Bank governor says Labuan must upgrade tax regime and spread wealth to ensure survival

Labuan International Business and Finance Centre (IBFC) needs to ensure that the local community benefits from its economic activity, become a more diversified and sustainable economy, and enhance tax incentives so that they are on a par with international best practices.

These are the three major challenges facing the IBFC, according to Muhammad bin Ibrahim, governor of Bank Negara Malaysia, the territory’s insurance supervisor, speaking at the Labuan industry annual dinner at the end of October.

Mr bin Ibrahim pointed out that after two and a half decades, Labuan is now home to close to 14,000 companies, 54 banks, more than 200 insurance-related entities, foundations and leasing companies. Unfortunately, however, there has not been enough “spillover benefits” to the local community, he said.

The governor said wealth inequality and unemployment, particularly among women, remain big problems in Labuan and need to be tackled.

“This state of affairs is disappointing and cannot persist. It reveals that an improvement in the current economic operating model is warranted. A new model must be designed that can benefit the local community in a more meaningful manner. Without doubt, it is our collective duty as an industry, whether as regulators or industry players, to advance the welfare of society through a more inclusive economic development. The success or failure to achieve this will reflect on us all as a collective,” said Mr bin Ibrahim.

The governor pointed out that Bank Negara Malaysia is playing its part through the creation of undergraduate scholarships to two deserving local students. It is now time for the offshore industry in Labuan, which he said has benefited significantly from Labuan since its inception, to “give back”.

Mr bin Ibrahim suggested innovative and creatively designed technical and industrial training that can improve the job prospects of local talents. “Strong commitment by industry captains to grant similar opportunities, apprenticeship and fit-for-work schemes, will surely hasten the upskilling of the locals. The industry ought to come together to devise a scheme that gives opportunities to locals to get good jobs,” he said.

The second big goal is to transform Labuan’s economic structure to become more diversified, resilient and sustainable, said the governor.

The finance and oil and gas sectors have been the main economic contributors to the island’s economy in recent times and now represent more than half (51%) of the economy. The fall in oil prices since 2015 has revealed the vulnerabilities of Labuan’s economy to the volatilities in the external environment. “The focus on only these two sectors has unwittingly elevated the concentration risk on the island’s economy and the associated employment,” said the governor.

The financial sector has not performed as well as was hoped in comparison with other international financial centres, said Mr bin Ibrahim.

He pointed to the Mauritius International Financial Centre, which was established around the same time as the IBFC, in the 1990s. The contribution to GDP of the Mauritius financial sector is 10.4% with an employment and tax revenue share of 4.5% and 6.5%, respectively.

The governor added that other financial centres which entered the game much later, such as Shanghai, have moved even further ahead in terms of tax revenue generated and job creation. The 2017 Global Financial Centres Index ranks Shanghai at 13th, with Mauritius in 73rd position. Labuan is currently not even ranked in the Index. “What this alludes to is that continuous reinvention of financial offerings by our market players is necessary for the IBFC to build a niche and gain international prominence,” he said.

The third key plank for Labuan’s future needs to come through rationalisation of tax incentives to bring them into line with international practices.

Mr bin Ibrahim pointed out that calls for greater regulatory harmonisation and the adoption of international best practices since the credit crisis of 2008 have gathered speed.

This has blurred the distinction between onshore and offshore regulatory requirements. “Offshore financial centres which remain mired in the old model and thinking are set to become part of a sunset industry,” he said.

The governor added that there have also been significant advances in international taxation practices. “Authorities are now more proactive in seeking to mitigate the distortionary effects of harmful tax competition on the allocation of resources and its negative implications on national tax bases,” he pointed out.

Malaysia, until early this year, had been an observer of the Organisation for Economic Co-operation and Development’s (OECD) Inclusive Framework on Base Erosion Profit Shifting (BEPS). Since January 2017, the country agreed to become a participating member in the Inclusive Framework.

Mr bin Ibrahim said this will allow Malaysia to participate in the BEPS-related work on an equal footing with other OECD and G20 countries. It will also enable it to help shape the content of the BEPS-related standards.

Work has also started on analysis of respective jurisdictions’ preferential tax regimes against the standards outlined to combat harmful tax practices. “The standard which forms one of the four BEPS minimum standards, will require authorities to step up on transparency and substance rules for geographically-mobile activities, such as financial services,” explained Mr bin Ibrahim.
“It seeks, for one, to prohibit the shifting away of income into preferential tax regimes where businesses have little or no economic activity. Such international developments will directly influence IBFC’s business model going forward,” he added.

“The world that we live in, since the creation of offshore Labuan in the 1990s, has drastically changed. What was relevant then is [not] relevant now. We have no choice but to change with it. It is an opportune time for us to review the current tax framework for Labuan,” announced Mr Ibrahim.

The governor said the purpose of this review will be to ensure alignment with international best practices and also to confirm the continued relevance of such incentives in catalysing new growth areas.

He said that tax incentives for businesses which have become irrelevant should be “rationalised”. The allocation of any preferential tax treatment must be supported by clear value propositions that are systematically measured across the qualifying period, added the governor.

“Businesses that enjoy tax incentives will be benchmarked against the performance indicators that quantify economics and financial benefits. This is not meant to be onerous. It is a necessary tool to ensure that the economy grows in an inclusive and sustainable way and the public policies implemented bear the intended benefits,” explained Mr bin Ibrahim.

He said that for financial industry players, any “preferential” treatment must be coupled with clear business strategy that contributes positively to the national and the local economy.

“The intended outcome of the revised tax structure would enhance the economy of Labuan with balanced development. The revised tax regime should also improve regulation, compliance and prevent tax leakages,” said Mr bin Ibrahim.

“There will be greater and closer cooperation between the authorities to address any regulatory arbitrage. The enhancement is also consistent with our continued commitment to advocating strong transparency and promoting greater fiscal sustainability. The review of tax incentives is also to preserve the IBFC’s reputation and competitiveness,” he added.

“It is not an option for us to remain where we are. We must embrace the new reality, change course and design a new strategy for our industry. Or else we will perish. We are in this as a community. As I said last year, we need to swim or we will sink, together,” concluded the governor