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Labuan Substances Requirements Regulations Invalid in Law

posted 9 months ago

Recently, the High Court in Bright World Trading Co Ltd & Ors v Director General of Inland Revenue & Anor and Other cases [2023] 6 CLJ 538 held that, amongst others, (a) the Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2018 [P.U.(A) 392/2018] (“2018 Regulations”) and Labuan Business Activity Tax (Requirements for Labuan Business Activity) 2018 (Amendment) Regulations 2020 [P.U.(A) 375/2020] (“2020 Regulations”) are invalid in law, and (b) the Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2021 [P.U.(A) 423/2021] (“2021 Regulations”) can only be applied prospectively.

The salient facts of Bright World (supra) are as follows:

a. There were 103 applicants which filed the judicial review applications to challenge the validity of the 2018 Regulations, 2020 Regulations and 2021 Regulations as well as the decision made by Minister of Finance (“MOF”) in his letter dated 1.4.2021 (“MOF’s Letter”).

b. The Schedule of 2018 Regulations set out the substance requirements that a Labuan entity need to meet in order to be regarded as carrying on a Labuan business activity. The substance requirements in the 2018 Regulations were further amended by 2020 Regulations.

c. If the substance requirements under the Schedule of 2018 Regulations are not met, then such Labuan entity will be subjected to the tax rate of 24% for that year of assessment under the Labuan Business Activity Tax Act 1990 (“LBATA”).

d. The MOF’s Letter endorsed and accepted the Inland Revenue Board of Malaysia’s position (“IRB”) that Labuan business activities that are not being listed in the Schedule to the 2018 Regulations, would automatically be subject to income tax under Income Tax Act 1967 (“ITA”) and no longer eligible for the lower tax rate at 3% on their chargeable profits under Section 4 of the LBATA.

e. Subsequently, the 2021 Regulations revoked the 2018 Regulations and set out the new substance requirements in its Schedule which is being applied retrospectively with effect from 1.1.2019. Any Labuan entities which failed to comply with the new substance requirements will subject to income tax under the ITA.

The High Court held that, amongst others:

a. The 2018 Regulations are ultra vires and invalid because:

i. It was the Deputy Prime Minister who made the 2018 Regulations.

ii. The Yang di-Pertuan Agong did not confer or designate the Deputy Prime Minister with the function and responsibility for the country finance under Section 2 of the Ministerial Functions Act 1969.

iii. There are no provisions under the LBATA which empower or authorise MOF or anybody to further sub-delegate power to make regulations under Section 2B(1)(b) of the LBATA.

b. Since the 2018 Regulations were not validly made at the first place, the 2020 Regulations have no effect too.

c. Hence, the MOF’s Letter which premised upon the 2018 Regulations (as amended by the 2020 Regulations) was made in excess of authority and liable to be quashed.

d. The 2021 Regulations cannot be applied retrospectively with effect from 1.1.2019 as:

i. It is impossible for all the applicants to now go back in time to 2019 to fulfil the substance requirements.

ii. There is no express provision in the LBATA which empowers the MOF to make regulations retrospectively.

iii. The 2021 Regulations made by MOF cannot take away the vested rights of the applicants by virtue of Section 20 of the Interpretation Acts 1948 and 1967.

e. Thus, the 2021 Regulations can only be applied prospectively.

f. Accordingly, the applicants only subject to tax under Section 4 of the LBATA and not Section 3B of the ITA.

Comments

This is a landmark decision which decided on the validity of the 2018 Regulations, 2020 Regulations and 2021 Regulations. When these regulations were gazetted, many questions and uncertainties entailed as many lacunas were observed.

Now, the High Court had ruled that 2018 Regulations and 2020 Regulations were invalid and thus no substance requirements were available at that material times for the Labuan entities which carrying on Labuan business activities to follow and thus subject to tax under Section 4 of the LBATA.

Although the IRB is now appealing against the High Court’s decision, many Labuan entities would be able to heave a sigh of relief for now. What interesting is that the 2021 Regulations were held by the High Court to be applied prospectively effective from 19.11.2021. Such decision gave a new timeline for the Labuan entities to check against its compliance status in accordance with the 2021 Regulations.

Note, however, this High Court’s decision is silent on the commencement date of regulation 3 of the 2021 Regulations which is in relation to control and management in Labuan. Following this decision, would there be a recourse or a remedy for the Labuan entities which ‘failed’ to comply with the 2018 Regulations, 2020 Regulations and 2021 Regulations to now take action and bring themselves back to the tax regime of LBATA?

Speak to HHQ Tax Team now to understand more about the potential legal remedies and your rights as a taxpayer.

 

About the authors

Desmond Liew Zhi Hong
Partner
Tax
Halim Hong & Quek
[email protected]

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