Tax Publications

Cross border taxation of Islamic finance in the MENA region ...

Executive Summary

The Qatar Financial Centre Authority has promoted a pioneering study into the tax treatment of cross-border Islamic finance transactions within the MENA region.

The Qatar Financial Centre Authority has promoted a pioneering study into the tax treatment of cross-border Islamic finance transactions within the MENA region.

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 reason is that most transactions that are undertaken in Islamic finance seek to achieve economic outcomes which are similar to the economic outcomes achieved by conventional finance. However to achieve these economic outcomes the Islamic finance transactions typically require more component steps than do the equivalent conventional financial transactions.

For example a conventional loan of money for a 12 month period at a fixed rate of interest with a single bullet repayment requires only one transaction, namely the transfer of money from the lender to the borrower along with the execution of a loan agreement specifying the interest rate and the date of payment. Achieving the same result by using a commodity murabaha transaction requires three transactions in the underlying commodity: its purchase by a bank, the sale of the commodity by the bank to the customer, and finally the sale of the commodity by the customer to another purchaser, typically a commodity market participant.

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 reviewed in detail in the report where in many cases a transaction which is economic equivalent to the issue of a conventional bond secured on real estate gives rise to transfer tax and capital gains tax liabilities which make the sukuk transaction prohibitively expensive to carry out.

Accordingly the Qatar Financial Centre Authority has partnered with the International Tax and Investment Center, which is based in Washington DC, to promote a study to look at the current position in key MENA region countries and recommend a strategy for updating local country tax systems for Islamic finance.

The detailed research work and report writing was led by Mohammed Amin (www.mohammedamin.com) who is an Islamic finance consultant and was previously UK Head of Islamic Finance at PricewaterhouseCoopers LLP, with the collaboration of Salah Gueydi, Senior Tax Advisor, Ministry of Economy & Finance, Qatar and Hafiz Choudhury, Tax Administration and Policy Advisor, International Tax and Investment Center. Ernst & Young’s Qatar office coordinated the distribution of questionnaires to Ernst & Young’s offices in the MENA region for completion and review by country tax authorities before return to the research team while PricewaterhouseCoopers Malaysia completed a questionnaire for Malaysia to provide a comparison from outside the MENA region. The United Kingdom provided a second non-MENA comparison, based upon Mohammed Amin’s knowledge as a UK tax advisor.

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 survey 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 transactions to be carried out without excessive tax costs.

The researchers considered two alternative approaches to the modification of tax law to facilitate Islamic finance which for simplicity they 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 which 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 be 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 upon 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 the countries 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, how the collection of Zakat deals with Islamic finance and the Shariah governance framework for Islamic finance.

Download the publication

IN THIS SECTION: