Tax comparison – Hong Kong, Singapore and Malaysia (including Labuan)


by Jacy Lau & Peter Searle, EC Trust (Labuan) Bhd, Licensed Trust Company, Labuan, Malaysia

Before deciding upon a location for establishing an international business in Asia, one must first consider alternative locations. Most citizens of British Commonwealth countries naturally look to Asian countries where English is used as the main language or one of the main languages, the government is stable, the common law of England forms the basis for its laws, and which are low- tax jurisdictions.

These criteria right away narrow the list to three practical alternatives: Hong Kong, Singapore and Malaysia (including Labuan).

One of the main criteria fordistinguishing between countries is to compare their double taxation agreement (DTA) network. DTAs have numerous advantages because they prevent double taxation of income. If you operate your international business without DTA protection, it is quite possible for you or your company to be taxed twice. You could be treated as a tax resident of more than one country. And even if you are a tax resident of only one country, you could be taxed in your country of residence as well as the country where the income is sourced.

Malaysia and Singapore win hands down in terms of DTA protection: they have two of the widest DTA networks in the world – about 70 comprehensive DTAs and increasing. By comparison, Hong Kong has only 20 DTAs, most of which were only signed in December 2010 and would not be operative for some time.

One of the main benefits of a DTA is that it deems a taxpayer to be a tax resident of only one of the two contracting states. For example, under Article 4 of the DTA between any DTA country and Malaysia, a dual-tax resident is deemed to be a tax resident only of the state in which he has a permanent home available to him. Similar Articles may be found in most of Malaysia’s and Singapore’s DTAs.

A number of countries have a “territorial” system of taxation such that it is only income sourced in that country that is subject to tax there. A good example in the Asia-Pacific region is Hong Kong. Such countries are not concerned from a tax perspective about residents setting up offshore base companies to derive foreign source income, as they do not tax such income anyway. Liability to Hong Kong profit tax does not depend on remittance, only source. It is the same with Malaysia.

Singapore is not so generous and, whilst it does not tax foreign source income of companies not remitted into Singapore, it taxes Singapore companies on foreign source income remitted into Singapore which has borne less than 15% foreign tax.

The principles in relation to the domestic source of income generally may be equally applicable whether a trade is carried on in the UK, Canada, Australia, New Zealand, Malaysia or Singapore.

The tightening common law rules on source of trading and services income that apply in Hong Kong and Singapore do not apply to Malaysia in general, or to Labuan in particular.

Hong Kong and Singapore companies that seek to avoid local source income so as to avoid their taxes of 16.5% and 17% respectively run the risk of becoming subject to source country taxation. These could be at very high tax rates.

In comparison, a Labuan company will pay tax of 3% of its audited profit, or RM20,000 flat tax by election (US$7,000), regardless of the source of income.

Accordingly, foreigners comparing using a “base” company in Singapore or Hong Kong may find the results more predictable, and agreeable, in Labuan. A Labuan company usually carries on business in, from, or through Labuan, but may also have a marketing office in Kuala Lumpur or Johor Baru.

Under most DTAs, business income is allocated to a taxpayer’s foreign permanent establishment on the principle that it is treated as a separate entity dealing at arm’s length with the taxpayer. If the taxpayer does not have a permanent establishment in the source country, then the business income is only taxable in the taxpayer’s country of residence and is not taxable in the source country. This is particularly advantageous for Malaysian companies, including Labuan companies.

For example, we have used the DTA between any DTA country and Malaysia, to obtain tax refunds of tax withheld, both from the Canadian Revenue Agency and the relevant province, in respect of income which has a source in any DTA country, where the Labuan company does not have a permanent establishment in any DTA country.

DTAs usually provide that income derived by a resident of one country which is permitted to be taxed in the other country in accordance with the taxation treaty is deemed for all purposes of the treaty to be income arising from sources in the other country. This empowers each country to exercise taxing rights allocated to it by the treaty.

Labuan companies are entitled to the benefits of all but 13 of Malaysia’s 70 or so comprehensive DTAs and may obtain the advantage of nearly all of Malaysia’s DTAs by electing to be taxed under the Malaysian Income Tax Act, which taxes domestic income at the rate of 25% and exempts foreign source income from taxation.

As Hong Kong has a “territorial” system of taxation, and as until 1996 Hong Kong had no DTAs, the question of source was, and still is, fundamental to Hong Kong’s right to tax. Until the entry of DTAs, Hong Kong had no need to define a Hong Kong corporate resident as it only taxed income sourced in Hong Kong. Corporate residence is now defined in Hong Kong’s DTAs as incorporation in Hong Kong, or “management and control” in Hong Kong.

If a Hong Kong incorporated company is foreign owned, and owned by residents of a country that uses central management and control as its test of where the Hong Kong company is resident, having its principal place of business outside Hong Kong, to avoid Hong Kong tax, may make it more likely to be taxable in the source country and may raise a doubt as to where the company’s central management and control is located.

In order to prove that the profits from trading in goods bought and sold (or services provided) outside Hong Kong or Singapore do not have a source in Hong Kong or Singapore, the Hong Kong or Singapore company must prove that substantial activity of the company was effected outside Hong Kong or Singapore. This puts the Hong Kong or Singapore company at greater risk of being taxable on its profits in the high tax jurisdictions in which it makes sales. The prolific use of BVI incorporated companies to avoid Hong Kong or Singapore tax only increases the prospect of taxation liability in high tax jurisdictions.

The Hong Kong and Singapore tax problems which have arisen in recent tax cases do not arise in Labuan where the 3% tax rate, or flat tax of RM20,000 (US$7,000), encourages Labuan companies to be taxable on their trading activities “carried on, in, or from Labuan … with non-residents”. Thus, there is greater flexibility in relation to trading in goods (or provision of services), thereby reducing the risk of assessment to the base company in the high tax jurisdictions with which the base company trades.