ISLAMIC FINANCE AND ACCOUNTING (IFE 735)TAX TREATMENT ON ISLAMIC FINANCE IN MALAYSIAGROUP MEMBERS: ABDUL HADI BIN MD AKHIR 2015769693FATIN NURSYAFIRA BINTI GHAZALI 2015170081NOR IZZUDDIN BIN NORRAHMAN 2015166457

1. Introductio

n2.Overview

3.Contents 4.Conclusion

SCOPE

Introduction

IntroductionIslamic finance is a financial system that operates

according to Islamic law (shariah-compliant). Just like conventional financial systems, Islamic finance features banks, capital markets, fund managers, investment firms, and insurance companies.

However, these entities are governed both by Islamic law and the finance industry rules and regulations that apply to their conventional counterparts.

The main principle of Islamic finance is its adherence to interest or riba free financial transactions, while other principles are prohibition of fixed return, profit and loss sharing and hence risk sharing, participatory financing, prohibition of gharar (uncertainty), speculation and gambling, money not having any inherent value in itself, and also equity-based financing.

Overview of Islamic Finance

Overview of Islamic FinanceThere are mostly five key principles of Islamic

Finance that may be taken into consideration to make sure it is Shariah compliant:

belief in divine guidanceno interest can be chargedno haram investments,risk sharing is encouragedfinancing is based on real assets.

Every Shariah-compliant financial transaction should not lead to riba (interest), gharar (uncertainty) and maysir (gambling).

Besides, it must be supported by an underlying economic activity and cannot be linked with elements that are considered as threats to the moral of a society such as gambling, liquor and arms trades.

For a contract to be Shariah-compliant or to be considered as Islamic finance contract, it must have the following four features of which to some extent may vary from those of conventional contracts:

1. There are at least two parties in an Islamic contract. 2. Other than that, there are offer and acceptance by both

parties (i.e. seller or buyer or vice versa) on the purpose and terms of the contract.

3. Third feature is the purpose of the contract must not be haram (forbidden) or against Shariah

4. Lastly is the subject of the contract must change hands upon completion of the contract.

Differences Between Conventional and Islamic Finance

Transactions

Property Financing

Home loans are lumpy assets and may be largest

financial commitment in the lifetime. Interest paid

is based on the loan remaining, the amount

deducted for interest from each fixed monthly

instalment decreases overtime as the loan

remaining decreases. This decreasing interest

deduction also means that the amount of principal

repaid increases every month i.e. the customer will

repay to the bank the loan amount, together with

interest at the prescribed rate. The prescribed rate

is based on a margin above the bank’s base

lending rate (BLR), and both the margin and the

BLR are variable from time to time.

Property Financing – i

Bai’ Bithaman Ajil (BBA)

This contract refers to the sale of property on a

deferred payment basis. The property chosen by

the client is bought to the client at an agreed price

which includes the bank’s mark-up (profit).

The client may be allowed to settle payment by

instalments within a pre-agreed period, or in a

lump sum i.e. the monthly instalment of the bank’s

selling price will not change throughout the tenure

of the financing.

CONVENTIONAL SHARIAH COMPLIANT

Conventional InsuranceConventional insurance is associated with

riba and major gharar, both of which are

forbidden by Islamic principles, for instance:

•shareholders own the insurance company.

The objective is to maximize profits.

Islamic insurance or TakafulIt is an arrangement by a group of people who have the desire to protect each other from defined risks and mishaps, by contributing to a pool of money out of their own resources.

The foundation of takaful is based on principle of Aqilah (persons of relationship) means the takaful operator will divide the contributions into tabarru (donation) and investment. Tabarru is for the purpose of meeting policyholder losses and mishaps.

Islamic Finance Transactions: Financial Reporting Standards in

MalaysiaThere is an urgent need to address issues on accounting and financial accounting, auditing and governance framework for Islamic finance.

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) issued more than 60 accounting, auditing, governance and Shariah standards for Islamic institutions.

Despite AAOIFI being a pioneer in the Islamic standard setting, the Malaysian Accounting Standards Board (MASB) has concerns that its accounting standards may not have been developed based on a conceptual framework similar to the MASB approved accounting standards.

In the Malaysian context, the Malaysian financial institutions shall account for Shariah-compliant transactions and events in accordance with MASB approved accounting standards which is now known as Malaysian Financial Reporting Standards (MFRS) after convergence with the International Financial Reporting Standards (IFRS), unless there is Shariah prohibition.

However, in order to facilitate its constituents’ application of MFRS to Islamic financial transactions,the MASB has issued a series of Technical Releases or Islamic accounting pronouncements, which complement, and is to be read in conjunction with the MFRS.

Malaysian Tax Legislation

Malaysian Tax Legislation

Different amendments by Malaysian Tax Legislator regarding tax treatment of Islamic financial instruments :

I. Income Tax Act 1967 (ITA)II. Stamp Act 1949 (SDA) III. Real Property Gains Tax (RPGT) Act 1976

Objective - to remove tax discrimination between the application of conventional instruments and Islamic instruments.

Amendments to the Income Tax Act

Section 2 (7) :“any reference in this Act to interest shall apply, mutatis

mutandis, to gains or profits received and expenses incurred, in lieu of interest, in transactions conducted in accordance with the

principles of Syariah” In this context, the profits (equivalent to interest as riba is not

allowed under Shariah principles) derived from Islamic financial transactions will have equal treatment as in a conventional financing arrangement i.e. interest for tax purposes.

Section 2(7) affects the tax treatment of Islamic income from the charging, deduction, tax exemption, and withholding tax perspectives.

The charging section of the ITA, Section 4, defines the scope of charge of the ITA as follows: ◦ Gains or profits from a business, for whatever period of time

carried on;◦ Gains or profits from an employment; ◦ Dividends; interest or discount;◦ Rent, royalties or premium;◦ Pensions, annuities or other periodical payments not falling under any

of the foregoing paragraphs◦ and gains or profits not falling under any of the foregoing paragraphs.

Prior to the amendment of Section 2(7) :Profits or gains received from Islamic investments were covered under

Section 4(a) in the case of business incomeGains or profits derived from a non-business Islamic source were

taxed under Section 4(f) because they did not fall under any other categories.

After the amendment of Section 2(7) :Gains or profits from Islamic business sources are still taxed under

Section 4(a)Gains or profits from nonbusiness Islamic sources are now taxed

under Section 4(c) and are given the same treatment of non-business interest income

Section 2 (8) :“Subject to subsection (7), any reference in this Act to the disposal of an asset or a lease shall exclude any disposal of an asset or lease by or to a person pursuant to a scheme of financing approved by the Central

Bank, the Securities Commission, the Labuan Financial Services Authority or the Malaysia Co-operative Societies Commission, as a scheme which is in accordance with the principles of Syariah where such disposal is strictly required for the purpose of complying with

those principles but which will not be required in any other schemes of financing”

This implies that the Act allowed Islamic financing to continue without any tax issues relating to asset transfer or lease.

Section 6A (3)“A rebate shall be granted for the year of assessment for any zakat, fitrah or any other Islamic religious dues payment of

which is obligatory and which is paid in the basis year for that year of assessment and evidenced by a receipt issued by an

appropriate religious authority established under any written law”

Section 18 [Part III]“Insurance” includes a takaful scheme pursuant to the Takaful

Act 1984. “Premium”, in relation to insurance, includes contributions or instalments payable under a takaful scheme

pursuant to the Takaful Act 1984.

Amendments to the Stamp Duty ActObjectives - To ensure that Islamic transactions are not subject to

adverse stamp duty implications, various stamp duty exemption orders have been issued over the years .

1. Stamp Duty (Exemption)(No. 8) Order 2000Exempted from stamp duty on all instruments of Al-Ijarah Head Lease

Agreement of immovable property executed between a customer and a financier (i.e. a bank, financial institution or leasing company), pursuant to a scheme of Al-Ijarah Term Financing Facility.

2. Stamp Duty (Exemption)(No. 9) Order 2000All instruments of the Asset Sale Agreement or the Asset Purchase

Agreement executed between a customer and a bank made under the principles of the Shariah law for the purpose of renewing any Islamic overdraft financing facility, if the instruments for the Islamic overdraft financing facility have been duly stamped

3. Stamp Duty (Exemption) (No. 38) Order 2002Exempted from stamp duty on all instruments of the Bai Inah Sale Agreement

or the Bai Inah Purchase Agreement executed between a customer and a financial institution made under the principles of Shariah law for the purpose of the issuance of credit cards.

“Financial institution” means any financial institution licensed underi. The Banking and Financial Institutions Act 1989;ii. The Islamic Banking Act 1983;iii. Development financial institutions supervised under Section 2 of the

Development Financial Institutions Act 2002; oriv. Any institution approved by the Central Bank of Malaysia.

4. Stamp Duty (Exemption) (No. 2) Order 2004All instruments executed between a customer and a financier under an Asset

Sale Agreement or an Asset Lease Agreement made under the principles of the Shariah for the purpose of renewing any Islamic revolving financing facility.

5. Stamp Duty (Exemption) (No. 3) Order 2004All instruments made by any financier which relate to purchase

of property for the purpose of lease back under the principles of the Shariah or under a principle sale and purchase agreement by which the financier assume the contractual obligations of customer.

Stamp duties are imposed on a large number of documents and contracts including a charge or a mortgage, and a conveyance, assignment or transfer.

Generally, stamp duties are imposed on an ad valorem basis although specific stamp duties are levied on certain documents.

Amendments to the Real Property Gains Tax Act

Gains derived from the disposal of real property, or the disposal of shares in real property companies, are subject to RPGTA.

But, if taxpayer’s business is dealing in property, his gains from such business are subject to income tax and not RPGTA.

In order to increase the attractiveness of the Islamic financial system, paragraph 3(g) was inserted into Schedule 2 of the RPGT Act to exempt the gains from the disposal of real property, as defined, by a person (i.e. customer) to an Islamic bank where that person is being financed by that bank “in accordance with Syariah.”

Tax NeutralityForm of tax incentives whereby a relief is given to the tax charges that was

supposed to be imposed onto the Islamic financial transactions.No Tax Neutrality Tax Neutrality

Disposal of assets/ properties may be subject to income tax or capital gains tax.

Underlying disposal of the assets/ properties required for Islamic transactions will be

disregarded for income tax purposes. In this regard, no additional tax impact on the sale and

leaseback required in Islamic transactions.Double stamp duty for the sale and leaseback of

assets/ properties.Stamp duty exemption on the underlying sale and

disposal of assets/ properties will mean that no additional stamp duty will be applicable compared to a conventional transaction

Uncertainty in respect of what a company can take as a tax deduction.

Profit element will be treated as “interest” for tax purposes. Tax deductibility on expenses incurred available so long as tests of tax deductibility has

been met.

Tax Incentives

On 2006, Malaysia has established the Malaysia International Islamic Financial Centre (MIFC)

The following are the focus areas of the MIFC:Sukuk originationIslamic fund and wealth managementInternational Islamic bankingInternational TakafulHuman Capital Development

Having ensured the convergence of the tax treatment between Islamic financial transactions and their conventional counterparts, the Government has taken additional measures to provide attractive tax incentives for the Islamic finance industry

i. Tax Exemption for Islamic Financial Institutionsii. Tax Incentives for the Issuance of Islamic Securitiesiii. Tax Exemption for Islamic Fund Management Servicesiv. Stamp Duty

COMMON PRACTICAL TAX ISSUES

Practical Tax IssuesTax on Islamic Banking Products, for example,

sukuk.◦the certificates issued in a sukuk are ownership

interests in the assets of the issuing vehicle rather than debt instruments.

◦This can raise a number of unexpected tax issues.

MALAYSIAN INSTITUTE OF ACCOUNTANTS (MIA)’S INITIATIVES TO SUPPORT THE GROWTH OF ISLAMIC FINANCE INDUSTRY

The MIAs’ Initiatives…(1)It plans to develop the knowledge base on

application of IFRS on Islamic Finance as well as to encourage research on this area through collaborations and sharing of findings with stakeholders.

The MIAs’ Initiatives…(2)MIA is collaborating with INCEIF (The Global

University of Islamic Finance) to conduct a gap analysis on the Bachelor of Accounting Programmes of local universities accredited by MIA to recommend relevant Islamic Finance (IF) modules that could be incorporated into the current syllabus.

Conclusion

Islamic-compliant financing is on a growth trajectory based on demographic trends, rising investible income levels and progress towards harmonization with global regulation. Whilst the economies of developed economies are under strain, real estate market participants are looking to funding alternatives such as Islamic debt. Islamic banks originating in the countries of the Gulf Cooperation Council (GCC) could emerge as forces to be reckoned with in the new global order of finance.

And because the Islamic finance in Malaysia is operating side to side conventional banking, there are a lot of differences that we have found in both of the financial system. Nevertheless, although there a lot of differences found, there are some similarities that we could be found on each financial system and mainly on taxation.

The common nature of taxation was mentioned and Islamic finance has to follow it no matter what. However, in being supportive to newly introduced financial system, Islamic finance has been given some initiatives to be compatible as well as on its way to strengthen the Malaysia’s economic on which perhaps aiming to be the central hub of Islamic finance.

Some issues may arise from the implementation of the common taxation to the new Islamic Finance system, but scholars will find a way to solve it. The help also comes from MIA to see the Islamic finance becoming a robust financial system in the world.

Thank you…