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By Mike Grover, Tax Specialist, Labuan IBFC Inc. Sdn Bhd Choosing a jurisdiction to invest in depends largely on an individual’s personal list of criteria and guidance from his professional advisers, but increasingly, Labuan International Business and Financial Centre has been gathering momentum as a reputable IBFC for transacting international trade and investment.
The bases for this evaluation are centred on Labuan’s business friendly laws, a robust regulator and a highly attractive tax system founded on the following:
- A simple and straightforward tax system ensuring certainty in tax treatment
- A tax system complemented by laws to eliminate ‘friction’ . Hence, there is no exchange control, no transfer taxes, no withholding tax and no indirect taxes that may be barriers to international transactions.
- Access to the majority of Malaysia’s extensive double taxation treaty network that currently stands at 75.
To illustrate the simplicity of the tax system: a Labuan company receiving passive income pays 0% tax, while an active, trading business never pays tax greater than USD6,000 annually. What is worth noting is that – regardless of the amount of operational substance the Labuan company has – Labuan IBFC tax outcomes do not change. In other words, a lightly managed Labuan company is taxed in exactly the same manner as another company which has extensive operational substance. This flexibility goes far to strike the right balance between the substance requirements of the investor’s home location and that of Labuan IBFC.
These attributes place Labuan very favourably as an excellent location to conduct international transactions from holding of investments, fund management, financing, leasing, brands, shipping and trading to mention a few.
The Labuan IBFC edge with Taiwan and China
An instance where Labuan IBFC can play a pivotal role in the business relationship between Taiwan and China is demonstrated here. Taiwan recently announced that it will allow Chinese investment in 100 of its industry sectors. However, Taiwan has high direct and withholding tax rates, making sense for foreign investment into Taiwan to be involved via a country that has a good tax treaty with Taiwan. Without a tax treaty, the withholding tax on finance costs to acquire the Taiwanese investment and payable to a non-resident can range from 15% to 20%. The return on investment in the form of dividends is also subject to 20% withholding tax, and any capital gains made on exit from Taiwan is subject to 20% tax.
For the Chinese investor, it is worth noting that although China has an extensive tax treaty network with 90 countries, it has none with Taiwan. Hence, a Chinese investor in a Taiwan venture would be sensible to do so via a treaty country (such as Malaysia) to enjoy reduced withholding tax rates on finance costs, royalty, technical support fees and dividends and even capital gains tax protection.
From the Taiwan perspective, it is also a win-win situation. Taiwan has 17 tax treaties including that with Malaysia and it can be said that the treaty is one of the most modern with more clarity to the taxing rights than, for example, older treaties such as the one with Singapore.
Another advantage of Labuan is that most, if not all, of Taiwan’s tax treaty partners seem to be subject to a ‘give-with-one-hand-while-taking-away-with-the-other’ situation. That is, a treaty partner can seemingly enjoy the benefits to mitigate Taiwanese tax on Taiwanese income but such income is subject to tax in the country of the recipient. An example of this - a UK company that receives Taiwanese dividend income enjoys a reduced rate of 10% withholding tax under the UK-Taiwan tax treaty but in the UK, the tax would be ‘topped-up’ to the UK corporate tax rate of 28%.
Now compare this with a Labuan company that has become a tax resident in Malaysia and satisfies the other conditions of the Malaysia-Taiwan tax treaty. In this instance, the Labuan company enjoys a 12.5% withholding tax rate on Taiwanese dividends but – more importantly – 0% tax in the hands of the Labuan company. This means the 12.5% Taiwanese withholding tax is the final tax with no tax incurred when the Labuan company pays a dividend (or interest, royalty or technical fees) to its foreign shareholder.
Similar results may be achieved with other forms of income and capital gains as well as some ancillary benefits. The financing of international acquisitions using a Labuan company may also reduce costs by minimising Chinese business tax in relation to financial income. Intellectual property such as brands designed for international markets may be owned by a Labuan company but registered in another jurisdiction for global property protection purposes.
The bi-lateral benefits
One interesting aspect of Malaysia’s tax treaty network is that it includes both China and Taiwan. This feature is especially beneficial for bi-lateral activities between the two countries such as in trading and shipping.
A Chinese trading company may inadvertently become a taxable presence in Taiwan by virtue of the ill-defined activities of their employees or agents in Taiwan, resulting in the Chinese trading company being subject to 20% tax on its Taiwan trading profits.
But by using a Labuan company to conduct the Taiwanese trading, a more secure position may be obtained because the Malaysian-Taiwan tax treaty gives clear guidance as to what activities constitute a taxable presence and which do not. Thus more certainty on Taiwanese tax exposure is obtained.
Shipping is even more appealing. Chinese shipping companies picking up passengers and cargo in Taiwan would be subject to Taiwanese taxation, and vice versa. By virtue of the Malaysia-China tax treaty, shipping income enjoys a 50% reduction while the Malaysia-Taiwan tax treaty allows 100% exemption. Therefore, if shipping operations were conducted by a Labuan Company owning or chartering ships registered under the Malaysian International Shipping Registry, these savings would be in place. In Labuan, the maximum tax payable is US6,500.
The above represents just a few of the scenarios that may interest Chinese investors in international trade or investment but the store house in Labuan IBFC contains opportunities limited only by appropriate planning and imagination. As published in A Guide to International Financial Centres – What Chinese Investors Need to Know 2011/2012
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