Accounting and tax in Islamic finance: Striking a balance.

The saying goes that the only certain things in life are death and taxes. But far from being one of life’s certainties, tax in Islamic finance varies considerably from market to market and is one of the most pertinent issues new markets must consider when developing Islamic fi nance or introducing new financial structures. REBECCA SIMMONDS explores the recent changes in the Islamic finance accounting and tax landscape.

Regulation
The most prominent independent regulator in regards to accounting and tax in Islamic finance is Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). Established in 1991, the regulatory body prepares accounting, auditing, governance, ethics and Sharia standards for Islamic financial institutions and the industry.

AAOIFI has 200 institutional members from 40 countries and its standards have been made mandatory in Bahrain, the Dubai
International Financial Center, Jordan, Lebanon, Qatar, Sudan and Syria.Authorities in Australia, Indonesia, Malaysia, Pakistan, Saudi Arabia, and South Africa have also issued guidelines based on AAOIFI’s standards and pronouncements. AAOIFI has issued 26 accounting and five auditing standards in addition to its 48 Shariah standards. The AAOIFI Accounting and Auditing Standards Board is composed of 20 part-time members, appointed by the Board of Trustees for a fi ve-year term. The board prepares accounting and auditing statements, a code of ethics, educational standards and guidelines for Islamic financial institutions, editing and amending existing standards as necessary.

Africa
South Africa is in the process of introducing legislation to facilitate the operations of Mudarabah, Murabahah and Musharakah, including amendments to the tax treatment of Islamic structures when it prepared to issue its sovereign Sukuk.

Asia
In July 2013, the Hong Kong government introduced new legislation to bring taxes for Sukuk issued in the country in line with the legislation laid out for conventional finance. The Inland Revenue and Stamp Duty Legislation (Alternative Bond Schemes)
(Amendment) Ordinance 2013 covers Sukuk issued after the 19th July 2013 and provides a boost to Hong Kong’s desire to become a global player in the Sukuk market due to the popular usage of US dollar, one of the preferred currencies for Sukuk issuance, and the potential market in Hong Kong and mainland China.

On the 30th June 2013, Malaysia’s Islamic Financial Services Act 2013 (IFSA) came into force, as a consolidation of the provisions established in the Islamic Banking Act 1983 and Takaful Act 1984 repealed into a single piece of legislation. The new law provides
the country’s regulator, Bank Negara Malaysia with increased oversight on banks and Shariah scholars, who are now to permitted to be held legally accountable for the financial products they approve and liable to fines and prison time for wrongdoing.

The State Bank of Pakistan recently announced it will be revising rules on Shariah governance and liquidity management for Islamic banks in the country, working with federal and state governments to provide tax neutrality for Islamic banks to limit extra product
costs. The adoption of Islamic Financial Services Board (IFSB) and AAOIFI guidelines will be expedited as part of
this process.

The Central Bank of the Philippines, Bangko Sentralng Pilipinas, in September 2013 requested that government permit its charter to be amended in order to allow the bank to provide Sharia compliant instruments to Islamic banks, in particular interbank lending products. The move is part of an aim to attract more Islamic finance business to the Philippines with the establishment of
Islamic finance legislation. The central bank has sought support from the IFSB and formed a working committee to draft the proposed law, which would include directives as to the country’s tax treatment of Islamic finance transactions.

At the tabling of the Singapore government’s 2013 budget, it was confirmed that Islamic finance business tax would be imposed at the rate of 12%, from the 1st April 2013, with the government asserting that tax incurred by Islamic finance contracts, is in line
with the treatment of economically equivalent conventional financing contracts.

The new tax rate was introduced due to the tenure expiry of two tax incentives for Islamic finance introduced in the country’s 2008 budget: A 5% concessionary tax rate on income derived from performing specific Shariah compliant activities and a 5%concessionary tax rate, to an insurer on income derived from off shore Takaful or reTakaful business.

Outlook
The issue of taxation for Islamic finance transfers is one of the most pertinent to investors and governments, and with the growth of the Islamic fi nance industry, the interest of new markets and increased demand for cross border transactions, tax and accounting standards will continue to be one of the most prominent issues to be addressed by the industry.

Source: IFN, 5Th March 2014.