauritius.

One of the most attractive features in the LTA is the Labuan Special Trust, modeled after the British Virgin Islands ‘VISTA’ Trust. A central provision of the Labuan Special Trust is that it can be used to hold shares in a Labuan Holding Company, which in turn may own assets such as cash, real estate, art securities, businesses, insurance policies, etc.

These shares, which are ‘on trust to retain’, may be held indefinitely. Interestingly, the management of the company may be carried out by the directors without any power of interference being exercised by trustees. There is thus a distinct separation between the custodian role of trustees and their fiduciary role of investment (which is handled by the company directors). This provision meets the contemporary needs of high net-worth individuals or families who recognise that members of the next, younger and better educated generation may wish to attempt more sophisticated investment options; yet by separating the roles indicated above, the founders of wealth (the older generation) could still keep the original legacy intact. This feature is one of the most sought after in Trust Law.

Other advantages under the Labuan Special Trust include: settlors having wide reserved powers that are reasonable but do not compromise the trust; protection of a trust against a foreign law claim; variety of trust types including one unique to Labuan, “the advancement of human rights and fundamental freedom”; duration of trusts, including in perpetuity; and, clear guidelines relating to beneficiaries and the information they will receive.

The Foundations Act will be an added incentive for the wealthy to set up in Labuan IBFC as these foundations will operate in a similar way to trusts and should appeal to individuals or families from Civil Law countries like Indonesia, Thailand, the Philippines and the Middle East.

Recent Liberalisation Moves  

In yet another change with the times, a ‘blanket approval’ was issued under which Labuan companies were permitted to deal with Malaysian (domestic) companies without prior approval, so long as the Labuan entity informed LOFSA within ten days of the transaction. This approval came into effect on 1 August 2008.

Since then, a second liberalisation came into force from 1 June 2009, which allows a Holding Company registered in Labuan to set up a regional headquarters or management office in Kuala Lumpur, the nation’s capital. Prior to this, a Labuan Company was required to have a physical presence on the island. Under the liberalisation move, the regional headquarters will pay tax under the Malaysian Income Tax Act 1967 (ITA) at the rate of 25%, but will have access to all of Malaysia’s 69 Double Taxation Agreements (DTAs). In all other matters, though, such as no foreign exchange controls and the convenience of dealing with a one-stop regulatory body, it will be treated as a Labuan Company. The flexibility of operating in a thriving, modern metropolis like Kuala Lumpur, combined with costs of operation which are about 40% lower than those in Singapore or Hong Kong, give investors the best of both worlds.

Further liberalisation moves by the Malaysian Government are expected for the banking and insurance sectors within the next two years. These are certain to further enhance and accelerate Labuan IBFC’s growth.

Tax and the Issue of Substance

Legitimate businesses in Labuan IBFC enjoy a competitive edge as the jurisdiction is a low tax territory. Tax benefits are enshrined in the Labuan Offshore Business Activity Tax Act 1990 (LOBATA), which states that offshore non-trading companies are not subject to tax, while companies conducting offshore trading activities can opt yearly to pay 3% of net audited profit or a flat rate of MYR20,000 (approximately USD5,800 at USD1=MYR3.5). Alternatively, a Labuan company can make an irrevocable election to pay tax under the Malaysian Income Tax Act 1967 (ITA) at 25%, thereby gaining more secure access to all of Malaysia’s 69 DTAs and exemption on foreign-sourced income as well as capital gains.

Under the new world order of the OECD with its Exchange of Information standard, secrecy will not be tolerated – transparency and the need for ‘substance’ will predominate. Where Labuan IBFC is concerned, nothing will be lost because the jurisdiction has stuck by its principle that only real, legitimate businesses are welcome. This means that the investor has to abide by the following criteria of substance as seen from the Malaysian tax perspective:

• effective place of management should be the country of residence. This means business activities such as management or commercial decisions are actually conducted in the jurisdiction, as are the main activities of the entity;
• accounts should be maintained in the jurisdiction;
• while the legal entity’s registered office could be located in Labuan, it must not also be regarded as a tax resident in another country;
• all relevant requirements pertaining to submission of tax returns should be complied with when due; and
• shareholding needs to be adequate based on the functions performed, taking into account the assets used and the risks assumed.

Even as the world shakes itself loose from the slough of despondency, Labuan IBFC is a bright spark worth keeping an eye out for, especially in the light of the Trusts Act and Foundations Act that meet many – if not all – the objectives of the wealthy individual or family.