Unfavorable taxation issues are one of the biggest obstacles to the spread of Islamic finance in the Middle East. MOHAMMED AMIN highlights a recent survey which suggests that Gulf countries take up the Malaysian model to ease the path.
Some countries in the MENA region, Bahrain and the UAE to name just two, have long track records in promoting Islamic finance, and have many Islamic banks, Takaful operators and asset management companies. Conversely some other countries showed relatively little interest in Islamic finance until recently. However over the last few years interest in Islamic finance has spread geographically, with a growing number of countries in the MENA region (and elsewhere) wanting to promote Islamic finance.
Islamic finance cannot flourish if the tax system treats it less favorably than conventional finance. In that regard, the author has been the lead researcher for a recently published study of the MENA region.
How the study came about
In October 2010 Doha in Qatar hosted the first MENA Tax Forum, organized by the International Tax and Investment Center (ITIC). The author was not present, but has been informed that many delegates asked for a detailed study of MENA Islamic finance taxation. Subsequently the Qatar Financial Centre Authority (QFCA) provided funding for a study. In September 2011 ITIC asked the UK Treasury to help find a researcher, and the author volunteered. He presented on the generic tax issues at the second MENA Tax Forum in Istanbul, Turkey in October 2011, at which the study was formally launched.
In addition to the author, the other two researchers involved in the study were Salah Gueydi, a senior tax advisor at the Ministry of Economy and Finance in Qatar; and Hafiz Choudhury, a tax administration and policy advisor for ITIC. Together they composed a questionnaire setting out four common Islamic finance structures: commodity Murabahah, Sukuk, Salaam and Istisnah, and asked 68 questions about the tax treatment.
Ernst & Young distributed the questionnaire to its MENA offices for completion and for confirmation by the relevant country tax administrations. Eight countries responded: Egypt, Jordan, Kuwait, Libya, Oman, Qatar, Saudi Arabia, Turkey and also the Qatar Financial Center (QFC). Comparative non-MENA information was obtained by having PricewaterhouseCoopers Malaysia complete a questionnaire for Malaysia, and through the author’s detailed knowledge of the UK tax system.
Research findings
While the details vary from country to country, in general it is possible to undertake simpler Islamic finance transactions such as commodity Murabaha, Salaam and Istisnah with taxation outcomes that are similar to the outcomes from conventional finance transactions. This parity of tax treatment arises notwithstanding the fact that only two respondents have explicitly amended their tax systems for Islamic finance, primarily because the transactions themselves are relatively simple. Those two respondents are Turkey (but only for Sukuk where the special purpose vehicle (SPV) is located onshore) and the QFC.
However a Sukuk transaction is more complex than the other three transactions, and has much more scope for tax costs to arise. For example in the case of an Sukuk Ijarah using real estate:
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The sale of the real estate from the original owner to the SPV may trigger built-in capital gains when that sale takes place.
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The transfer on sale to the SPV may be subject to real estate transfer tax.
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Transaction taxes may arise when the SPV leases the real estate back to the original owner.
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The SPV may have a taxable gain when it sells the real estate back to the owner at the end of the Sukuk period.
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That sale back may also be subject to real estate transfer tax.
The study found that apart from Turkey and the QFC, implementing Sukuk would entail prohibitive tax costs in the responding countries, except for those countries which generally do not charge corporate taxes.
The UK and Malaysia have both eliminated such additional tax costs from issuing Sukuk. However they differ in their approaches. The UK wishes to avoid including religious provisions in tax law. Accordingly it has meticulously outlined in secular language the steps of certain transactions which are likely to be carried out by Islamic financiers, and then prescribed their tax treatment.
As a Muslim majority country, Malaysia has no qualms about referring to Islamic finance in its tax law. Malaysia has an advance approval mechanism for Islamic finance transactions. Its tax law then contains quite brief provisions which permit peripheral transactions associated with approved Islamic finance transactions to be disregarded for tax purposes.
Recommendations
The report recommends that MENA region countries adopt the Malaysian model, as it allows much simpler legislative drafting than does the UK model.
If possible, the researchers would like to extend their research to indirect taxation of Islamic finance, Shariah governance arrangements and the way Zakat is applied to Islamic financial institutions.
The full text of the 84 page report can be downloaded from http://www.qfc.com.qa/en-US/About-qfc/Tax/Tax_Publications.aspx
Mohammed Amin is an Islamic finance consultant and was previously the UK head of Islamic finance at PricewaterhouseCoopers. He can be contacted at
[email protected]
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