An offshore bank is typically a bank thats outside your country of residence. They typical impose only a low or in some case's a nil rate or tax, confidentiality for all clients, minimum reporting requirements, political and economic stability. The origins of the offshore banking industry are found in a group of islands off the Northwest coast of France.
Offshore banking is basically the cross border intermediation of funds and the provision of services by banks that reside in OFCs to non residents. Offshore banking seems to be particularly appealing option especially to the heavily regulated and maturing financial markets of emerging economies. Mostly economies that have high growth rates and those that is in need of investment financing. Emerging economies seems to be using offshore as their channel.
Benefits of Offshore Banks
1) Potential tax efficiency: No tax deducted on interest earned. Interest on our offshore accounts is paid without the deduction of tax†Offshore income may not be subject to tax. Depending where you live, income on an offshore bank account or investments may not be subject to tax in your country of residence, if that money is not remitted into your country of residence, no inheritance tax, capital gains tax or death duties. Jurisdictions such as the Isle of Man and Jersey, Channel Islands have no inheritance, capital gains taxes or death duties (probate may be required in certain circumstances)
2) Convenience: One bank wherever you go. Investing your money offshore allows your finances to remain and grow in one place as you work or travel around the world. Wherever in the world you move, you'll have a bank that understands your needs and can provide financial solutions tailored to meet those needs 24/7. Offshore banks have sophisticated internet banking and multi-lingual call centre services. These allows the investors to have access to their money or anything regarding their money 24/7.
3) A safe haven: Offshore centers protect ones assets. For instances; If one lives in a country that is politically or economically unstable, placing your money offshore offers protection for your assets. In times of economic instability, banking offshore provides a safe home for your money. Offshore accounts are not governed by your country of residence but by the laws of the offshore jurisdiction where they are held.
There are a number of advantages to offshore banking and finance, such as:
Trouble-free access to accounts,
Increased privacy
Less legal regulations
Protection from government orders to freeze or seize financial assets.
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PART 2: LIRERATURE REVIEWS
REVIEWS ON LABUAN IBFC
In 1990, the island of Labuan was nominated as Malaysia's official offshore financial hub where it operates under the name of Labuan International Offshore Financial Centre until the end of 2007 in which the centre grew up both in reputation and financial standing during that time.
However, in January 2008, the name Labuan International Business and Financial Centre (Labuan IBFC) was introduced to reflect the jurisdictions' growth and rapidly increasing in international status. In addition, the jurisdiction of marketing division of Labuan IBFC Inc. Sdn. Bhd. was incorporated in July 2008 too as the official agency authorized by the Malaysian government. This is in relation to market, promote, and otherwise serve as the world's point of contact for Labuan IBFC. Besides, Labuan IBFC also continues to structure new products, services, and regulatory environment where it is able to play an important and legitimate role in international trade and finance while offering significant advantages for corporations and individuals.
Labuan International Business and Financial Centre (Labuan IBFC) is regulated by the authority of Labuan Financial Services Authority (Labuan FSA) which was previously known as Labuan Offshore Financial Services Authority (LOFSA) after the new legislation came into force on 11th February 2010. Basically, Labuan FSA regulates the legislative and legal framework of Labuan IBFC operation.
Labuan Financial Services Authority (Labuan FSA) was set up on 15th February 1996 as a single regulatory body to lead and coordinate efforts in promoting and developing Labuan as an International Business and Financial Centre (IBFC). Furthermore, the establishment of Labuan FSA is emphasized with the government's commitment in order to make Labuan high in reputation as the most excellent IBFC.
Besides, Labuan Financial Services Authority (Labuan FSA) is also expected to restructure the government mechanism in supervising the International Business and Financial Centre (IBFC) to carry out research and development works in order to draw up plans for further growth and greater efficiency for the Labuan.
FEATURES OF LABUAN IBFC
Tax
Preferential tax regime
No capital tax gains
No withholding tax on dividens, technical fees, interest and royalties
No tax on investment holding activities
No stamp duty on instruments related to offshore business activities
General
Minimal foreign exchange control regulations
Confidentiality
Availability of banking facilities
Good infrastructure, including telecommunications and transport
Availability of support services such as management, legal and accountancy services
Politically and economically stable environment
Competitive operating costs
OFFSHORE COMPANIES
Only one director and one shareholder required
Coporate directors permitted
No minimum share capital requirements
No debt to equity ratio requirements
No debt to equity ratio requirements
Quick and easy incorporation
Branches of foreign companies, offshore trusts and offshore limited partnerships may also be established in Labuan IBFC.
Increase literature review
PART 3: ANALYSIS AND FINDINGS
3.1 THE LABUAN IBFC
Labuan IBFC is used for :
Trading
Investment holding
Leasing
Fund management
Patent and royalty companies
Money broking
Issue of financial instruments, both conventional and Islamic
Acquisition, merger, re-construction and tax planning exercises
Banking and insurance
Mutual funds and unit trust funds
Company management
Partnerships for projet management and certain professions
Estate planning and family trusts
The Labuan IBFC has several advantages in the conduct of offshore business which have attracted international institutions to set up a base in Labuan. Some of these advantages include:
-A competitive tax regime. The tax rate imposed on offshore companies is among the lowest in the world. Non- trading companies such as investment holding companies are totally exempted from tax.
-Political stability in the country which is a essential factor in the investment decisions of the potential players.
-Lower operating costs compared with other financial centres in the region i.e. setting-up cost, professional fees charged by accountants, lawyers and other professional service providers
-Easy access by air. Labuan is easily accessible by air (within 3-4 hours) from many capital cities in the region such as Hong Kong, Bangkok, Jakarta, Manila, Brunei and Singapore. An added advantage of Labuan is that it shares virtually the same time zone with most of these cities making the conduct of business extremely convenient.
The growth of Labuan IBFC has been slow in the initial years but recently it has been able to establish a reputation for accessibility, clarity, proactiveness and an orientation for quality customer service. The attractiveness of Labuan has been further enhanced with new incentives and policies to ensure Labuan stays competitive. The objective of the plan was to evolve a competitive, dynamic and resilient financial system that could face the challenges of globalization and withstand the economic cycle (Swire, 2001).
In addition, in order to attract more institutions to the Labuan IBFC, the offshore banking industry in Labuan will also no longer be restricted to the top 200 banks, but instead extend to financial institutions with sound track record, accorded a good ranking by acceptable rating agencies, supervised by an appropriate regulatory body and conform to generally accepted standards of international banking practices. With this, the Labuan IBFC will be poised to move ahead to expand the offshore banking industry.
As part of measures to make the Labuan IBFC an attractive investment centre, the legal framework was improved further to provide a conducive environment for the development of diversified offshore financial activities. The existing legislation continues to be reviewed to make the necessary regulatory changes to facilitate the expansion and deepen the offshore financial services industry.
Offshore general insurers were also allowed to underwrite domestic large and specialized risks. And in an effort to increase national retention of insurance premium, all offshore reinsurance by Malaysians were required to be channeled to Labuan reinsurance companies before going overseas. Further, large Malaysian companies are allowed to set up captive insurance companies in Labuan.
Swire (2007) reported that the Malaysian Finance Ministry is working with the financial authorities of Labuan to create a new tax structure aimed at attracting more companies to the Labuan IBFC.
The Labuan IBFC has developed into an active international centre for Islamic finance in recently, regionally and global, supported by an infrastructure that provides the establishment for the promotion of Islamic financial services. The Shariah Advisory Council is part of this infrastructure, which advises LOFSA on matters relating to Shariah-approved financial instruments in Labuan IBFC. This has paved the way for a more efficient and effective beginning of innovative and new Islamic financial instruments.
The current liberalization of exchange control administration rules by Malaysia is expected to benefit players in Labuan IBFC. Increased investments in ringgit assets for non-resident investors should transform into greater opportunities for product enhancements. Offshore players are also anticipated to also take advantage of opportunities emerging due to increasing trade linkages with regional economies and other parts of the world, facilitated by the more flexible exchange control administration.
The Labuan IBFC is said to be repositioning itself, as offshore centre's become more competitive. Labuan IBFC is doing so through the identification of niche businesses, looking outside traditional products and services and capitalizing on its strengths.
3.2 THE ISSUES ON OFFSHORE BANKING AND FINANCE
Although offshore banking has important implications for the financial systems, there are some issues that are linked to Offshore Banking and Finance.
Limited accessibility
Offshore jurisdictions are located in remote areas thus it can become more costly to those investors who have to physically visit the bank. The advancement of global telecommunications technology may not be a substitute for having access to in-person documents and service yet. This can be quite expensive and impractical for the investors who have to visit an offshore. Besides, offshore banking and finance are also more reachable to those with higher incomes where the costs of having an offshore account are much larger than those from normal banks.
Association with the underground economy
The association of Offshore banking and finance with underground economy has long been prevalent where the black market and other organized crimes such as money laundering are involved.. After the event of September 11th, 2001 happened, tax havens in offshore banking and finance, and clearinghouses were also indicted the supporting from various terrorist groups, organized crime gangs, and other state or non-state groups. The existence of offshore banking and finance also support tax evasion because offshore banking and finance provide tax evaders with a convenient place to deposit their hidden income and wealth.
Not ideal for developing countries
The speed of funds called "hot money" that is being transferred in and out from one country to another negatively impacts developing countries that practice offshore banking and finance. This "hot money" is then supported by offshore accounts and may be the source of increased problems concerning financial instability. Besides, the tax burden in the developed countries tends to fall disproportionately upon the middle income groups. Moreover, avoiding from paying tax will lead to a higher tax proportion paid by high income groups. Nevertheless, many of these groups are able to use offshore banking and easy money transfers out of the country to avoid paying the taxes owed.
Taxation
Originally offshore centre's where prominently known for facilitating structures which helped to minimize exposure to tax. Due to tax avoidance, this has led to a decrease in success of offshore centres, resulting in tax neutrality of some offshore banks. Some issues regarding tax is, accusations from pressure groups suggesting that no tax or very low tax creates unfair tax competition, for example less developed countries benefit from tax revenue, therefore they cannot afford to keep up with developed nations who choose not to tax clients.Traditionally, offshore centers provided services aimed at those wishing to minimise their tax liabilities. Offshore companies incorporated in tax haven jurisdictions would be used for tax-efficient and confidential holding of assets or tax-efficient trading. According to Keneally, K. and Rettig, C. P. (2009), In July 2008, the U.S. Senate Permanent Subcommittee on Investigations reported that the United States is estimated to lose $100 billion annually in tax revenues to offshore abuses.
5.Investors not protected by the law
According to an article written by Lim, J. (2007), the writer mentioned that according to ASIC executive director of consumer protection Greg Tanzer, investors should take extreme care when investing overseas as they might not be protected by the law of the country they reside in, which in this case was Australia. "If you take up an offer of securities from an overseas entity that has not complied with Australian law or deal directly with an overseas broker, you may lose the protections provided by Australian law," he said.
Scrutiny
Non-cooperative jurisdictions are common in offshore banking, these are financial centre's that don't usually meet the international standards because they do not adhere to the regulations set or do not follow the supervisory bodies.
7. Regulation
Another issue facing offshore centre's is the light regulatory requirements; it brings some benefits to offshore centres but has some disadvantages as well. For this reason of having lighter regulatory requirements, clients are attracted to these centres because it seems less complicated to deal with. Due to light regulatory requirements offshore centres are perceived as being venues for laundering the proceeds of illicit activity.
8. Confidentiality
Among many elements that make offshore centres attractive is that they provide high confidentiality of clients bank accounts. This has become an issue because some of these bank accounts are being used for money laundering purposes. Even though it's the duty of a bank to provide confidentiality about a client's bank account FATF (Financial Action Task Force) has the right to obtain information regarding suspicious banks.
Statutory banking secrecy is a popular feature of several offshore centre's; however, many financial centre's do not have such statutory right, financial information has to shared about foreign residents who are suspected of evading home -country tax by their respective jurisdictions.
The days when jurisdiction sought out illegal monies or terrorist moneys are long gone. Mitchell (2005) mentioned that there has been a huge change in the offshore world where regimes such as that of St Vincent and the Grenadines that once used the slogan of "strictest privacy" have embraced the fight against money laundering and terrorist financing and introduced operational regimes to ensure this.
However there is still confidentiality but it comes in relation to the reason why the customer needs confidentiality. If one needs confidentiality to protect the fact that their money is illegal, confidentiality will not be granted. In most offshore centers that find it critical about being reputable members of the international financial community, there is protection of criminal money. There is in fact a place highly efficient mechanism for the sharing of information in relation to charged or suspected criminal activity. However the playing field is not level even in the sharing of information in relation to criminal activity. The playing field is even less level when it comes to confidentiality that is afforded to civil matter such as information that is relevant to taxation. ( Mitchell, 2005)
9. Effects on international trade
Offshore centre's make it easier to carry out global trade and ease international capital flows. International joint ventures are often structured as companies in an offshore jurisdiction where by neither party in the venture party would like to form the company in the other party's home jurisdiction to avoid unwanted tax consequences. Most offshore financial centre's still impose little or no tax, the increasing sophistication of onshore tax codes has meant that there is often little tax benefit relative to the cost of moving a transaction structure offshore.
Recent research has examined the effects of offshore financial centre's on the world economy, and it was found out that there is a high level of competition among banks in such jurisdictions to raise liquidity in nearby onshore markets which have close relationships with offshore centre's.
Lack of comprehensive and up-to-date data
This lack of comprehensive and up to date data on OFCs' financial activity impedes effective monitoring and analysis of capital movements. In his journal Crockett (2000) mentioned that the available banking stock data indicate roughly US$1.4 trillion in deposits by reporting banks vis-à-vis OFCs at end June 1999. Even for banking activity, however, this is likely an underestimate as the available data are incomplete, lack timeliness and do not include off-balance sheet activities, which are believed to be substantial. Discussions that were held with financial market participants suggest that the magnitude of flows through OFCs is significant and increasing. Considerable efforts have been undertaken in recent years by national authorities and international financial agencies to improve statistics on debt and capital flows. Most onshore jurisdictions with significant financial activities provide, on a voluntary basis, relevant and timely data to the BIS for its Locational Statistics. Not all OFCs with significant financial activities report to the BIS, and many that do report with long delays and without the requested breakdown of their claims between debt securities and other claims.
Monetary stability
Dong He and Robert N McCauley (2010) in their journal mention that the development of offshore markets in a given currency poses several challenges to a central bank's responsibility for maintaining monetary stability. An offshore market in a given currency can increase the difficulty of defining and controlling the money supply in that currency. Equally, an offshore market in a given currency can pose a challenge to measuring and controlling bank credit. For example, domestic firms and households, perhaps through the aggregation of some non-bank financial institution (like money market funds), can substitute offshore deposits in the domestic currency for onshore ones. If these in turn are lent back into the economy (so-called round-tripping), hard-to-measure and hard-to-control offshore deposits and credit can substitute for their domestic counterparts. If monetary policy is based to some extent on the control of money or credit, then the effect of offshore use of the currency on money or credit should be factored in when setting monetary or credit targets or monitoring ranges.
They continue to say that offshore activity in the currency might also affect the shape of the yield curve or the exchange rate. According to McCauley (2010), policymakers would have to factor the effects of overnight rate into their inflation forecasts and set the short-term interest rate with a vision to targeting inflation and growth.
PART 4: COMMENTS AND RECOMMENDATIONS
The Labuan IBFC links in to the global economy along three dimensions
Regulation
The legislation that governs all Labuan offshore companies is the Offshore Companies Act 1990 (OCA 1990). The body responsible for regulating Labuan offshore companies is Labuan Offshore Financial Authority (LOFSA). Labuan FSA's role and functions include: processing applications and supervising international financial and business activities done out of Labuan IBFC; developing national objectives, policies and setting priorities; administer and enforce legislation; incorporate and register Labuan companies. On the stock market side, Bursa Malaysia is the main regulator and regulates and operates the trading activities in Malaysia.
The following acts represent regulating authorities in Labuan:
Offshore Companies Act 1990
Offshore Banking Act 1990
Offshore Insurance Act 1990
Labuan Offshore Trust Act 1996
Labuan Trust Companies Act 1990
Labuan Offshore Limited Partnerships Act 1997
Labuan Offshore Securities Industry Act 1998
Labuan Offshore Business Activity Tax Act 1990
Income tax (Amendment) Act 1990
Exchange control Act 1953
Banking Institutions:
For offshore banking to take place in Malaysia, it has to be carried on in Labuan by an offshore company or a foreign offshore company that is incorporated or registered. Involved also is an office, branch or subsidiary of a licensed Malaysian bank.
Insurance Institutions:
The Offshore Insurance Act 1990 provides the legislation for licensing and regulating persons carrying on offshore insurance businesses such as direct insurance, captive insurance, reinsurance and other insurance related activities such as insurance management, underwriting and insurance broking. All types of insurance are covered by offshore insurance except for the insurance of high net worth individuals.
Offshore insurance business may be carried on in Labuan by an offshore company, a foreign offshore company and a branch of a licensed Malaysian insurer. The application for an offshore insurance license is vetted by LOFSA and approved by the Minister of Finance.
Labuan Financial Exchange
The Labuan Offshore Securities Industry Act 1998 laid down a basis for the opening of a securities exchange and for the establishment and supervision of investment management companies.
Amendments in the Labuan Offshore Security Industries included several updated provisions relating to private funds and allowed finance managers to supervise and administer foreign funds in Labuan. In October 2000, the Labuan International Financial Exchange (LFX) was officially launched. It trades in financial instruments such as equities, investment funds, debt instruments and insurance-related instruments and it is wholly owned by the Kuala Lumpur Stock Exchange. It is seen as one of the key components in promoting Labuan as an offshore financial centre, as a prospective centre for Islamic finance.
LFX has no restrictions on the type of financial instruments and no pre-determined minimum quantity for listing, and there is no requirement for participants to have a physical presence in Labuan as well. Trading is done on its electronic bulletin board and trading agents place their interests to buy or sell on the board and conduct their own negotiations.
Trust Companies:
To carry on a trust business in Labuan, a trust company must be incorporated or registered under the Malaysian Companies Act. the offices of the trust company are privy to confidential information, meaning they would not disclose any information unless requisitioned by a court.
4.1.2 Location
(Map of Labuan from maps.google.com.my)
The island of Labuan is Federal Territory under the administration of the Federal Government of Malaysia and is located off the south-western coast of the East Malaysian State of Sabah in the heart of South East Asia, and faces the South China Sea. It comprises of the main island of Pulau Labuan and six smaller islands namely Pulau Kuraman, Pulau Daat, Pulau Rusukan Besar, Pulau Rusukan Kecil, Pulau Papan and Pulau Burung. It is located at 05 latitude North and 115 longitude East, and lies approximately 10 km southeast off the coast of the East Malaysian state of Sabah.
Function
Labuan IBFC provides a wide range of products and services including banking, investment banking, leasing, insurance and insurance-related, trust business, fund management, company management services and capital market activities, both conventional and Islamic. The functions established for Labuan IBFC are as follows;
- To compliment Kuala Lumpur as a regional financial centre, strengthen the contribution of the financial services sector to the gross national product of Malaysia, and promote the economic development of Labuan and its vicinity.
-To be accountable for setting national policies, objectives and priorities for the organized development and management of the Labuan IBFC.
- To be responsible for the support and expansion aspects of the IBFC and recommend to the Government on new measures to speed up the growth and development of the Labuan IBFC. Focus will be directed particularly on promoting and coordinating the "software aspects" of the IBFC such as policy and legal matters, while the physical infrastructure ("hardware") side continues to be coordinated by the Labuan Corporation.
- To oversee the activities and operation of the Labuan financial services industry and to process applications to conduct business in the Labuan IBFC specifically in Labuan banking, trust and fund management, insurance and insurance related business incorporating and registration of Labuan companies as well as for the setting up of Labuan trust companies
- To administer and enforce the financial services legislation and work together with the industry players in Labuan IBFC to promote Labuan financial services. The Labuan legislation which the Authority presently has to administer, enforce, carry out and give effect is listed in the legislation section.
SOLUTIONS TO THE ISSUES OF OFFSHORE BANKING AND FINANCE
Keneally, K. and Rettig, C. P. (2009) quoted IRS framework for citizens that tries to avoid taxation. They mentioned that according to the IRS failure to file tax return a penalty may be imposed in certain circumstances, amounting to five percent of the net tax amount required to be shown on the tax return for each month or fraction thereof, to a cap of 25 percent, with an increase to 15 percent and a cap of 75 percent if fraud is established. While in cases of failure to pay taxes, the memorandum noted that a late payment penalty may be imposed equal to 0.5 percent of the late payment monthly with a cap of 25 percent.
In such cases the government should try to implement some law that protects their citizens incase something malicious happens to the offshore accounts. There is no way country residents or citizens will stop investing in offshore centers more especially when they feel offshores offer their investment a safe haven.
In a research done by Keneally, K. and Rettig, C. P. (2009) the IRS has a series of documents providing for managerial oversight of offshore cases and setting out a penalty framework to be applied in those cases in which the taxpayer makes a voluntary disclosure of offshore issues. The memorandum summarized that U.S. citizens, residents, and certain other persons are required to report interests in or signature or similar authority over financial accounts outside the United States that exceed $10,000 in the aggregate in a given year
Many of the countries consider or actively use the offshoring strategy as an instrument to decrease the labor costs, to achieve new technologies and to try to stay competitive worldwide Juma'h (2007) . Offshoring serve production chain of low costs regions and guarantees that through the Foreign Direct Investment there is transference of technologies from foreign countries to local countries.
First and foremost offshore banking has a impediment on the issue of frictions that are associated with tax regimes, the overly stringent regulatory frameworks, the restrictions on Capital flows. In offshore Banking, there are dubious activities involved that in a way continue to make offshore a pervasive activity especially in terms of the number of OFCs and the volume of transactions carried out in different centers. To solve this issues there could be further harmonization of tax regimes and better prudent frameworks, coupling increasingly universal implementation would definitely regulate questionable activities been carried out in offshore centers.
It is clear that offshore Banking has a problem of clients.It is difficult as a client to gauge the financial health and the stability of an offshore bank.It is also very difficult to gauge the political and economic stability of the country in which an offshore centre is located.This is beause most of the centres are usually smaller countries and islands.This problem can be solved by opening offshore centres in major developing and emerging economically and politically known countires that would attract more clients.
Also this issue of clients can be solved by clients making sure that the offshore centre they are dealing with has some affliates with some known bank.Another issue would be offshore centers been highly leveraged.This could be because of operational leeway.Leeway is basically a shift or drift in operation.This could be as a resul of poor management and internal controls.It coul also be as a result of an internal explotation of less stringent regulations in place that remains as an open question.This issue can be solved by offshore excutives choosing the right expetise and the right skilled management to take care of the internal management of transations and the whole operations of an offshore center.The regulatpry advantages that permit significant number of offshore banks to be more profitable than onshore banks may allow them to be more leveraged when there is an accounting risk.This is because they have a greater liberty of managing their balace sheets.
It is possible that offshpre banks may allocate a higher proportion of assest to higher risk, higher retun activities.Basically the ration of capital to risk weighted assets of offshore declines than that of onshore banks.So this problem can be solved by offshore banks paying more attention to their leeway operations as it may result in them been more leveraged then onshore banks especially when accounting for the risk of rsk compositon of portfolios.
There are also allegations of money laundering that involves the passing of funds through the offshore centers banking accounts. This is one of the dubious activities that people associate with offshore banking that has been a challenge in its operation. Most of the time there aspects associated with money laundering. First and foremost, the allegations of the sources of funds raise issues. This aspect is basically aimed at illegal drug business for example'
PART 5: CONCLUSION
As a conclusion, offshore banking and finance is a huge field and a significant part of the international financial system. Offshore banking and finance activities have always been viewed as possibly having some illegal component. In fact, it is a simply valid and legal activity that has been reviewed by knowledgeable attorneys and accountants.
Labuan should continue to strive to maintain its clean image, and at the same time endeavor to promote more activities and services to become a truly integrated service provider centre. New activities and innovative products are should be continuously developed in Labuan, which will benefit investors, as well as provide them with avenues to take advantage of the wide spread investment opportunities in the region and use Labuan for such purposes.
the focus now must be to build on their strength. It also said that several areas could be further developed, such as the banking and insurance sectors, and the concerted promotion of Labuan as a meeting and conference centre.
