Labuan is well positioned to capture Chinese offshore business – literally and metaphorically. For all the cachet attached to well-established jurisdictions in the Caribbean, a call made to that part of the world on a Shanghai afternoon may well go unanswered. Labuan – a Malaysian territory that lies just off the north coast of Borneo – can claim to be in the same time zone as what it sees as a key target market.
"Malaysia and China have carried on trading activities for centuries, so we are a ‘known’ quantity,"said Martin Crawford, CEO of Labuan International Business and Financial Center (Labuan IBFC Inc. Sdn. Bhd.). "And being in the same time zone as Shanghai and Beijing makes it easy for travel and communications between the countries."
Labuan IBFC is responsible for marketing and promoting the jurisdiction, while regulation is the purview of Labuan Offshore Financial Services Authority.
Labuan’s principal rivals for offshore business in the region are Hong Kong and Singapore. To the extent that there is like-for-like competition – given their different areas of expertise, the relationship could be described as complementary – Labaun’s primary advantage is cost.
Crawford estimates that Labuan is about 40% cheaper than Hong Kong or Singapore, which means it can fulfill many of the back-room support functions for its peers as well as attracting a fair amount of business in its own right. The jurisdiction has 60 banks, 140 insurance entities and 23 corporate service providers, known locally as trust companies, to meet this demand. Labuan-based trading companies can also take advantage of the 3% tax levied on audited net profits (or opt for a flat payment of around US$5,600) versus 17% and 16.5% in Singapore and Hong Kong, respectively.
Company registrations rose 9.1% year-on-year in 2008 for a total of 6,898. More than half are from the Asia-Pacific region, with China, Hong Kong, Taiwan, South Korea and Japan together accounting for 14.5% of registrations.
Yet success is not measured by registration numbers alone. Labuan is not looking to mirror the low cost, high volume model of international business company incorporations pursued by the likes of the British Virgin Islands (BVI). For example, while many of the standard perks apply – low administration fees, no stamp duty, zero tax on capital gains, dividends and overseas income – Labuan’s compliance code requires that firms submit annual tax returns. This is not the case in some jurisdictions.
"The growth of Labuan as an offshore financial center is based on creating economic activity and expertise rather than just a pure volume business,"said Raymond Wong, Labuan-based regional managing director for Asia Pacific at Equity Trust. "We are not a Rolls Royce but something mid-range, like a Toyota Camry. It’s a case of balance – people who just want something cheap won’t come to us."
Given recent calls for a clampdown on the activities of offshore financial centers, this might be a wise strategy. Labuan failed to make the Organization for Economic Cooperation and Development’s "white list"of jurisdictions that are transparent over their tax affairs, but it is working to sign the requisite number of tax information exchange agreements.
"I was surprised that we were on the [gray] list, but the government is addressing it,"said Wong. "It was inevitable things would go in this direction and, if anything, it will help rather than hinder us."
A major change in Labuan’s tax structure came in August of last year when companies were given the option of being taxed under the Malaysian Income Tax Act rather than the Labuan Offshore Business Activity Tax Act. Those who made the switch are now taxed 25% of their locally sourced income but in return they get enhanced access to all of Malaysia’s 69 double taxation agreements (DTAs). The system operates in a similar way to the two company category model used elsewhere: Investors can follow the minimal disclosure route, which comes with limited benefits; or they can go for a more transparent structure and, in return, reap the rewards offered by DTAs.
A further reform, introduced in June of this year, allows Labuan-registered holding companies to establish regional or operational headquarters in Kuala Lumpur. Firms are subject to the Malaysian Income Tax Act but they are treated as Labuan entities for all other tax matters.
The changes are part of a wider evolution in the territory’s services – an evolution driven by investors’ needs as much as by calls for good governance.
According to Wong, the typical Chinese investor in Labuan would be a corporate entity using the offshore structure to make investments within Asia, particularly in Malaysia itself. It may be a merchant shipping timber from Malaysia to China or a trader sourcing oil from Africa and distributing it across the region.
These business functions require a fairly basic trading company structure. However, the investor may be a person of considerable means and much of this income is generated in Labuan in the form of dividend payments. It makes sense to create a trust in Labuan to protect the money. This opens the door to a range of high-end wealth management services.
"We target high-net-worth individuals who want to set up investment holding vehicles or trading businesses,"said Wong. "They are making money here and often want to set up trusts for their families."
Labuan offers a variety of trusts that can accommodate a wide range of assets from cash and securities to property and gold. But they all come with the same basic advantages: minimizing the tax liability in the owner’s country of origin; legally insulating assets from litigation, bankruptcy or seizure; and protecting wealth should the owner’s home country experience political volatility. Trusts also pay no withholding tax on distributions and are largely exempt from operational taxes provided they are non-trading.
In addition, Labuan will soon introduce a Trusts Act and a Foundations Act. It is thought that Chinese investors, used to operating under a civil law system at home, would feel more comfortable with the new foundation structure.
The two acts are the product of a significant redrafting of the territory’s offshore legislation. Offshore business in Labuan is directed by nine acts, which are being consolidated into four amended acts while a further four acts are created. The intention is to clarify some of the gray areas that currently exist.
With these amendments, Wong believes most of the legislative issues that once troubled the territory will be solved. But he argues that more could be done to promote the strong infrastructure that Labuan has created for its financial services industry. Certainly in China, the territory suffers from a lack of familiarity among investors who take their business to BVI and the Cayman Islands out of habit as much as anything else.
Wong is also keen for the authorities to push ahead with plans for more products and services in areas such as wealth management. He wants Labuan to make inroads into Hong Kong and Singapore’s stranglehold on private banking in the region, a task he admits will take time.
Labuan’s future does indeed seem to lie in cornering niches in the offshore market. Labuan IBFC has picked five areas in which it sees strong prospects for growth: holding companies, captive insurance, investment funds, Islamic finance and private wealth management. It is in the two of these that appear the least mainstream – captive insurance and Islamic finance – that striking progress has been made.
Captive insurance, whereby a subsidiary is set up in an offshore financial center with the sole purpose of insuring or reinsuring the risks of its parent, is a relatively new phenomenon in Asia. Only 8% of companies in the region participate, compared with 84% of the Fortune 500. Nevertheless, Labuan is expanding its footprint, helped by cost advantages. Annual operating costs are roughly half those of Hong Kong and Singapore, and the capitalization requirements and tax burdens are also considerably lower.
Labuan registered two new captives in 2008, bringing its total to 32. Gross captive premiums rose by 47% year-on-year to US$187 million. The number of captives is set to reach 40 by the end of the year, just 10 short of Singapore’s total.
"Captive insurance is important now more than ever because of cost pressures on companies,"said David Kinloch, corporate insurance advisor to Labuan IBFC. "It really is the ideal way to cut insurance costs but still maintain the integrity of the coverage."
Less surprising is Labuan’s thriving Islamic finance business, which has benefited from wider Malaysian efforts to lead the market. Labuan was involved in the Malaysian International Islamic Finance Center from its inception and also plays a role on the Gulf Co-operative Council.
While other offshore jurisdictions are only now making their first forays into Shariah-compliant financial services, US$4.75 billion worth of Islamic notes were listed on the Labuan International Financial Exchange by the end of 2008, up 10% from the previous year. Total deposits of Islamic banks stood at US$337 million last year, up 26% year-on-year. Five new Islamic private funds were also established, taking Labuan’s total to 16, with collective assets of US$2.8 billion.
As part of the territory’s legislative reforms, a Labuan Islamic Financial Services and Securities Act is in the pipeline, which will make it one of few jurisdictions to have a comprehensive set of regulations covering all aspects of Islamic finance under a single piece of legislation.
The Islamic regulations dovetail with the rules being drawn up for offshore practices in general, opening up new lines of business for Islamic high-net-worth individuals who are interested in wealth management and investments in Asia.
"The new Labuan Islamic Finance Services and Securities Act, the Trusts Act and the Foundations Act are further measures to provide impetus to growth,"said Labuan IBFC’s Crawford.