The issuance of the guidelines was a clear demonstration of the commitment of the Malaysian government to participate in the Inclusive Framework on Base Erosion Profit Shifting (BEPS) Action Plan as a BEPS Associate. However, the Guidelines are not clear in terms of what existing and future Labuan leasing companies need to practically do in order to comply with them.
This briefing paper explores some of the matters discussed at the symposium, being the drivers for the Guidelines, what clarifications on the operational and substance requirements were provided, the points discussed and issues raised at the symposium and also our thoughts on the clarifications which were provided.
Drivers for the Guidelines
As mentioned previously, a key driver for the Guidelines was to ensure Labuan becomes BEPS compliant. This commitment was repeated at the symposium with the LFSA representative highlighting action 5 of BEPS (Forum on Harmful Tax Practices – FHTP) which looks to address harmful tax practices to ensure those countries committed to the inclusive framework for BEPS implementation are equitable, transparent and substantive. The FHTP key assessment factors look at the following behaviours (i) regime ring-fencing, (ii) absence of substantial activities and (iii) lack of transparency.
The LFSA had concerns over what could be viewed as a ring fenced regime coupled with the absence of substantial activities. The LFSA feel the Guidelines address those concerns in a way which, in their view, balances compliance with global regulatory requirements and commercial practicality of implementation.
There is a clear economic agenda to the Guidelines, with the substance requirements in particular looking to drive economic growth in Labuan. For example, the LFSA hopes that the key substance requirements (physical operational office, substantial business activities, employment and annual business spend) will lead to the building of critical mass within the island of Labuan, increase the pool of local talent to support the expanding Labuan IBFC, create enhanced liveability and infra-support and lead to greater island connectivity.
There was also mention of diversification as a driver, away from Labuan’s heavy reliance on the oil and gas industry to focus more on aviation business (currently approximately 1/3 of the leasing business through Labuan is in relation to aviation assets). Labuan has over 70 double taxation treaties in place, and it is clear there is a play to promote Labuan as a leasing hub more globally rather than just as a vehicle to lease into Malaysia.
Key changes to Labuan’s Leasing Regulations
Delegates at the symposium had hoped for further clarification on the new operational and substance requirements, however, little guidance was provided. A comment was passed that the purpose of the Guidelines was to create flexibility by putting the requirement to determine what was required in order to comply on the leasing companies themselves. Whilst this creates flexibility in the LFSA’s view, it is creating uncertainty for those who will need to comply with the Guidelines.
We have set out below the clarifications which were provided on the amended and the new operational and substance requirements which, in the main, were more of a restatement of the Guidelines themselves.
Key Issues discussed
The LFSA did note that certain functions of the leasing business were permitted to be outsourced, but such outsourcing would be subject to prior LFSA approval. Outsourcing guidelines are to be released shortly which will (as expected) focus on the current service providers and the level of support they can provide.
Despite the LFSA previously suggesting that existing arrangements were to be “grandfathered”, and so the Guidelines not applying to leasing companies which have already received prior LFSA approval, the LFSA clarified that such leasing companies must comply with the new substance requirements by the 01 January 2019 or risk being de-licenced, even if no further business was to be run through that leasing company.
Further clarification is required in respect of exactly what documentation is required to be stamped in Labuan, other than the lease agreement between the leasing company and the operator. The LFSA commented that any transaction document which related to the leasing would need to be stamped in Labuan, including any guarantee of the obligations of the leasing company, whether the parties to such guarantee were a Labuan/Malaysian entity or otherwise. This raises the practical issue of what documentation exactly needs to be stamped in Labuan.
In an aircraft leasing transaction the operator is generally responsible for change of law risk and so liable for any withholding tax payable as a result of such change of law.
A number of aircraft lessors have set up their own vehicles in Labuan for the purpose of leasing to Malaysian operators. The main issue to be resolved between the lessors and the operators will therefore be who will bear the change of law risk in respect of the changes to be implemented – the lessors or the operators?
Given lessors general attitude to change of law risk, our prediction is that lessors (who have leasing companies in Labuan) will look to restructure their leases to push the requirement of establishing and maintaining a leasing company in Labuan on to their operators, who would be better placed to comply with the Guidelines by leveraging their existing operations in Malaysia. The alternative is that substantial work will be required, and not insignificant expense incurred, by the lessors in order to establish a fully operational office in Labuan – all within 10 months.
Further clarification and how BLP can help
The LFSA are to organise a meeting with the leasing companies in Labuan in April to further discuss the Guidelines and, in particular, the substance requirements. We understand details will be available in the coming weeks. From speaking to a number of the leasing companies at the symposium, pushing for either full “grandfathering” of existing deals/structures or an extended compliance period for such deals/structures will be firmly on the agenda.
In the meantime, the LFSA have also set up an email address for any questions on the Guidelines: email@example.com.
Please do not hesitate to contact us should you wish to discuss anything in relation to this briefing paper. BLP has significant experience executing aircraft leasing, financing and sale and purchase transactions through Labuan leasing structures as well as the restructuring of such arrangements.
BLP’s global aviation practice has over 200+ years’ of combined experience transacting aviation related business in global financial centres, and we are recognised by clients and directories as market leading lawyers in the aviation sector. We have significant expertise gained from working for aircraft lessors, airlines, airports, banks and other financial institutions, arrangers, suppliers and manufacturers across the full spectrum of aircraft financing techniques including secured lending, export credit, credits, insurance-based products, finance and leveraged leasing, securitisation, Islamic finance and operating leasing.
In Asia we have a substantial amount of experience leasing, trading and financing aircraft and engines in many key jurisdictions, such as Malaysia, Indonesia, Vietnam, Myanmar, Thailand, Philippines, Australia, Japan, India and the PRC (including through free-trade zone structures).