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| Labuan:
The Undiscovered "Pearl of the South China Sea" |
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| Labuan
is an offshore tax haven you probably don't know much about. This is
a significant advantage since keeping a low profile is an integral part
of privacy, after all. Just how "secret" are you if you conduct
your banking or business transactions in such well-known jurisdictions
as Switzerland or the Cayman Islands? |
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| If
privacy weren't high on your list of financial criteria, you wouldn't be
interesting in going offshore in the first place. |
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| So what does
Labuan have to offer besides a small footprint in the offshore world? Banking...
IBC formation... captive insurance companies... a new international financial
exchange... a location adjacent to the major financial centres of Singapore
and Hong Kong... and something you might never have heard about until now:
Islamic banking. |
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| Here's a little
background before we delve into specifics: |
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| Labuan is
a small island at the mouth of Brunei Bay at the easternmost tip of Malaysia.
Brunei Bay itself is part of Borneo (a large island shared between Malaysia,
Brunei, and Indonesia). Labuan is therefore a "satellite" island
of this much larger land mass. |
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| Labuan isn't
particularly large at 38 square miles (92 square kilometres), but
offers fishing, diving (including wreck dives), talcum-powder beaches,
and World War II memorials as lures for many prospective tourists. "The
Pearl of the South China Sea" is home to landscaped roads, beautiful
houses, and modern shops, hotels, and restaurants. Its bustling economy
(based primarily upon tourism and offshore finance) provides the
island's 65,000 residents with one of Asia's highest living standards. |
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| Relevant
History of Labuan |
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| The name "Labuan"
itself is significant because it means "an anchorage." It's a noteworthy
distinction because it's Malaysia's only deep-water port (and a duty-free
one, as well). |
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| This
port has historically been a major trading center for Chinese, Arabian,
and Indian merchants passing through the area, The Portuguese, Spanish
and Dutch also made good use of the port, ensuring that Labuan has been
a focal point of the maritime history of the area. |
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| In 1846,
Labuan was ceded to the British by the Sultan of Brunei so that the British
Empire could suppress pirate activity with a patrol station placed between
Singapore and Hong Kong. |
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| Two years
later the island became an official British colony. |
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| It wasn't
until 1963 (115 years later) that Britain relinquished control of
Labuan. Japan did occupy the island for 3 years during World War II, but
otherwise there were no breaks from British administration. |
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| Labuan
did gain its independence by joining the Federation of Malaysia in 1963,
but 1984 arrived before the Malaysian State Government of Sabah finally
signed over Labuan to the Federal Government of Malaysia itself. Under
this new administration, Labuan's strategic proximity to major shipping
routes and offshore oil and gas fields was promoted with a long-term infrastructure
program officially begun in 1990. Today, Labuan has become a thriving free
port, offshore oil and gas industry base, tourist destination, and a leading
international offshore financial centre. |
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| Labuan
As An Offshore Financial Center |
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| Ever since
1990, Labuan has been increasing the diversity of its offshore activities.
The latest information demonstrates that Labuan is a base of operations
for: |
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the LFX (Labuan International Financial
Exchange)
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the LOFSA (Labuan Offshore Financial
Services Authority)
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more than 61 banks (of which are 52
foreign-owned)
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almost 2,500 IBC's
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numerous PCC-based captive insurance
companies
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an international Islamic money market
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an E-Commerce Gateway for e-commerce
enterprises
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| The pace of Labuan's growth is increasing.
For example, 396 Labuan IBC's were registered or incorporated in 1999,
a dramatic increase from 268 in 1998. |
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| You might notice that Labuan is
still a relatively small OFC, despite the intent of the Malaysian government
to shape the island into a financial vehicle that would compete with Hong
Kong and Singapore for international offshore business. |
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| The slow progress has been blamed
upon a lack of effective promotion. |
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| This would appear to be the case
since Labuan offers major tax incentives, including no capital gains taxes,
no contract note duties or exit levies, and a minimal corporate tax of
RM20,000 (US$5,263) or 3% of taxable income, whichever is lower. |
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| The
In's and Out's of Labuan IBC Incorporation |
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| Companies
incorporated in Labuan under the Offshore Companies Act of 1990 and the
Labuan Offshore Business Activity Tax Act of 1990 enjoy preferential treatment
over traditional Malaysian companies. |
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| There are
essentially two different kinds of Labuan IBC: "trading" companies which
deal in real-world goods and services internationally, and "non-trading"
companies which are holding companies for equities and other investment
securities. |
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| Corporate
entities considered "trading" companies are given a choice of paying either
3% of their net audited profits to the Inland Revenue Department, or paying
RM20,000 (US$5,263) a year as a fee to the Registrar of Companies. The
company is permitted to choose whichever amount is lowest, to its own advantage |
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| On the other hand, "non-trading"
companies are not subject to tax at all. |
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| Other characteristics
of Labuan IBC's include: |
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at least one shareholder and one director
is required
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however, no restrictions on the physical
location of either
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corporate directors and corporate secretaries
are allowed (secretary must be resident in Labuan, however)
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a Registered Office and a Registered
Agent are needed to conduct business
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a Registered Office must hold a Register
of Directors, secretaries, members, transfer, mortgages, debentures, debenture
holders, and interest holders, as well as the corporate books and seal
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the minimum capital required is RM50,000
(US$13,158)
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there are no capital
duties and no stamp duties (transaction costs are therefore low)
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AGM's (annual
general corporate meetings) may be held anywhere in the world
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exception: if
proof of residency is required, then corporate meetings must be held in
Labuan
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| An additional note is that when
incorporating in Labuan, certain words are restricted as company names
and require Ministry approval. |
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| These words include: |
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Finance
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Bank
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Trust
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Royal
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Insurance
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Security
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and related terms considered sensitive
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| If a corporate name is considered
unrestricted then only 1-3 days are required to form the IBC. |
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| Privacy
considerations: |
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no information
is required by Labuan authorities prior to incorporation or prior to tax
status being granted
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exceptions include
banking and insurance-related ventures operations
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no information
is made available to the public about Labuan IBC's
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all information
is strictly held in confidentiality and the Secrecy Act prohibits any release
of such information to the public
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| Some disadvantages: |
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bearer shares
and no-par value shares are not permitted
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trading with Malaysians
and Malaysian companies is subject to restrictions
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| Costs: |
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formation costs are around US$3,600
(US$2,800 for incorporation, US$800 for the Registered Office and Resident
Secretary) the annual government fees are US$800
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the annual fees for the Registered Office
and Resident Secretary will continue at US$800 each year
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there are also annual filing fees of
about US$190, as well as a filing fee of US$30 for the company's Annual
Return if applicable
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the total annual costs are about US$1,820
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| To summarize, the strong points
of Labuan IBC incorporation are favourable tax rates, privacy, low transaction
fees, and flexibility. |
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| Labuan is far from the cheapest
OFC in the world but it is low-profile. |
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| The
LFX (Labuan International Financial Exchange) |
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| The LFX is a subsidiary of the Malaysian
Kuala Lumpur stock exchange. It's been designed to be as modern and as
flexible as possible. |
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| Features
of the exchange include: |
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Internet-based facilities
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US dollars used as a medium of exchange
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no restrictions on the type of tradable
financial instruments
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equities, investment funds, debt instruments,
insurance-related instruments, and over the counter instruments tailor-made
for investors and issuers (based on both conventional and Islamic principles)
are all accepted
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participants need not have a physical
presence in Labuan
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authorised and paid-up capital for any
company wishing to be listed is US$5 million and US$100,000, respectively
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the organization is self-regulated
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| All LFX trading is to be executed
on the LFX's electronic bulletin board. Registered trading agents must
place their buy and sell orders on the board and are permitted to conduct
their own negotiations. Like more well-known exchanges, the trades settle
and deliver on a T+3 basis (i.e. a trade must be settled and delivered
within three days after it has been executed). About the only restriction
of note is that LFX trades are subject to a minimum size of 100 units. |
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| Although under
the jurisdiction of LOFSA (not the Malaysian Securities Commission),
the LFX will supervises its market participants by way of its own licenses
and rules. |
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| You may
recall that only two years ago, Malaysia defied the IMF and
the remainder of the international financial community and imposed capital
controls upon its economy. Malaysian politicians even called for international
financier George Soros to be tried as a war criminal for his well-known
ability to destroy over-valued national currencies. |
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| All this
government chest-thumping resulted in the fixing of the Malaysian ringgit
at 3.8 to the US dollar in September 1998. This stemmed the outflow
of short-term capital from Malaysia in wake of the Asian economic crisis
and may actually have helped rather than harmed Malaysia. So much for the
esteemed wisdom of the IMF in such matters. |
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| But regardless
of your personal opinion of the Malaysian currency fixing and capital controls,
you need not worry about this kind of bureaucratic interference if you
do your business in Labuan. All Labuan banking operations are free from
capital controls since US dollars, not ringgit, are the standard currency.
As official reassurance, the LFX states that: |
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"There
will be no restriction on foreign investors holding securities listed on
LFX as it is envisaged that the issuers will most probably be from various
countries."
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| The government's
idea is to encourage international investors to complement instead of compete
with local Malaysian corporate entities. Therefore, companies listed on
the Malaysian KLSE (Kuala Lumpur Stock Exchange) are not eligible
to list on the LFX. The Malaysian authorities want to keep the offshore
and onshore markets separate. |
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| How successful
has the LFX model been so far? Well, the lack of effective promotion
has got the exchange off to a slow start. |
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| The secondary
market on the LFX will not be very liquid, obviously. Therefore it
would appear that the main role of the LFX at this point in its
life cycle is to give companies more visibility and also to raise much-needed
capital. This would appear to the business plan of several prospective
LFX listings to be announced in the near future. The home page of
the exchange can be found on this page under Additional Resources. |
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| Captive
Insurance Companies |
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| Labuan is
also working to acquire a reputation as a world-class destination for the
captive insurance industry. |
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| A captive
insurance company is an insurance entity which is wholly-owned by another
organization. The subsidiary is used to insure the risks of the parent
and its affiliated companies and assists in controlling costs and associated
risks. The specific advantages of captive insurance companies include customized
coverage, improved cash flow, direct access to wholesale reinsurance markets,
and reduced operating costs. |
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| LOFSA has
recently adopted and endorsed the protected cell company (PCC) structure,
which will complement existing captive insurance opportunities. A Protected
Cell Company is one which legally segregates the accounts of each "cell"
from the liabilities of every other. This prevents the entire structure
from crashing down if one sector becomes insolvent or encounters similar
problems. |
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| Labuan-based
captive insurance companies enjoy the exact same taxation benefits as other
Labuan IBC's and can choose to pay either 3% of net profits or a fixed
rate of RM20,000 (US$5,263) per year. Additionally, Labuan's set-up
costs are reputedly 50% lower than the average competitor in the captive
insurance market. And due to the absence of stamp duties and management
fees, ongoing costs are estimated by LOFSA to be 30% below average. |
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| The Labuan
captive insurance industry began in 1996 with a single company, and has
now grown to include 17 companies by the year-end of 2000. |
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| New
Directions At LOFSA? |
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| LOFSA (Labuan
Offshore Financial Services Authority) is the regulatory agency of the
Labuan financial sector. It spearheads and co-ordinates efforts to
promote and develop Labuan as a first-class international offshore financial
centre. Among other tasks, LOFSA processes and grants applications
for business operations licenses. Its supervisory and legal framework is
in accordance with international standards, including money laundering
legislation which is currently in the draft stage. |
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| Recent
developments as LOSFA include the appointment of a new director general,
Citibank Bhd's vice-president, Noorazman Abdul Aziz. This new director
general will now take up the challenge of promoting Labuan to the offshore
investment world more successfully than in the past. Of course, the jurisdiction's
low profile is an advantage, but the slower than anticipated growth has
been a disappointment to the Malaysian government so far. |
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| Islamic
Banking Appendix |
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| Labuan
is presently attracting additional Islamic banking ventures to its jurisdiction.
But exactly what is it? There's no doubt that Islamic banking is a
very large question mark to Westerners and non-Muslims. It's a new financial
system that barely existed until recently, but is now picking up momentum.
The budding industry has arisen from the financial constraints imposed
upon those who are devout followers of Islam. |
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| The
Islamic religion prohibits interest payments. A prohibition against
interest payments is effectively a prohibition against a predetermined
claim on a productive surplus. Therefore traditional Western commercial
banking is not accessible to those Muslims who wish to rigidly adhere to
the ideals of their faith. Since interest of any kind is forbidden (and
this holds true regardless of interest rates, or the purpose of the interest-bearing
loan), Islamic businessmen have discovered a clever way around the
ban. |
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| Islam
allows the owners of capital to share in a surplus as long as the surplus
is uncertain. So Islamic banks instead invest their money in trade
and industry and share the profits with their depositors. Only the ratio
of the profit-sharing is known in advance, not the rate of return itself.
Therefore this is permitted under Islamic law. The result of this strategy
is that Islamic banks are equivalent to investment banking institutions
rather than commercial banks and can be best understood on this basis. |
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| These
banks typically offer three broad categories of account: current, savings,
and investment accounts. A current account gives no return to the depositor,
since it is nothing more than a safekeeping arrangement between the depositors
and the bank. Depositors may withdraw their money at any time, and the
bank may use the depositors' money. |
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| A
savings account is operated similarly, but the bank may pay the depositors
a variable return periodically, depending on its own profitability. Since
this type of payment is not a condition for lending by the depositors to
the bank, nor is it predetermined, it is considered lawful under Islamic
rules. An investment account is a term deposit. It cannot be withdrawn
before maturity. The profit-sharing ratio varies between banks and is subject
to supply and demand conditions imposed by marketplace. Islamic term deposits
have typically produced real-world returns comparable to the rates offered
by Western commercial banks. |
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| Because
of its investment orientation, Islamic banking is concerned about the
viability of projects and their profitability, but not the size of their
collateral. Good projects which could potentially be cut off from conventional
bank funding for insufficient collateral could be financed by Islamic banks
on a profit-sharing basis. |
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| Therefore
Islamic banks can function on a micro- or macro-investment basis, giving
them the flexibility to catalyze numerous new businesses and stimulate
economic development. Therefore, Labuan is making a strong bid to attract
as much Islamic banking as possible. This new and growing industry has
vast potential, since the majority of investors from Islamic countries
still place their funds in conventional financial centres due to a lack
of alternatives. |
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| Conclusions |
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| Labuan's
only problem at this point appears to be a lack of effective promotion
of its benefits. Located next door to Singapore and Hong Kong, and
looking to both the Islamic and Western world for business opportunities,
it has tremendous potential for the future. |
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| It's entirely
possible that despite its slow start, Labuan's attractive and competitive
features might one day allow it to compete with the bigger and better-known
OFC's of the world. But right now one of Labuan's best advantages is that
it seems to be off Big Brother's radar screens for now. A low-key offshore
tax haven is the best kind! |
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