This article first appeared in The Edge Malaysia Weekly on September 4, 2023 - September 10, 2023

IN recent years, offshore or international financial centres have increasingly been cast in a negative light, tainted by high-profile scandals such as those of 1Malaysia Development Bhd (1MDB) and the Pandora Papers.

In the case of 1MDB, billions of dollars misappropriated from the fund were found to have been moved through offshore centres such as the British Virgin Islands and the Seychelles before being used to buy real estate and luxury items in the US. As for the Pandora Papers exposé in 2021, it remains etched in the minds of many as the largest-ever collection of leaked data exposing tax haven secrecy.

In Singapore, police are currently investigating what is said to be one of the biggest money laundering cases in the history of the city state. They are waiting for documents from at least nine financial institutions to aid in their probe, it was reported.

It is against this challenging global backdrop of recent years that Malaysia’s Labuan International Business and Financial Centre (Labuan IBFC) is seeking to make a stronger mark for itself. It plans to develop a niche in the areas of Islamic finance/sustainability, captive insurance and digital financial services, while strengthening its regulations and compliance with international standards to move away from the stigma associated with offshore centres. These are encapsulated in its five-year strategic roadmap that runs from 2022 to 2026 (see “Five-year game plan enough to give Labuan an edge?” on Page 58).

In an exclusive interview with The Edge in Kuala Lumpur — his first since taking the helm in May 2021 — Labuan Financial Services Authority (Labuan FSA) director-general Nik Mohamed Din Nik Musa, better known as Nik Din in the industry, says Labuan has come a long way since it was set up as an international offshore financial centre (IOFC) almost 33 years ago in 1990.

According to him, Labuan today ranks among the top three international financial centres in Asia in banking, insurance and captive insurance in terms of volume of international business. Notably, on a global basis, Labuan is ranked among the top 10 in terms of growth of new captive formations.

Last year, Labuan IBFC’s tax contribution to the federal government breached the RM1 billion mark for the first time, coming in at RM1.2 billion.

“Where we are today is something that we can be proud of. I would say Labuan can hold its own against other offshore centres. In Malay, we say boleh tahan [not bad]. If you look at Asia, there are only about 10. I would say that, of the international financial centres in Asia, Labuan is in the top three in terms of banking, insurance/reinsurance and captive insurance,” says Nik Din.

“Of course, the big boys are Singapore and Hong Kong. The other [centres around us] are small — Samoa, Vanuatu, Marshall Islands, Cook Islands, even the Maldives — and some, like Brunei, have closed. So, as far as we are concerned, in this part of the world, after 30-odd years, we are competitive, we have modern regulation and we are thriving. We have a lot of support from the government and there is room to grow, of course.”

Be that as it may, critics say Labuan has been slow to develop. The brainchild of former prime minister Tun Dr Mahathir Mohamad, Labuan started its journey as an IOFC in October 1990. At the time, the ambition was to make it a successful international offshore centre and a renowned commercial and trading centre in Asia-Pacific. Decades on, however, not many consider Labuan to be particularly dynamic.

Nik Din takes the criticism in stride. “I’m not surprised [by some of these negative perceptions people have] because it may be based on how Labuan was, maybe two or three decades ago. I must say that when we started, we were quite cautious, quite slow, and there’s a reason for that. People still have that memory, that mindset, and I don’t blame them. It’s partly because of [a lack] of awareness programmes also,” he says.

“Because we are international, sometimes we are known to outsiders more than by our own people, which is not right. We need to make our people aware of Labuan also, which we are doing now.”

Labuan’s cautious pace of growth in the first decade stemmed from the fact that it wanted to attract only good-quality companies, says Nik Din. “In the first 10 years, we only wanted to attract licensees [that is, regulated institutions such as banks, insurers and other financial institutions]. In addition, we hadn’t found a niche for ourselves yet, so we were just promoting everything — universal products, like we were a supermarket. Connectivity was also a factor for international investors. To get to Labuan, they had to fly to KL then Sabah, or KL then Labuan. That’s still an issue.”

A challenge at the time also was that companies that wanted to set up there would end up having to deal with multiple agencies. This issue was solved, however, with the establishment of the Labuan Offshore Financial Services Authority (LOFSA) as a one-stop agency in February 1996. It was renamed Labuan FSA in January 2008.

“Now, everything comes under Labuan FSA — we supervise, regulate, make policies, develop, enforce and so on. The only mandate we do not have is tax, which remains under the purview of LHDN (Inland Revenue Board),” he says.

These efforts have paid off slowly but surely. “In the first year [1990], we had only eight licensees. At the end of 2000, there were 190. So, we were growing at 19 licensees a year on average in the first decade. But if you look at 2011 to mid-2023, the number has grown on a yearly basis to 37 on average. So, you can see the jump when we had a clearer vision for Labuan.”

Since 1996, the number of licensees or financial institutions in Labuan has grown more than 10 times to 930 as at mid-2023, while the overall number of Labuan companies has grown more than five times to 4,858, off a peak of 5,802 in 2020 as some companies closed down following the pandemic.

In terms of the number of international banks, as at end-2021, Labuan has 70 compared with Singapore’s 99 and Hong Kong’s 61. As for insurers and reinsurers, Labuan leads with 230 compared with Singapore’s 180 and Hong Kong’s 163.

“We have the numbers, but we have to work on building the volume of business. We’re still not there yet compared with the bigger centres,” Nik Din acknowledges.

In terms of captive insurance, though, Labuan has had a chance to make a mark. A “captive” is an insurance or reinsurance company set up by a non-insurance parent company — usually a multinational corporation — to insure the risks of its parent or related/associated companies. For example, national oil giant Petroliam Nasional Bhd (Petronas) has a captive unit, Energas Insurance, in Labuan.

Labuan currently has 71 captive companies compared with Singapore’s 83, making it the second-largest market in Asia.

In 2013, Labuan took a noteworthy turn, rebranding itself as a “midshore” rather than offshore jurisdiction.

Nik Din says: “We did some soul-searching and decided to rebrand ourselves, seeing as how offshore centres have been tarnished by money laundering, shady activity, high secrecy, tax evasion and all that. We wanted to move away from this stigma … and we rebranded ourselves as midshore. In 2008, we had already removed the word ‘offshore’ from our name (LOFSA) and became known as Labuan FSA. And from an IOFC, we became an IBFC.

“Academically, we fall under midshore. As a midshore, you have to have a strong regulatory framework and comply with international standards, but [companies operating in midshore jurisdictions] still enjoy the benefits of lower tax. It’s like having the best of both worlds.”

Singapore, Hong Kong, Malta, Ireland and Cyprus are among the jurisdictions considered midshore.

While there is no formal definition for it, a “midshore” jurisdiction has certain characteristics, says Istee Cheah, a lawyer with Wong & Partners.

“Being midshore is not just about moving away from the word ‘offshore’, because midshore jurisdictions typically have more stringent or heightened legal and compliance requirements and they do maintain some level of taxes, together with possibly some opportunities for tax planning,” Cheah, a partner in the tax, trade and wealth management practice, tells The Edge.

To attract good companies, it is key for Labuan IBFC to be, and be seen as, a well-regulated jurisdiction — something Nik Din says it has placed importance on since Day One.

“We don’t want to be a tax haven or a centre that is poorly regulated,” he says. “We pride ourselves on being a well-regulated centre and having a good supervisory framework in place. And we are constantly assessed by international multilateral agencies.”

These agencies include the International Monetary Fund (IMF), which rated Labuan IBFC as having a “strong legal and regulatory framework” in 2002 and 2014. The Financial Action Task Force (FATF) — the global standard-setting body for anti-money laundering and combating financing of terrorism — and its associate member, Asia/Pacific Group on Money Laundering (APG), deemed Labuan a “low-risk jurisdiction” in 2007 and, again, in 2015.

FATF/APG are expected to do their next round of assessment in 2024, says Nik Din.

“One thing I can say for sure is that Labuan is not a port of entry for money laundering. Money laundering will not begin from Labuan, and why I say that is: one, we don’t accept cash deposits; and, two, we have a very strict know-your-customer [process]. But in terms of flow-through, there could have been, because many centres are involved in this flow-through.”

While Labuan FSA has detected a few wrongdoings by Labuan entities related to money-laundering offences, no case has been prosecuted in court thus far, he says. Nonetheless, stern actions have been taken against these entities, which include forfeiture of the proceeds of crimes to the government of Malaysia, imposition of monetary compound and directives to the entities to cease and desist from Labuan IBFC.

This year, Labuan IBFC is on track to beating last year’s RM1.2 billion tax contribution to the federal government, says Nik Din. In 2020, tax revenue rose sharply to RM921 million from just RM182 million in 2019, before dropping to RM855 million in 2021 as some companies closed down as a result of the pandemic.

Tax revenue has spiked significantly in recent years, mainly because of the removal of an option for Labuan companies to pay tax at a flat rate of RM20,000 a year.

“We removed that tax option at the end of 2019. Previously, we allowed companies to opt for either 3% tax of audited annual profit or RM20,000 flat. So, some of our licensees preferred to pay RM20,000, as it was lower. But we changed it because the OECD (Organisation for Economic Co-operation and Development) was of the view that the more profit you make, the more you should pay in tax,” says Nik Din. 

The higher tax revenue helped boost Labuan IBFC’s proportion of contribution to the island’s gross domestic product to more than 50% in 2020, for the first time. Last year, it was 52%. 

Also helping the economy was the OECD’s “substance requirement” under its BEPS 1.0 (base erosion and profit shifting) regime. 

In a nutshell, it led to Labuan FSA putting out guidelines at end-2019 that required companies to have a certain number of full-time employees and spend a certain amount in Labuan to show that they had economic substance.

“For example, a bank would have to have a minimum of three people and spend a minimum annual operating expenditure of RM200,000. For a fund manager, it would be two and RM100,000 respectively,” says Nik Din.

Labuan IBFC is the island’s largest white-collar employer. “We have close to 10,000 staff, many of whom are based in Labuan itself. Some are based in Kuala Lumpur because we allow marketing offices and co-location,” he explains.

One of the biggest challenges ahead for Labuan IBFC is gearing up for new tax rules under BEPS 2.0. Specifically, Pillar Two introduces a global minimum effective tax rate of 15% for multinational groups with consolidated revenue of more than €750 million.

This is a matter that will affect all jurisdictions, even offshore centres, says Nik Din. Malaysia estimates implementing it in 2024, it was reported late last year.

“In Labuan, we have only a handful — 10 out of almost 5,000 companies — with global group revenue in excess of €750 million. Therefore, they will be partly affected. If they pay 3% [tax] in Labuan, they have to pay the remaining 12% outside Labuan. So, that will be our challenge. We have a strategy for that but I can’t share it with you yet. Once we firm that up, we’ll make it known on how we want to deal with that matter,” he says.

Nik Din notes that if OECD decides to lower the €750 million threshold in the future, then even more Labuan companies will be affected.

“So, we cannot be competing [with other centres] only on tax, because we know that one day, that importance will go down in rank. So, our challenge is, how do we want to attract talent and new business to Labuan? We have to compete based on quality of service, product, regulation and lifestyle, for example. So, that is a challenge for us. It may not be soon, but in these two, three years’ time … we have to look at other attributes to attract investors and players, to retain players,” he says.

Increasingly, companies affected by Pillar Two tax rules will be looking towards non-tax factors when making investment decisions and decisions on where to locate manufacturing or service hubs or entities, says Anil Kumar Puri, EY Malaysia’s international tax and transaction services partner and international corporate tax advisory leader. 

“Factors such as the availability of talent and skilled labour — including an efficient immigration system — infrastructure, cost, connectivity, a strong financial system, robust legal framework, tax and regulatory consistency and certainty, and ease of doing business are going to become increasingly important. If a group of companies is going to have to pay 15% tax almost anywhere they set up operations, they would look to a country that offers all these non-tax benefits and conveniences ... as opposed to a country that is more difficult or expensive to operate in. So, those are some of the areas that all countries, including Malaysia/Labuan will need to continue to focus on,” he says. 

In Anil’s view, Labuan and Malaysia as a whole are already pretty efficient in terms of companies being able to set up their operations within a short timeframe and operate effectively. “That said, we need to continue to see where we can improve in order to remain an investment destination of choice,” he says.

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