Reasons Behind the Maintenance of Tax Substance

Reasons Behind the Maintenance of Tax Substance

Labuan companies are enjoying the favorable working environment in Labuan. You must be wondering why is Labuan. So, the major reason behind its operations in Labuan is the beneficial tax treatment that is offered by the host country. In this article, we will highlight the reasons for maintaining tax substance in Labuan.

The era when an offshore company could use a mere registered address are about to become a practice of the past, because the local and international tax authorities have modified the offshore businesses maintenance and Income & Profit Laws to bring more transparency in taxation systems.

The increasing importance of business substance is a consequence of the implementation of Automatic Exchange of Information (AEOI) by the Organisation for Economic Co- operation and Development (OECD). The tax authority is also vigilant as it is in continuous monitoring of the tax evasions. Till date, more than 200 tax authority firms are constantly taking interest to reflect their tax systems by sharing the information regarding financial accounts (like brokerage accounts, mutual funds and banks). This will ensure in the transparency of accounts as all your foreign entity accounts will be presented to your local tax authority.

Very often, the company might encounter double taxation when tax resident based in Labuan lacks of economic substance/ tax substance. The company is considered for doing the tax residency with more tax substance’s areas. As a consequence, the Labuan company is subjected to paying tax in foreign corporate and Labuan income tax.

A Closer View at The Business Substance

Some might have not known the business substance clearly so they may encounter following questions:

  • From where the business is controlled and operated in Labuan?
  • What is the nature of the business and whether it is working in Labuan or not?
  • Where are the higher management functions and their roles and duties in the host country?
  • When and where the meetings of directors are conducted?
  • Where is the physical appearance of the company, warehouse and its associated establishment?
  • Do they have hired staff in Labuan?
  • What are the financial assets of the company in Labuan and its jurisdictions?
  • Where are the bank accounts of the company?
The business substance is described as the working reality of the corporate structures comprising of office, bank account, personnel, sale proceeds and top management’s decision making (Dig1). It reflects and the legitimacy of the business is proved. The corporate structure is related to these measures in relation to the level of real economic activity or in another way. The business substance is more importantly about the having of the infrastructure and personnel in the perfect place on the right time as well as with the doing of proper things.
Cycle of Business Substance

Maintaining tax substance is very important for Labuan entities in order to mitigate exposure to foreign tax jurisdiction authority. Companies founder should be aware with missing substance run the risk of (1) double taxation of income within a cross country value chain, and (2) challenges from tax authorities with the risk tax audit, penalties and court cases.


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