Tax Motivation to Use a Labuan Entity

Individuals in high tax countries are commonly taxable on their world-wide income & capital gains e.g. Australia, UK, US, Canada, most of Western Europe.

Companies in high tax countries may be taxable on their world-wide income & gains (e.g. US), or they be exempt on such income & gains (e.g. Australia), but when the company pays a dividend, it will be taxable to the shareholders.

Individuals in low tax countries are often taxable on their world-wide income, but there is often no tax on capital gains (e.g. Malaysia, Singapore). Other low tax countries only tax income that is locally sourced (e.g. HK).

Companies in low tax countries are often only subject to tax on locally sourced income (e.g. Malaysia, HK), or are only taxable on foreign source income remitted (paid) to the country of residence (e.g. Singapore ).

Absence specific anti-deferral rules, individuals in high tax countries could avoid home country tax on foreign source income by incorporating a company in a low tax jurisdiction, and causing the low tax company to derive the income or gains. High tax countries generally have Controlled Foreign Company (CFC) provisions which prevent such deferral in relation to usually, passive income. The CFC provisions attribute the passive income to the shareholders in the company, even though no dividend is declared. However, active income from carrying on a business, is usually not subject to CFC provisions .

Accordingly, there is a tax motivation for residents of high tax countries to carry on an active international business from a low tax country, to achieve home country tax deferral on that foreign source income.

The reason Labuan, Malaysia is particularly attractive as a base, is that it is entitled to use of all but about 10 of Malaysia’s 60 or so double tax agreements, which minimize source country tax, in the case of business profits derived without a “permanent establishment” in the source country, to zero. Most tax havens have no DTAs . The other major reason is that the source of the income is irrelevant to a Labuan company. Compare a Malaysian domestic company that has international transactions which are entered into in Malaysia, and will probably have a Malaysian source, and be liable to Malaysian tax at 26%. Likewise with HK & Singapore companies with 17.5% & 18% tax on international transactions which are entered into in HK or Singapore, and probably have a HK or Singapore source.