What Are the Disadvantages of a Labuan Company?

A Labuan company costs more to run than most people expect, and two of the reasons people avoid it stopped being true years ago.

Four costs are real and should be priced in before you sign. Economic substance is a standing expense, not a one-off. A deduction penalty lands on your Malaysian customers rather than on you. One tax choice cannot be reversed, and treaty access is not automatic.

None of the four is fatal. All of them are cheaper to understand now than to discover in year two.

The two objections that no longer hold are the ban on dealing with Malaysian residents and in ringgit, which was repealed in 2022, and the claim that Malaysia sits on an international blacklist.

Key Takeaways

• Substance is a standing cost. Most trading activities require at least two full-time employees in Labuan and RM50,000 of annual operating expenditure there. Regulated activities require more.
• Failing it is expensive. Chargeable profits are taxed at 24% instead of 3% for that year of assessment.
• Your Malaysian customers pay for it. Under section 39(1)(r) of the Income Tax Act 1967, a Malaysian resident paying a Labuan company cannot deduct 97% of most payments, and 25% of interest and of lease or rental payments.
• The tax choice is one-way. If you choose to be taxed under the ordinary Malaysian rules instead, you cannot go back.
• Two myths. The ban on dealing with Malaysian residents and in ringgit was repealed in 2022. Malaysia is not on the EU or FATF lists.
• Who it does not suit. Businesses whose customers are mostly Malaysian residents, businesses that cannot fund real presence, and anyone who wants a passive shell.

The Substance Requirement Is a Real Running Cost

This is the drawback that surprises people most, because the headline rate gets quoted without it.

To qualify for the 3% rate, a Labuan entity has to keep real people and real spending on the island. How much of each depends on what the entity does. The requirements sit in P.U.(A) 423/2021.

Activity	Full-time employees in Labuan	Annual operating expenditure
Most trading activities	2	RM50,000
Banks, insurers and trust companies	3	RM200,000
Fund managers and brokers	2	RM100,000
Investment holding, not pure equity	1	RM20,000
Pure equity holding	Exempt from the employee requirement	RM20,000, plus a board meeting in Labuan

RM is the Malaysian ringgit. A two-person Labuan operation therefore carries two salaries and RM50,000 of local spending before it has earned anything, and that cost recurs every year the structure exists.

The requirement also tightened in September 2025. The wording changed from "full time employees" to "fit and proper full time employees", and five conditions were added.

The work must suit the business. The employee must be competent for it, and free of conflicting duties. They must be employed by the Labuan entity, permanently or on contract. And they must physically do the work in Labuan.

The numbers did not change. What changed is how easily an arrangement on paper satisfies them.

Miss the requirement for a basis period and chargeable profits are taxed at 24% for that year of assessment rather than 3%. Substance is not a formality. It is the condition the rate hangs on.

The Substance Rules Have a Disputed History

This belongs in an honest account, and most published material leaves it out.

The regulations that set the requirements were published in November 2021. They state that they apply from the start of 2019, which is nearly three years earlier.

A group of Labuan companies challenged that in the High Court. The court held that the earlier version of the regulations was invalid. It also held that the 2021 version could not reach back to take away rights people had already acquired.

The Inland Revenue Board appealed. The case is known as Bright World Trading.

We cannot point you to a verifiable public record of how that appeal ended. Labuan service providers have written that the appeals were struck out, but we have not seen a court record or a professional firm confirming it, so we are not going to state it as settled.

What can be observed is that the Inland Revenue Board continues to administer the regime, and issued further guidance on Labuan substance during November and December 2025. Plan on the basis that the requirements apply, and if you have an exposure that turns on the earlier years, have your position reviewed by a Malaysian tax adviser rather than relying on a general article. This one included.

Paying a Labuan Company Costs Your Malaysian Customer Money

This is the sharpest commercial drawback, and it is not about what your company may do. It is about what it costs the person on the other side of the invoice.

A Malaysian resident who pays a Labuan company loses most of the tax deduction on that payment. The rule sits in section 39(1)(r) of the Income Tax Act 1967, and the current percentages were set in 2020. What cannot be deducted:

• 97% of most payments,
• 25% of interest,
• 25% of lease or rental payments.

Read that from your customer's side. A Malaysian company weighing a RM100,000 invoice from your Labuan entity against the same invoice from a Malaysian supplier is comparing two very different after-tax costs. That is a competitive disadvantage in the Malaysian domestic market, and no amount of structuring on your side removes it.

An exemption order covered these payments for the years of assessment 2019 to 2025. Whether an equivalent exemption applies to ordinary Labuan business activity for later years is something to confirm with a Malaysian adviser for your own year, because the position has moved and general guidance ages quickly here.

If your revenue comes from outside Malaysia, none of this touches you. If it comes from inside Malaysia, it may be the deciding factor.

Two Objections That Are Out of Date

Both of these still appear in current articles. Neither survives a look at the law.

"A Labuan company cannot deal with Malaysian residents or in ringgit." It can. Those restrictions sat in the Labuan Companies Act 1990, and they were repealed in June 2022, with effect backdated to the start of 2019. What survives is the deduction consequence for the payer described above. That is a tax question, not a ban.

"Labuan is blacklisted." It is not, on any of the lists that matter.

Malaysia is on neither annex of the EU list of non-cooperative jurisdictions for tax purposes, in the version the Council adopted in February 2026. It is not on the EU list of high-risk countries for money laundering either.

The Financial Action Task Force keeps two lists of its own, and Malaysia is on neither. It has in fact been a member of the FATF since 2016.

The honest footnote: Malaysia was added to the EU Annex II state of play document in October 2021 over a foreign source income exemption regime, and gave a commitment to amend it. It does not appear on the lists adopted in February 2025 or February 2026. So the answer is not that Labuan was never questioned. It is that the question was dealt with.

The Tax Election Is a One-Way Door

A Labuan entity can choose to be taxed under the ordinary Malaysian income tax rules instead. Firms usually consider it to reach Malaysia's treaty network. The provision is section 3A of the Labuan Business Activity Tax Act 1990.

The choice cannot be undone. It binds the year you make it and every year after that. There is no way back to the Labuan regime once you have made it. The Act calls this an irrevocable election.

That is not a reason to avoid it. It is a reason to model it properly before signing, with the treaty position and the long-run rate difference in front of you, rather than treating it as a switch that can be flipped again if circumstances change.

Treaty Access Is Not Automatic

A Labuan entity is a Malaysian entity, so it is natural to assume it inherits Malaysia's double taxation agreements. Several of Malaysia's treaty partners have negotiated protocols and provisions that exclude Labuan entities from the benefits of the relevant treaty.

We are deliberately not publishing a list of those countries. The lists in circulation trace back to a single source that is several years old, and treaties are renegotiated. If treaty access is central to your plan rather than incidental to it, the specific treaty needs to be checked before the entity is formed, not after.

Banking Takes Longer Than People Expect

Opening accounts for any entity in an international financial centre takes longer and asks more than a domestic incorporation does.

The wider picture is documented. Between 2011 and 2018 the number of active correspondent banks worldwide fell by roughly a fifth. Jurisdictions widely classed as offshore centres lost noticeably more of theirs than comparable places did, by about 11 percentage points. Those figures come from the Bank for International Settlements.

What we will not do is quote a timeline. Nobody publishes reliable figures on how long an account takes to open for a Labuan entity, and the numbers that circulate come from firms selling incorporations. Expect enhanced due diligence, prepare the ownership and source of funds documentation properly, and budget more time than a domestic account would need.

The Compliance Calendar Changed

From the year of assessment 2025, Labuan entities file under self assessment, and the deadline moved.

The Return of Profits is due seven months from the date following the close of your accounting period, and it must be furnished electronically.

So an entity whose financial year ends on 31 December 2025 files by 31 July 2026.

The old declaration forms LE4 and LE5 no longer exist on their own. They are part of Form LE1 now.

Accounts must be audited, and the return is made on the audited net profit. Labuan FSA also issues a directive on accounts and record keeping, dated 31 October 2016, and guidelines on beneficial ownership for Labuan entities.

Note the deadline carefully, because a great deal of published Labuan guidance still gives three months from the start of the year of assessment, meaning 31 March. That was correct once and is not correct for the year of assessment 2025 onward.

Who a Labuan Company Does Not Suit

The useful version of this article is the part that tells you to look elsewhere.

• Your customers are mostly Malaysian residents. The deduction penalty makes you structurally more expensive than a domestic supplier.
• You cannot fund real presence. Two employees and RM50,000 a year in Labuan is the floor for most trading activity, and it is now assessed on whether the people genuinely work there.
• Treaty access is the plan. If the entire benefit depends on a treaty, check the treaty first. It may not be available to a Labuan entity.
• You want a shell. A dormant structure with no people and no spending does not qualify for the rate, and the 24% fallback removes the reason for the structure.

Where Labuan does fit, it fits because the business is genuinely international, has real operations it can locate on the island, and wants a supervised jurisdiction with a clear rulebook rather than the cheapest possible registration.

If you want to test your own case against these points rather than against a brochure, our corporate services team can walk through it with you, and our economic substance page sets out what maintaining the requirement involves in practice. The frequently asked questions page covers the shorter questions, and our article on whether a foreigner can own 100% of a Labuan company answers the one that usually comes next.

This article is general information about Malaysian and Labuan law as it stood on 4 October 2026. It is not tax or legal advice, and your own position should be reviewed before you act on it.

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