Non-deductibility rules on payments to certain Labuan entities

Exemption from non-deductibility rules on payments to certain types of Labuan entities

Following Budget 2019, Section 39(1)(r) was introduced into the Income Tax Act 1967 (ITA) to provide that a tax deduction will not be allowed on payments by Malaysian residents to any Labuan company, subject to any rules that may be prescribed by the Minister of Finance (MoF). Thereafter, the following were gazetted to set out the relevant rules relating to Section 39(1)(r):

• Income Tax (Deductions Not Allowed for Payment Made to Labuan Company by Resident) Rules 2018 [P.U.(A) 375/2018]
• Income Tax (Deductions Not Allowed for Payment Made to Labuan Company by Resident) Rules 2018 (Amendment) 2020 [P.U.(A) 376/2020]

As highlighted in an earlier alert, the LFSA had issued a circular dated 23 December 2019, stating that the above-mentioned non-deductibility Rules will not apply to certain transactions (see Tax Alert No. 24/2019). The Income Tax (Exemption) (No. 22) Order 2021 [P.U.(A) 425] was gazetted on 23 November 2021 to legislate certain exemptions from the non-deductibility rules. 

The Order provides that a Malaysian-resident is exempted from the provisions of Section 39(1)(r) in respect of payments made to a:

• Labuan company which undertakes a qualifying activity under the Global Incentives for Trading (GIFT) programme
• (b)  Labuan company which has made an election under Section 3A of the LBATA (i.e., an irrevocable election to be taxed under the ITA)
• (c)   Labuan company which carries on a Labuan business activity under Section 2B of the LBATA

Note:

For the purpose of Point (c) above, the “resident” (making the relevant payment) refers to a Labuan company which carries on:

• A Labuan business activity which is not specified in the Schedule to the Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2021 (refer to the article above), or
• An activity other than a Labuan business activity under the LBATA

The following terms have been defined in the Order:

(a) Gift

Programme of incentives for a Labuan International Commodity Trading Company (LICT) to use Malaysia as its international trading base to undertake qualifying activities

(b) Lict

A Labuan company which:

-        Is incorporated or registered under the Labuan Companies Act 1990

-        Is licensed under Section 92 of the Labuan Financial Services and Securities           Act 2010

-        Maintains a registered office in Labuan but is allowed to establish its                         operational office anywhere in Malaysia, and

-        Undertakes a qualifying activity under the GIFT programme

(c) Qualifying activity

Trading of physical products and related derivative instruments in relation to:

-        Petroleum and petroleum-related products, including liquefied natural gas

-        Minerals

-        Agriculture products

-        Refined raw materials

-        Chemicals

-        Base minerals

The Order stipulates that the exemption granted does not absolve the Malaysian resident from any requirement to submit returns, statements of accounts or any other information as required under the ITA.

The Order is deemed to have come into operation on 1 January 2019. The exemptions for Points (a) and (c) above are effective from the year of assessment (YA) 2019 to YA 2025.