In 2019, the Government of Malaysia introduced economic substance laws in Labuan and effectively abolished the flat tax rate of paying RM20,000 for each year of assessment. Subsequently, Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2021 was passed in November 2021 outlining the economic substance requirements (“ESR’) for each category of Labuan business activities. Whilst most of the business activities that are in scope are financial services related activities which require licensing to operate but there is one business category that does not require any licence.
Our write-up focuses on the yearly cost of maintaining a Labuan company against the potential tax savings under the Labuan tax regime. If a Labuan company is conducting or intending to do one or more of the following business activities, it is set for the preferential rate of 3% tax provided that the company meets the minimum ESR –
1. “Administrative services” is defined as services pertaining to employee management, payroll management, property management, human resource management, financial planning, contract or subcontract management, facilities management, or proposal management.
2. “Accounting services” is defined as services pertaining to recording, analysing, summarising, or classifying financial, commercial and business transactions and information of a person or business.
3. “Legal services” means services mean conveyancing services, legal advisory services, litigation or legal representation services in any proceedings before any court, tribunal or other authority, or legal dispute resolution services including alternative dispute resolution.
4. “Backroom processing services” are services relating to settlements of receivables and payables, clearance, record maintenance, regulatory compliance or information technology (IT) related services which are usually performed by administration and support personnel who do not deal directly with clients.
5. “Payroll services” means services relating to processing, calculation, payment and deduction of remuneration, benefits, tax and statutory payment or issuance of payslip and tax statement.
6. “Talent management services” means the provision of human resource services to attract, onboard, develop, motivate, and retain employees.
7. “Agency services” means the provision of specific services on behalf of another group, business, or person pursuant to an agency agreement between the agent and its clients.
8. “Insolvency related services” are services related to administering company liquidations or winding up or personal bankruptcy.
9. “Management services” covers the organisation and coordination of activities of a business in order to provide services to the clients and usually consist of organising, supervising, monitoring, planning, controlling and directing business’s resources such as human, financial and technology.
YOUR BUSINESS ACTIVITY IS IN SCOPE AND COMPLYING WITH THE ESR
Your Labuan company must demonstrate economic substance in Labuan by hiring 2 full-time employees and spend at least RM50,000 (approx. USD12K) of its OPEX on an annual basis. Once fulfilled, the company will be eligible for the 3% tax on its audited profit. A 24% flat tax will be charged on the audited profit if it fails to comply with the economic substance requirements. However, if the company reports audited loss, there is no tax payable regardless ESR is met or not.
IS LABUAN A GREAT CHOICE FOR YOU?
Mindful that this write-up revolves around our perspective on yearly maintenance cost of a Labuan company and the Labuan’s low tax rate. There are other factors you need to consider first before deciding to give Labuan a go. Consult us if you need more information.
Please note that we are overprovisioning the cost in the above table. Certain items are optional and can be taken out or reduced from the list.
Question, is it worth to set up a Labuan company that has to incur yearly expenditure of approximately USD24,000.00? Our take is that Labuan is ideal for businesses with high sales growth with low expenditures. With the minimal 3% tax chargeable on audited profit, Labuan company can preserve the profits, build the capital and grow the business on your own terms.
DOES THE TAX SAVINGS OUTWEIGH THE COST OF LABUAN COMPANY?
If you’re carrying on one of the business activities listed above and fulfils the ESR, the 3% tax will automatically apply to your Labuan company. And hypothetically, if you’re making USD200,000 of profit before tax in a year, Labuan can be a great choice for you with tables below illustrating the potential tax savings. Anything below the USD200K threshold may not be cost feasible anymore. Reason simply, the cost to maintain your Labuan company can go up to USD25,000 per year (refer Table 1). This estimated cost is calculated on the basis that the company operates on a minimal scale as sole entrepreneur would have conducted. The cost includes paying the company’s annual renewal fees, staffs’ monthly salaries, payroll and accounting services, audit fees, full suite of administrative support services, employment statutory contributions and a basic office rental to comply with the ESR.
Let’s say you have decided Malaysia is the right place for your business operation. You work out your business plan and find the volume is less than USD100,000 a year (profit before tax). Then the domestic Malaysia Sdn Bhd is more cost-efficient vehicle for you (refer Table 3).
Please contact us if you need assistance to set up a Sdn Bhd company.
Now, maybe you want to go regional. Singapore has a stellar international reputation and is the perfect choice in the SE Asian region. The country’s excellent business orientated policies, favourable tax regime and superb banking facility that you can count on. Businesses are taxed at 17%. That’s the headline tax rate for Singapore corporations. There are tax incentives, including a much lower tax rate applied to the company for the first 3 years of its operation. Table 2 below provides comparison of the tax payable vis-à-vis profit earned by a Singapore company and a Labuan company after 3 years in operation.
Whereas for Malaysian Sdn Bhd, the headline tax rate is 24%. Table 3 below provides comparison between domestic corporate tax in Malaysia and Labuan’s low tax, with the same 3 years of operation scenario.
Commenting on the applicable tax rates of the 3 jurisdictions’ shown in the tables above, the higher the taxable income, the more tax you may save using a Labuan company.
KEEN TO SET UP A LABUAN COMPANY?
LASTLY, we believe Labuan company is an efficient tax entity. Furthermore, Labuan follows a single-tier tax policy which means income that has been taxed at the corporate level can be distributed via dividends to the company shareholders, tax free (subject to the nationality of the shareholders). Bottom line is if you’re making USD200,000 and above on audited profit, the tax savings may outweigh the cost of maintaining your Labuan structure. Nevertheless, every situation is different, and it entails proper planning with lots to evaluate before settling for Labuan.
Get in touch with us if you find Labuan is attractive for your business set up. We are here to assist!
Please note that this write-up is not an international tax, legal or accounting advice. Readers should consult own tax, legal and accounting advisors before engaging us. This write-up has been prepared for informational purposes only and is not to be relied upon as a professional opinion whatsoever.