A new study into the cross border tax burden on Islamic finance transactions in the Middle East and North Africa region, relative to the tax burden placed on conventional finance, underscores the importance of regional tax legislative changes to equalize the tax treatment of shariah-compliant financial options.
The study reviewed the tax treatment of four common Islamic finance structures, commodity murabaha, sukuk, salaam and istisna in eight MENA region countries: Egypt, Jordan, Kuwait, Libya, Oman, Qatar, Saudi Arabia, Turkey and also in the Qatar Financial Centre.
The report shows that while simpler Islamic finance transactions can be carried out in some of these countries without prohibitive tax costs, only Turkey and the QFC have a tax system that enables sukuk (bond) transactions to be carried out without excessive tax costs.
Islamic finance is of growing importance within the MENA region, but the taxation systems of almost all countries were developed in an environment of conventional finance. This can mean that Islamic finance suffers a tax burden that is not suffered by conventional finance. The study aims to support local authorities to revise their regimes to make Islamic finance transactions across borders as competitive as conventional finance in tax terms.
Most Islamic finance transactions seek to achieve economic outcomes that are similar to those achieved by conventional finance. However, to achieve these economic outcomes the Islamic finance transactions typically require more component steps than the equivalent conventional financial transactions, which results in the greater tax burden.
The additional transactions required by Islamic finance are at risk of being subject to transfer taxes or to taxes on income or gains. This can be seen most clearly by considering the sukuk transactions (bond), reviewed in detail in the report, where in many cases a transaction, which is economically equivalent to the issue of a conventional bond secured on real estate, gives rise to transfer tax and capital gains tax liabilities, makeing the sukuk transaction prohibitively expensive to carry out.
The study, led by Islamic finance consultant Mohammed Amin with support from regional branches of PwC and Ernst and Young, considers two alternative approaches to the modification of tax law to facilitate Islamic finance which, for simplicity, the authors term the Malaysian approach and the United Kingdom approach.
The Malaysian approach is based upon the regulatory authorities putting in place a process for advance determination of whether a transaction does or does not constitute Islamic finance. For those transactions that are certified as being Islamic finance transactions, tax law can be modified relatively easily to give these Islamic finance transactions the same taxation outcome as the equivalent conventional transactions. Where intermediate transactions are necessary to effect the Islamic finance structure, the intermediate transactions can readily be disregarded for tax purposes.
The United Kingdom approach is based upon the philosophical objective of separating religious matters from tax law. Accordingly, the United Kingdom does not want the tax treatment of a transaction to depend on whether or not it is Shariah compliant. Indeed, the United Kingdom wishes to keep all religious references out of tax law. Accordingly, the United Kingdom has proceeded by defining certain kinds of transactions using purely secular free-standing language which makes no reference to Islam or to Islamic finance. Once the transactions have been defined, their tax treatment can be specified in a manner that results in the same tax treatment that will be given to equivalent conventional finance transactions. The United Kingdom approach requires much more complex drafting of tax law since no reference can be made to external Islamic finance sources; conversely, it has the merit of keeping religion out of tax law.
In the case of Muslim majority countries, such as those in the MENA region, the study recommends the Malaysian approach as being quicker and simpler to implement.
The report is described as being “Phase One.” Subject to resources, the team intends to extend the work by looking in a similar way at matters such as the impact of consumption taxes like Value-Added Tax on Islamic finance transactions.
(Global Tax New / 21 Feb 2013)
Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com