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Report on the cross-border taxation of Islamic finance in the MENA region

Summary

15 February 2013 updated 15 March 2014

In September 2011, the UK Treasury circulated their Islamic finance email distribution list, to ask if anyone wished to assist the International Tax and Investment Center (ITIC) in Washington DC on a study of the cross border taxation of Islamic finance in the Middle East and North Africa (MENA) region.

I volunteered.

The following month I found myself speaking at the Second MENA Tax Forum in Istanbul. The project has also taken me to Kuala Lumpur in September 2012 to speak at the Global Islamic Finance Forum 2012 and and to Oman in November 2012 to speak at the Third MENA Tax Forum. (My presentation is mentioned on page 11 of the document at the preceding link.)

Cover of MENA tax report

Click the report image to download it.

Apart from the presentations, the output from our work is a detailed report, "Cross border taxation of Islamic finance in the MENA region Phase One" which was published on 13 February 2013 by the Qatar Financial Centre Authority. It can be downloaded free by clicking the image of the report cover.

On 12 February 2013 I gave a presentation to the Insitutute of Islamic Banking and Insurance based upon the report. That can now be watched on video.

On 6 March 2013 the magazine Islamic Finance News carried an article by me based on the study: "The taxation of Islamic finance in the Middle East and North Africa (MENA) Region." This is reproduced below with the permission of the editor.

Reproduced lower down are the press release issued by QFCA and ITIC, and the executive summary of the report.

Article: The taxation of Islamic finance in the Middle East and North Africa (MENA) Region

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 favourably 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 and was conducted

In October 2010 Doha, Qatar hosted the first MENA Tax Forum, organised 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, Senior Tax Advisor, Ministry of Economy & Finance, Qatar and Hafiz Choudhury, Tax Administration and Policy Advisor, ITIC. Together they composed a questionnaire setting out four common Islamic finance structures, commodity murabaha, sukuk, salaam and istisna and asked 68 questions about the tax treatment.

Ernst & Young distributed the questionnaire to their 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 Centre (QFC). Comparative non-MENA information was obtained by having PricewaterhouseCoopers Malaysia complete a questionnaire for Malaysia, and by the author having 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 istisna 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 onshore (located in Turkey), 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 ijarah sukuk using real estate:

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 United Kingdom 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 and next steps

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

Press release

Qatar Financial Centre Authority logo International Tax and Investment Centre logo  

 

Turkey and the Qatar Financial Centre (QFC) identified as having the most Islamic Finance friendly tax systems out of eight countries in the MENA region

Doha, 13 February 2013 – Turkey and the Qatar Financial Centre (QFC) have the most Islamic Finance friendly tax systems out of eight countries in the MENA region, reviewed in a study conducted by three leading experts, Mohammed Amin, Salah Gueydi and Hafiz Choudhury, and sponsored by Qatar Financial Centre Authority in partnership with the International Tax and Investment Center, based in Washington DC.  The study, Cross border taxation of Islamic finance in the MENA region - Phase One, shows that while simpler Islamic finance transactions can be carried out in some countries without prohibitive tax costs, of the countries reviewed only Turkey and the QFC have a tax system that enables sukuk transactions to be carried out without excessive tax costs.

The study goes on to examine two alternative approaches a country can take to update its tax system to support Islamic finance transactions (referred to in the study as the UK model and the Malaysian model), and concludes by recommending the one that is adopted in Malaysia as being quicker and simpler to implement for Muslim majority countries.

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 detailed research work was led by Mohammed Amin who is an experienced 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 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 report is the first of a series.  The team intends to extend the work in future studies to cover, for example, the impact of consumption taxes such as Value Added Tax on Islamic finance transactions, the cross border treatment of Islamic finance transactions within international double tax treaty arrangements designed primarily with conventional finance in mind, the Zakat treatment of Islamic finance transactions and the Shariah governance framework for Islamic finance. Other countries in the MENA region may also be reviewed in subsequent reports.

Ian Anderson, Chief Finance and Tax Officer at the QFC Authority, commented: “The QFC Authority welcomes the findings and recommendations of this 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 MENA countries were developed in an environment of conventional finance. This too often means that Islamic finance suffers an additional and therefore unfair tax burden not borne by conventional finance. This report points out the best way forward to help level the playing field in the MENA region and potentially beyond. We are delighted to have sponsored this research, the first of its kind, and support the development of Islamic Finance worldwide.”

Daniel A. Witt, President, International Tax & Investment Center, said:  “ITIC is proud to have been associated with this study. Part of our mission is to support countries in removing barriers from international trade and investment. In an increasingly globalized world, and rising prosperity in many Muslim majority countries, Islamic finance institutions are already a very important part of the financial infrastructure of global business. I believe that this study is the very first analysis of taxation issues across countries. We very much hope that it will start the dialogue within and between countries with active Islamic finance markets on dealing with the very real barriers to the growth of such markets raised by tax rules. We very much hope to continue this important work with the support of active financial centres such as represented by the QFC Authority and that of influential market players.” 

Mohammed Amin, the report’s main author, commented, “The study shows clearly that the additional transactions required by Islamic finance to achieve economic outcomes similar to conventional finance are at risk of being subject to transfer taxes or to taxes on income or gains, and can make Islamic finance transactions prohibitively expensive.”

“The Malaysian approach, which the report recommends, 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, tax law can be modified relatively easily to give them 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 disregarded for tax purposes.”

“The United Kingdom approach, which we also reviewed, requires much more complex drafting of tax law, since no reference can be made to external Islamic finance sources although the UK’s secular approach does have the merit of keeping religion out of tax law.”

“We concluded that the Malaysian system is quicker and simpler to implement for Muslim majority countries.”

Ends

About QFC

The Qatar Financial Centre (QFC) is a financial and business centre established by the Government of Qatar and located in Doha. It has been designed to attract international financial services institutions and major multi-national corporations in particular those operating in the reinsurance, captive insurance and asset management sectors and to encourage participation in the growing market for financial services in Qatar and elsewhere in the region. The QFC operates to international standards and provides a first class legal and business infrastructure for those operating within the QFC. The QFC was created by Qatar Law No. (7) and has been open for business since 1 May 2005.

QFC Authority

The QFC Authority is the commercial, administrative and legislative body responsible for leading the expansion of Qatar’s financial services sector, providing a uniquely sustainable platform for regional growth in reinsurance, captive insurance and asset management.

About the International Tax and Investment Center, United States of America

The International Tax and Investment Center (ITIC) serves as a clearinghouse for information on best practices in taxation and investment policy, and as a training center to transfer such know how to improve the investment climates of transition and developing countries, thereby spurring formation and development of business and economic prosperity.

Organized in 1993, ITIC is an independent nonprofit research and education foundation with offices in Russia, Azerbaijan, Kazakhstan, Jordan, the Philippines, Ukraine, the United Kingdom, and the United States.

International Tax and Investment Center

1800 K Street, NW, Suite 718
Washington, DC 20006, United States
Phone: +1 202 530 9799
Fax: +1 202 530 7987
Email: Washington@iticnet.org
Website: www.ITICnet.org

Qatar Financial Centre Authority (QFC Authority)

Yusuf Jehangir
Head of Marketing and Corporate Communications
Qatar Financial Centre Authority
Tower 1, Diplomatic Area
P.O. Box 23245
Doha, Qatar
Phone: +974 4496 7784
Fax: +974 4496 7669 
Email: info@qfc.co.qa
Website:www.qfc.com.qa

Executive summary of the report

Qatar Financial Centre Authority logo International Tax and Investment Centre logo  

 

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.

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