The Devastation of Labuan Island, the Nearest Tax Haven to Japan

Did you know that there is an island that was once touted as “the closest tax haven to Japan”?

Since the 1990s, companies from around the world have established corporations on this island in the South China Sea to avoid tax collection. In recent years, however, the Malaysian government has tightened regulations and the COVID-19 crisis has caused a population exodus. The situation is said to be far removed from the glamorous sound of a “tax haven”.

Labuan Island is located in the northern part of Borneo, about 2.5 hours by direct flight from Kuala Lumpur, the capital of Malaysia. From Kota Kinabalu, on the outskirts of the island, it is a three-hour bus ride to the other side of the river, and from there it is a 30-minute ferry ride.

Upon arrival at the international ferry terminal, the scenery of a peaceful rural port town unfolds. It was a far cry from the glittering image of “tax havens” as places used by rich people and corporations to evade taxes.

A “tax haven” is a country or region that strategically provides preferential tax treatment to companies from outside the region. Because taxation is completely exempted or significantly reduced, they are also called tax havens or low-tax jurisdictions. Representative “tax havens” include Caribbean islands such as the British Cayman Islands and the Virgin Islands, Luxembourg, Monaco, and Delaware in the eastern United States.

 

Labuan Island was established in 1990 at the behest of then Prime Minister Mahathir, who reportedly had a grand vision of creating a “second Hong Kong”. At the time, the introduction of an exorbitantly low corporate tax rate of 3% or a flat annual tax rate of 20,000 ringgit (approximately 640,000 yen at today’s exchange rate) attracted domestic and foreign companies one after another, and there were great expectations that the island would serve as a catalyst for the Malaysian economy. Japanese companies were no exception, and three major mega banks, Mitsubishi UFJ, Sumitomo Mitsui, and Mizuho, were among the representative companies that entered the country and continue to establish branches there.

On the other hand, it has long been pointed out that tax havens have been misused by multinational corporations and wealthy individuals to transfer assets for tax evasion, as well as for money laundering, crime, and the concealment of terrorist funds, and there have been constant calls for the use of tax havens as a source of danger.

 

The turning point was the publication of the Panama Papers in 2016. The Panama Papers revealed some of the realities of tax evasion by the wealthy and drew international criticism. In response, the Malaysian government tightened the taxation system in Labuan Island in 2020. Labuan’s role as a “tax haven” has effectively ended.

Labuan is a small island that can be circled in 30 minutes by car. Other than the ferry terminal, harbor, hotels, restaurants, and other major functions clustered in the southern part, the rest of the island is a jungle area. Moving from the ferry terminal to the center of the city, you will find general stores, restaurants, and other stores that give it the feel of a rural port town, but it cannot be called a flattering financial town, as there are stores that have been vacated after the withdrawal of the Hong Kong and Shanghai Banking Corporation (HSBC), a major British financial institution.

Walking through the center of the city, one sees a modern building that clearly stands out from its surroundings. The shiny silver-colored circular office building is the International Business and Financial Center, a symbol of Labuan Island when it was a “tax haven”. The center was established in 1990 when the Malaysian government introduced a preferential tax system, but today it houses only duty-free stores and small locally owned clothing stores and restaurants. The owner of the clothing shop said, “It is deserted except when local people come to shop on weekends or when there are events.”

An official from an agent company that attracts companies to Labuan said of the current situation on the island: “Since the regulations on tax havens have been tightened, the offices that used to be located in the financial center are now leaving the island in droves. Tourism used to be good, with Chinese tour groups coming three times a week, but the COVID-19 crisis has destroyed that. The only thing supporting the island’s economy is the port. The war in Ukraine has raised the price of natural gas and oil, and the high cost of living has also kept tourists away. I would like to see more investment from Japanese companies.”

The agent company to which the person concerned belongs is also struggling to secure human resources, as there is no end to the number of young employees changing jobs one after another and moving to the capital city of Kuala Lumpur. We caught a glimpse of the actual situation on the island.

When we went to the nighttime drinking district, there was no one on the street, just a series of dark night streets, just as the agent company official mentioned above had said. Somehow, I found a club-like establishment and entered it, but as it was around 10:00 p.m., there were hardly any customers to be seen. After a while, I was approached by a Filipina female employee in her 50s.

She said, “Are you alone, mister? Would you like to have a drink with the girls? I’ll give you a small fee for drinks and service.”

As soon as I accepted the offer, the female employee shouted, “Come on, everyone!” As if on cue, a crowd of young women in mini-skirts gathered around.

“Choose any girl you like.”

When Marin, a 23-year-old woman, learned that the reporter was Japanese, she said, “You are Japanese? That’s unusual. Usually here on the island, we get Chinese, Malaysians, Indians, and Australians,” she said with a hint of surprise. She has only been working at the club for a little over three months.

We all live in the dormitory above the club. There is no entertainment here, and I want to go back to the Philippines.

Inside the club, a show had started with about 20 Filipina pub girls dancing on the stage and in the hall. While I was watching them dance, a female employee in her fifties called out to me again, “Mister, where is your hotel?”

The price of about 20,000 yen is higher than the local market price. The added price may be due to the pride of being in a tax haven.

When the date changed, I went out to the biggest club on the island and found it more crowded than I had expected. The crowd grew and before I knew it, the club was packed to capacity. As the night wore on, the place became more and more lively, with people dancing on the tables and stirring up drinks. One of the customers told us that the club is “one of the few places where you can have fun with your friends” and that it gets crowded every night around the time the date changes.

In fact, Labuan Island has deep ties with Japan. It all started with the Japanese occupation of the island during the Pacific War.

In 1942, the Japanese military set their sights on Labuan Island as a bridgehead for the invasion of Borneo and established a base there. Since then, the island has been the scene of fierce battles with the Allied Forces, especially the Australians.

On September 9, 1945, after the defeat in the war, the Japanese signed the Instrument of Surrender to the Australian forces, which was also located on Labuan Island. Later, the island was also called “Maeda Island,” after the commander of the Borneo Defence Force, Toshiaki Maeda. Even today, there is a cenotaph for the victims of World War II on the island, and the vivid traces of the war can still be felt.

It has been more than 80 years since the Japanese occupied the island. The small island, which was at the mercy of history as a war zone and a tax haven, is now returning to its former rural state.