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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. Here's a little background before we delve into specifics: 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. 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. 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). 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. 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. Two years later the island became an official British colony. 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. 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. Labuan As An Offshore Financial Center 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:
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. The slow progress has been blamed upon a lack of effective promotion. 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. The In's and Out's of Labuan IBC Incorporation 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. 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. 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. On the other hand, "non-trading" companies are not subject to tax at all. Other
characteristics of Labuan IBC's include:
These words include:
The LFX (Labuan International Financial Exchange) 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. Features
of the exchange include:
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. 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. 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. 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.
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. How successful has the LFX model been so far? Well, the lack of effective promotion has got the exchange off to a slow start. 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. Labuan is also working to acquire a reputation as a world-class destination for the captive insurance industry. 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. 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. 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. 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. 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. 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. Labuan is presently attracting
additional Islamic banking ventures to its jurisdiction. But exactly what
is it?
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. 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. 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. 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. 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. 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. Conclusions
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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