Economic Substance requirements included in Labuan tax returns

Companies in Labuan will be required to file their corporate tax returns by October 28, 2020 (extended from end of May due to the COVID-19 pandemic).

Note: this article has been updated on August 20, 2020

Within the tax forms will be additional declarations that confirm whether or not the company is adhering to Economic Substance requirements.

Economic Substance is the extent to which a company or organisation has operational and economic activity in a country. For example, if the company has an office, transactions, employees, local expenses and other infrastructure then it is deemed to have substance.

Following recommendations from the Organisation for Economic Co-operation and Development (OECD) on Base Erosion and Profit Shifting (BEPS), Economic Substance has increased in importance and many jurisdictions have had to take steps to ensure companies adhere to minimum standards.

If firms fail to show adequate Economic Substance, they may not be granted a license to operate in that jurisdiction, or their license will not be renewed. In Labuan, however, substance requirements are not usually linked to the license, but only to the tax payable.

Substance requirements for Labuan depend on the activity of the Labuan entity. There are specific requirements for licensed entities such as banks, insurance brokers, and fund managers etc, and requirements for unlicensed activities such as a “non-pure holding activity” or “pure holding activity” as well as certain “trading activities”. In Labuan, the requirements are focused on the activity of every entity, and all types of entities (companies, foundations, partnerships, trusts etc.) are treated equally.

Over the last 20 months, Malaysia and Labuan have issued various legislation as to what constitutes sufficient economic substance for various types of activities:

  • Pure Holding Company – a Pure Holding Company is a company that primarily earns dividends and capital gains. No other activities are allowed, besides a bank account which may pay some interest. In Labuan, in order to adhere to substance requirements, it should incur a minimum of RM20,000 in annual local expenses and be controlled from Labuan
  • Non-Pure Holding Company – a company that holds a variety of assets that earn different incomes, such as interest, dividends etc from external sources, is deemed a Non-Pure Holding Company. In order to comply with substance requirements, they are required to incur a minimum of RM20,000 in annual local expenses and hire one full time employee
  • Trading company – a Labuan entity that carries out administrative functions and services such as accounting, administrative, legal and related services is deemed to have a trading activity. They require operating expenditures of RM50,000 per year with two full time employees
  • Licensed entities – for all licensed entities, substance requirements range from a need to have local operating expenditures of RM200,000 and three employees for banks, expenses of RM100,000 and two or three employees for Labuan captive insurers, to local expenditures of RM100,000 and one employee for certain types of leasing companies (for full details, contact Alpadis Group)
  • Other, non-defined trading companies – these will automatically be taxed under the domestic Income Tax Act (ITA), whether they have substance or not
  • Intellectual Property – Entities generating revenue from intellectual property will be taxed under the ITA

Those that do not show sufficient economic substance will be taxed under LBATA at a rate of 24% (as opposed to the usual Labuan rate which stands at 3%, or a tax exemption for entities with a “non-trading activity”). Importantly, though, fund managers and certain other licensed entities that do not show economic substance, while they will be taxed at a higher rate, will not lose their licence, unlike other jurisdictions.

In Labuan the declaration on whether an entity has complied with the substance requirements or not has now been included in the updated tax returns for Labuan entities. There is no separate reporting on substance.

For more information on Economic Substance and the filing of tax returns, contact Alpadis Group