Offshore Labuan Entity Shall Not Be Forced To Re-Submit Tax Return Under Federal Income Tax Law
Recently, industry players of Labuan offshore were bewildered by the new directive from Inland Revenue Board (IRB) issued by way of a letter dated 5.2.2021 addressed to the Chairman of Association of Labuan Trust Companies Act (ALTC) (hereinafter being referred as “IRB letter”). The IRB letter has allegedly trying to subject Labuan entities carrying out “other trading” activities, which at all material time operating Labuan business activities under the Labuan Business Activities Tax Act 1990 (“LBATA”) under the Jurisdiction of Income Tax Act 1967 (“ITA”). Whilst in the first place, as we are well aware of, these are the Labuan entity registered under Labuan Companies Act 1990 (“LCA”) carrying out Labuan business activities which are only subjected to tax regime under Section 3 and 3A of LBATA. The tax submission of such Labuan entities strictly under the LBATA jurisdiction as provided under Section 3, and only on the election of the Labuan entities that they can submit their tax return under ITA.
On the onset, the position taken by IRB letter are as follows:-
a) That the newly Amended gazetted Labuan Business Activity Tax Act (Requirements for Labuan Business Activity) 2018 (Amendment) Regulations 2020 which was made on 23.12.2020 (“2018 Regulations”) has caused Labuan entity carrying on “other trading” activities not to be included in the meaning of “Labuan entity” under Subsection 2B(1)(a) of LBATA; and
b) Thus, such business activities must submit the income tax return form under the ITA as follows:-
i. the year of assessment for 2019, the due date is 31.12.2020;
ii. the year of assessment for 2020, accounting period up to 30.6.2020 due date is 31.3.2021.
iii. Year of assessment for 2020, accounting period up to 31.7.2020 – 31.12.2020 is according to ITA 1967
The directive by IRB has adversely affect such Labuan entities which carries out Labuan business activities. The decision or position taken by the IRB letter has material implication to these Labuan entities in the following manners:-
a) Such unprecedent move has created the position that such Labuan entities are now subjected to ITA, which has never been provided in any written law in our jurisdiction;
b) That all resubmission for the tax return has to be done retrospectively for the last 2 years from 1.1.2019 under the ITA;
c) The worse practical consequence would be, the resubmission under ITA would mean that the applicable return tax under rate LBATA of 3% (pursuant to Section 3 of LBATA) will be increased as follows (pursuant to Section 6 read together with Schedule 1 of ITA):-
Company with paid up capital not more than RM2.5 million
On first RM500,000 17%
Subsequent Balance 24%
Company with paid up capital more
than RM2.5 million 24%
On first RM600,000 17%
Subsequent Balance 24%
Company with paid up capital more
than RM2.5 million 24%
d) Thus, due to the grave difference between the tax rate pursuant to LBATA and ITA, the Labuan business entity that are not classified under the 2018 Regulations will have to pay the difference for the 2 financial years of assessment.
The Positions Taken by IRB In The Said Letter May Be Illegal According To The Applicable Law
IRB position in interpreting the 2018 Regulations after it was amended by 2020 regulations has departed from the intention of the Minister of Finance when the Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2018 was initially made on 31.12.2018.
At the outset, we have to determine what is the position of a Labuan offshore company to the ITA. As such we have to refer to Section 3B of ITA:-
Section 3B of ITA:-
“Non-chargeability to tax in respect of offshore business activity
3B. Notwithstanding section 3, tax shall not be charged under this Act on income in respect of an offshore business activity carried on by an offshore company, other than an offshore company (in this Act referred to as “chargeable offshore company”), which has made an election under section 3A of the Labuan Offshore Business Activity Tax Act 1990.”
Now what is an offshore business activity as defined by the ITA? We have to refer to the interpretation in Section 2(1)(c) of ITA:-
“offshore business activity” is construed as reference to “Labuan business activity”
Meanwhile, in LBATA:-
a) Labuan business activity is defined as (pursuant to Section 2 of LBATA):-
“a Labuan trading or a Labuan non-trading activity carried on in, from or through Labuan, excluding any activity which is an offence under any written law”
b) Labuan entity shall be specified in the Schedule pursuant to Section 2B(1)(a) of LBATA where any Labuan company is one of the Labuan entity:-
2B. (1) The Labuan entities-
(a) shall be as specified in the Schedule;
c) Further, pursuant Section 3 of LBATA, a Labuan entity carrying on a Labuan business activity shall be charged to tax in accordance with this Act for each year of assessment in respect of that Labuan business activity:-
Labuan business activity chargeable to tax.
3. Subject to this Act, a Labuan entity carrying on a Labuan business activity shall be charged to tax in accordance with this Act for each year of assessment in respect of that Labuan business activity.
d) Pursuant to Section 3A of LBATA, unless upon own election, Labuan business activity cannot be chargeable under the ITA:-
Labuan business activity chargeable to Income Tax Act 1967 upon election.
3A. (1) Notwithstanding any other provision of this Act, a Labuan entity carrying on a Labuan business activity may make an irrevocable election in the prescribed form that any profit of the Labuan entity for any basis period for a year of assessment and subsequent basis period to be charged to tax in accordance with the Income Tax Act 1967 in respect of that Labuan business activity.
Pursuant to Section 2B(1)(b) and 21(1)(a) LBATA, a subsidiary legislation was made to regulate the requirements for Labuan business activity in 2018 (“2018 Regulations”) in order to give effect to the enforcement of Section 2B(1)(b) of LBATA which says as follows:-
Section 2B. (1) The Labuan entities-
(b) shall, for the purpose of the Labuan business activity-
(i) in relation to a Labuan trading activity-
(A) an adequate number of full-time employees in Labuan; and
(B) an adequate amount of annual operating expenditure in Labuan,
as prescribed by the Minister by regulations made under this Act.
(ii) in relation to a Labuan non-trading activity-
(A) have an adequate number of full-time employees in Labuan;
(B) have an adequate amount of annual operating expenditure in Labuan;
(C) comply with any condition in relation to control and management in Labuan,
as prescribed by the Minister by regulation made under this Act.
Section 21(1) The Minister may make regulations-
(a) generally, for the purpose of carrying out, or giving effect to, the provisions of this Act;
In entirety, the 2018 Regulations is to regulate the adequate number of fulltime employees of a Labuan entity and adequate amount of annual operating expenditure in Labuan in order to give effect to the provisions of LBATA. Perhaps we must examine the nature and contents of 2018 Regulations for better perspective as follows:-
a) 2018 Regulations is made pursuant to Section 2B(1)(b) and 21(1)(a) of LBATA, it would be apparent that such regulation is with the aim to give effect to the enforcement of the substance compliance under section 2B(1)(b) of LBATA;
b) The contents of 2018 Regulations is limited and/or confined to the creation of different categories of nature of Labuan business activities and laying down its substance compliance in terms of minimum number of full staffs and minimum operating expenses within Labuan.
It is worthy to note despite there is an amendment to the 2018 Regulations made in 23.12.2020 (“the amendment by 2020 Regulations”), the contents of 2018 Regulations maintained as the same as it is only dealing with the substance requirements pursuant to Section 2B(1)(b) of LBATA.
2018 Regulations HAS NEVER and CAN NEVER alter and/or redefine and/or change the meaning of Labuan Entity.
There is no way that the 2018 Regulations pursuant to Section 2B(1)(b) and Section 21 (1)(a) of LBATA as mentioned above can reclassify or limit or alter the definition of Labuan entity.
It would be apparent that the parent act of provision LBATA which gave rise to the 2018 Regulations is strictly dealing with the substance compliance, it has no effect of altering or redefining the meaning of Labuan entity under LBATA. The tax policy and the meaning of Labuan entities is still well defined and properly entrenched under LBATA which has been in force and acknowledged since LBATA being enacted. It has never been a case where any Labuan entities having issue with Section 2B of LBATA, then such Labuan entities would “suddenly and automatically” be subjected to ITA. Perhaps the position taken by IRB is misconceived and without legal basis altogether.
As we are well aware of, Labuan off shore jurisdiction is a well-known off shore jurisdiction within Asia, it has brought billions of transactions which benefited not only our country, and also the region. Whilst such transaction has never been intended and/or meant to be transacted in Malaysia to start with, that will not create any harmful tax practice to our ITA jurisdiction. In fact, Labuan business activities is strictly defined as transaction carried on in, from or through Labuan. Such position taken by IRB will “chase off” all Labuan entities by electing other off shore jurisdiction, which will not only cause loss of revenue in million based on the tax revenue from Labuan entities but also will disrepute our country in the eyes of the international community. It is highly probable, especially when IRB is taking a position where thousands of Labuan entities whom have submitted and paid tax return under LBATA has to resubmit under different tax rate pursuant to ITA for the year of assessment 2019 and 2020. Such decision would be taken, if not deemed to be unfair, a retrospective and oppressive directive.
We are of the view that the Minister of Finance would have no right and certainly have no intention to alter and re-define the interpretation of Labuan entities in Section 2B(1)(a) as it would be an act of ultra vires the parent act, and the 2018 Regulations has never done so. Indeed, the Regulations together with its amendment in 2020 is ONLY to regulate the substance compliance requirements for Labuan entities under section 2B(1)(b) of LBATA.
Therefore, IRB position in the said letter stating that “other trading” is no longer a Labuan entity, merely because it is not classified in the schedule in the 2018 Regulations, is misconceived and without legal basis. Further IRB position is inconsistent and beyond the scope of LBATA and the 2018 Regulations.
Nowhere in the 2018 Regulations nor its amendment i.e. the amendment by 2020 Regulations provides that if a business activity does not fall in any of the categories mentioned in the Regulations, the Labuan entity is no longer a Labuan entity under section 2B. Not only 2018 Regulations never provide so, the provision under LBATA will always prevail and remain intact despite any regulations.
Key example is circulation by Labuan Financial Services Authority on 9.2.2021 which informed that a new separate gazette will be issued to regulate the business activity requirement of Labuan International Commodity Company (LITC) after it was removed from the schedule in the amendment by 2020 Regulations. Thus, merely because a Labuan entity is removed from the 2018 Regulations, the entity will not be automatically be removed as a Labuan entity pursuant to LBATA. As being mentioned earlier here, for all intents and purposes, the 2018 Regulations is essentially enacted merely to regulate the compliance for Labuan business activity, thus despite the new amendment, it will not change its purpose.
In fact, no amendment was made to the LBATA as a result of the amendment to the 2018 Regulations which remove certain Labuan business activity from the Schedule therein. Hence, Section 3 of LBATA shall prevail and remain enforceable where a Labuan offshore company shall not and will not be subjected to ITA (unless upon election pursuant to Section 3A of LBATA).
Thus, based on the current circumstances, IRB may have misinterpreted the 2018 Regulations because such interpretation implied that the 2018 Regulations is ultra vires the parent act whilst it was not the intention of the Minister when the 2018 Regulations were made and when the Regulations were amended by way of 2020 Regulations.
IRB Positions Has Been Compromised By Its Own Previous Conduct
As we are all aware of, the year of assessment for 2019 has been submitted an accepted by the IRB. Even IRB has acknowledged the position of the 2018 Regulations is all about substance compliance/requirements only, whereby as long as the 2018 Regulations is complied with, there is no issue of Labuan entity to submit its tax under LBATA.
Most importantly, initially, the Regulations in 2018 has never included “other trading” category in the Schedule, but such Labuan entity has submitted their tax return to IRB under LBATA without any objection by IRB.
Suddenly, now IRB has taken the position if a category of business activity is not listed in the Regulations, it will not be considered as Labuan entity. We are of the view that there is no provision in the LBATA nor the 2018 Regulations with the amendment that merely because the “other trading” is not included in the 2018 Regulations, it would automatically require the said Labuan entity to submit to the jurisdiction of ITA.
Over and above, it would be unfair for a company who has chosen to incorporate a business or entity in pursuant to Section 2B(1)(a) of LBATA to be subjected to ITA when they do not elect to do so as provided in Section 3A of LBATA.
To correct this of what we believe to be an “honest” misinterpretation of the Labuan Business Activity Tax Act (Requirements for Labuan Business Activity) 2018 (Amendment) Regulations 2020 by IRB, we are of the view that filing a Judicial Review Application to the High Court against IRB would be appropriate. What we would seek from the Court is Court’s order in the nature of Mandamus, to force IRB to cancel or withdraw its directive in the letter dated 5.2.2021.
This article are prepared and published by Messrs Gan & Zul, Advocates & Solicitors, Kuala Lumpur.
Ben Lee Kam Foo (Partner)
Head of Dispute Resolution
Arbitrator & Adjudicator
Fellow of ADR, AIAC
Cross Border Taxation Planning
Shafihani Binti Md Ali (Senior Associate)
General Dispute Resolution
Contractual, Land and Commercial Disputes
Pre and Post Liquidation Disputes
Nur Amalin Shahida Sabidi (Associate)
General Dispute Resolution
Commercial Retail Tenancy Disputes
Contractual, Land and Commercial Disputes
Phang Ting Hong (Associate)
Construction Dispute Resolution Division