Over the past decade, the Islamic finance industry has been recording a steady growth rate and edging itself up to double digits. In 2018–19, the Islamic finance industry registered a growth rate of 11%. However, 2020 brought to the Islamic finance industry and the world an economic crisis that this generation has not seen before.
A global pandemic, historic drop in oil prices and introduction of new taxes in the states where Islamic finance has major prominence have all had impact on the relatively young finance industry.
Review of 2020
Islamic finance is heavily concentrated in the GCC/oil-producing states, therefore, oil prices have an impact on the state of the industry. The first quarter of 2020 saw a significant drop in oil prices, bringing crude to its lowest level since 2002.
Further, because of the measures to combat and contain the COVID-19 pandemic such as lockdowns, the closing-up of borders, etc, countries that are central to the Islamic finance industry saw a drastic economic slowdown.
According to the S&P, Islamic bond issuance will drop to US$100 billion in 2020 compared with US$162 billion in 2019 and the industry will continue to see a downward trend in 2020 with an expectation of minimal recovery in 2021.
With pressures on the main income streams such as oil revenue and revenue from tourism in core Islamic finance counties, the GCC governments have shifted to tax to supplement their income. A major move from Saudi Arabia during the year was the increase of the value-added tax (VAT) rate from 5% to 15% effective from the 1st July 2020. This is a departure from the GCC Common Framework.
Additionally, Saudi Arabian also introduced a new real estate transaction tax of 5% for all disposal of real estate post-4th October 2020.
The most recent entry to the VAT fold in the GCC is the Sultanate of Oman with the release of a decree to introduce VAT at 5% in six months’ time, taking the go-live date to April 2021. Qatar is expected to follow suit too within 2021.
2020 also saw major updates in the international tax space in the GCC. Every country in the GCC is either part of the Base erosion and profit-shifting (BEPS)-inclusive Framework or has the Multilateral Instrument (BEPS Action 15) in force in 2020. The Multilateral Instrument (MLI) is meant to implement a series of tax treaty measures to update international tax rules and to lessen the opportunity for tax avoidance by multinational enterprises to present BEPS.
Saudi Arabia has had transfer pricing (TP) laws in place since the 1st January 2019 with the MLI in force since May 2020.
The UAE is close behind with the MLI in force from September 2019 and has a country by country reporting legal framework in place effective for the 2019 fiscal year. The UAE is yet to have specific TP laws. In 2020, in response to the EU blacklisting it, the UAE introduced the Economic Substance Reporting Regulations which discourage unfavorable tax structures or harmful regimes and promote tax transparency.
Oman is also following a similar path as the UAE with the MLI in force from the 1st November 2020.
Preview of 2021
With the lockdown measures implemented in 2020, the world has experienced the importance of going digital. Digitalization would help growing industries such as Islamic finance to be more stable during volatile times. Going online would require a sound infrastructure and with methods of seamless information exchange. The GCC is forward-thinking in this aspect as this system of exchange of information is built into the spine of the common frameworks for tax in the GCC.
With the major players in the GCC supplementing core income with the introduction of taxes and therefore managing to keep the economy more buoyant, it would aid by providing a cushion to the Islamic finance industry to bounce up from.
Experts expect minimal to no recovery to be made by the Islamic finance industry in 2021. It would perhaps take more than a year for the industry to see an upturn and for these states to utilize the tax income by churning it back into the economy.
We expect that the events of 2020 would have a positive impact on the Islamic finance industry as since June 2020, the issuance of sustainable Sukuk saw an increase to the tune of US$4.12 billion. Countries such as the UK and Turkey in the past decade have acknowledged Islamic finance through the incorporation into legislation, with Turkey introducing tax concessions for the same. The introduction of the BEPS-inclusive Framework and transfer pricing laws in the Islamic finance-concentrated states of the GCC have led such states to move away from the label of tax havens. This increased transparency will open up cross-border dealings with the rest of the world to a greater extent and we believe that Islamic finance will see this effect in the years to come.
Samer Hijazi is the partner and head of the Abu Dhabi Office at Grant Thornton UAE. He can be contacted at [email protected] Lancia Sequeira is the tax manager at Grant Thornton UAE. She can be contacted at [email protected]