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TAX TREATMENT ON ISLAMIC FINANCE

in Malaysia

Copyright November 2012 by the Malaysian Institute of Accountants (MIA). All rights reserved. Permission is granted to make copies of this work provided that such copies are for use in academic classrooms or for personal use and are not sold or disseminated and provided that each copy bears the following credit line: Copyright (Month and Year) by the Malaysian Institute of Accountants (MIA). All rights reserved. Used with permission of MIA. Contact communications@mia.org.my for permission to reproduce, store or transmit this document. Otherwise, written permission from MIA is required to reproduce, store or transmit, or to make other similar uses of, this document, except as permitted by law. Contact communications@mia.org.my Photo credits:
Cover page - Taman Botani Putrajaya, January 7, 2012 Phalinn Ooi (http://www.flickr.com/photos/phalinn/), used under a Creative Commons Attribution licence: http://creativecommons.org/licenses/by/3.0/, (http://www.flickr.com/photos/phalinn/6656701051/); Page 10 - The Art of Putrajaya Mosque February 24, 2008 Mohd Nor Azmil Abdul Rahman (http://www.flickr.com/people/azmil77/), used under a Creative Commons Attribution licence: http://creativecommons.org/licenses/by/3.0/, (http://www.flickr.com/photos/azmil77/2287772441/); and Page 15 - MOF Facade - Ministry of Finance, Putrajaya, May 19, 2008 William Ng (http://www.flickr.com/photos/williamnyk/), used under a Creative Commons Attribution licence: http://creativecommons.org/licenses/by/3.0/, (http://www.flickr.com/photos/williamnyk/2566727177/).

Contents
Glossary Overview of Islamic Finance Differences between Conventional Finance Transactions - Examples and Islamic

Page
2 5 7

Islamic Finance Transactions: Financial Reporting Standards in Malaysia Malaysian Tax Legislation Tax Neutrality Governments Initiatives towards Islamic Finance

10

12 14 15

Tax Incentives Common Practical Tax Issues - Example Malaysian Institute of Accountants (MIA)s Initiatives to Support the Growth of Islamic Finance Industry

16 18 20

Glossary
Bai A sale or contract of sale. It sometimes precedes another term used to denote various sales-based modes of Islamic finance such as Murabahah, Istisna and Salam. A sale where payment of the consideration is deferred, either in instalments over a specified period or in full on a specified date. It is commonly used in long-term mortgage loans on which the homeowner pays instalments for typically 10, 20 or more years. A contract of sale and purchase of an asset whereby the seller sells to the buyer in cash and subsequently buys back the asset at a marked up deferred price; A contract of sale and purchase of an asset whereby the seller sells to the buyer at a deferred price and subsequently buys back at a lower cash price.

Bai Bithaman Ajil (BBA) or cost plus profit margin financing contract Bai Al-Inah

Gharar (Uncertainty) Halal Haram

An element of a contract which is unknown, uncertain, ambiguous or deceit. For example, sale of birds in the sky, short-selling. Permissible. That is neither prohibited (haram) nor of doubtful permissibility (shubhah). Prohibited. Examples of activities prohibited in Islam include the sale and consumption of pork and pork-related products, pornography and fornication, gambling and intoxicants. Some jurisdictions also extend the prohibition to the sale of tobacco and/or armaments. Transferring a debt from one debtor (transferor) to another (transferee). Once the transferee has accepted the transfer of the debt, the transferor would be released from any obligation. Rebate. A contract whereby the lessor transfers to the lessee in return for a payment or series of payments the usufruct of an Ijarah item for an agreed Ijarah period, with terms mutually agreed by the contracting parties. An Ijarah contract with an undertaking by the lessor to sell the Ijarah item to the lessee and/or an undertaking by the lessee to purchase the Ijarah item by, or at the end of the Ijarah period. [Ijarah= lease; thumma= then; al Bai= a sale] An Ijarah or equivalent to a hirepurchase contract accompanied with an arrangement to transfer the Ijarah item from the lessor to the lessee through either a gift or a sale by, at the end of the Ijarah period. [Ijarah means lease; muntahia refers to as ending whereas Bittamleek means with ownership]

Hiwalah

Ibra Ijarah (Leasing)

Ijarah Thumma Al Bai (also called Ijarah WaIqtina) Ijarah Bittamleek Leases) Muntahia (Financial

Tax Treatment on Islamic Finance in Malaysia

Glossary (continued)
Istisna sale) (manufactureA sale in which the subject is an item that has yet to be fabricated, manufactured, or constructed. Delivery of the item takes place at a future predetermined date. The consideration may be paid before, at or after delivery, or based on the stage of completion. An open promise by one party to pay whoever performs a particular task. It is a unilateral binding on the initiator. To add obligation [of the guarantor] to the obligation of the principal debtor in respect to the demand for something [debt; compensation]. For example: If someone has a debt, another person is wishing to give guarantee of the debt; the first person is called asil (the principal debtor) and the second person is called kafil (guarantor). All dealings where placement of bet is required. Involves an arrangement between 2 or more parties, where a loss for one means a gain for the other. For example, gambling and games of chance. A form of partnership between a party which contributes capital (rabb al-mal i.e. capital provider) and another which contributes effort, managerial and/or entrepreneurial skills (mudarib i.e. manager/entrepreneur). Profit from the outcome of the venture is shared between the capital provider and manager/ entrepreneur according to a mutually agreed profit sharing ratio, while losses are borne solely by the capital provider, provided such loss is not due to the managers/ entrepreneurs negligence or violation of specified conditions. A sale based on trust, in which the seller must disclose to the purchaser the mark-up on the item sold. The consideration may be paid either in cash or deferred. It is similar to a BBA contract but for shorter-term financing. Payment can be made by lump sum or by instalment. A form of partnership where partners contribute capital in cash or in kind, and share profits according to an agreed profit-sharing ratio, while losses are shared according to the capital contribution ratio. A lease contract which the lessee does not have the intention to own the asset. A benevolent interest-free loan in conventional finance. In Shariah, a borrower is obligated to repay only the principal amount of a loan and the lender is not entitled to demand any return over and above the principal. For example, a borrower takes a loan of say RM100 and repays the lender on maturity exactly the same amount of RM100 without an increment.

Jualah Kafalah

Maysir (Gambling)

Mudarabah sharing)

(profit

Murabahah financing contract

Musharakah venture) Operating lease Qard Hasan

(Joint

Tax Treatment on Islamic Finance in Malaysia

Glossary (continued)
Rahnu (pawnbroking) A possession offered as security for a debt so that the debt will be paid from them in case the debtor failed to pay back the debt. Other names: pledge, mortgage, pawn, collateral but with Shariah rulings. Covers any return of money on money, whether the interest is fixed or floating, simple or compounded and at whatever rate. Such gain is prohibited. A sale in which payment is made immediately while goods are delivered at an agreed later date. It is equivalent to an advance payment. It was originally created to provide financing for farmers. Islamic laws derived from Al-Quran and As-Sunnah. A separate subsidiary company set up to contain investments. Such a company protects its assets secure if the parent company goes bankrupt. Financial instruments that serve much the same purpose as debt, but which are structured to avoid the payment of interest. Donation, gift or contribution. An arrangement under which participants agree to contribute to a fund, where sums from the fund would be disbursed to participants or their beneficiaries on the concurrence of pre-agreed events. A contract between an agent and principal. In most circumstances, the agent would be entitled to be paid ujrah (fee) for his services rendered. Obligatory contribution assessed based on certain assets owned by a Muslim that satisfy certain conditions and is to be distributed to specified categories of beneficiaries.

Riba (Interest)

Salam delivery) Shariah

(deferred

Special Purpose Vehicles (SPV) Sukuk (Bond) Tabarru Takaful (Insurance)

Wakalah

Zakat

Tax Treatment on Islamic Finance in Malaysia

Overview of Islamic Finance


This publication seeks to provide some basic insights and understanding of Islamic Finance. The objective is not to go into substantive details but to enumerate some of the pertinent points that may need to be considered before undertaking Islamic Finance opportunities.

What is Islamic Finance?


In simple term, it is a form of finance that is based on Shariah or the body of Islamic law. It offers a way of conducting financial transactions which is Shariah-compliant and according to certain defined ethical values such as fairness (i.e. price manipulation is prohibited), transparency (i.e. adequate information disclosure is encouraged) and risk-sharing (i.e. mutual co-operation and benefit is encouraged). In ensuring Shariah-compliant, five key principles are strictly observed:

1 Belief in divine guidance 2 No interest can be charged 3 No haram investments Risk sharing is encouraged Key Principles of Islamic Finance Financing is based on real assets 4

These principles can be viewed as activities that are prohibited and those which are encouraged. In certain circumstances, it may be similar to conventional financial products but the fundamental principles remain different. For instance, every Shariah-compliant financial transaction is not based on usury (interest), 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.

(interest)

Riba

(gambling)

Maysir

(uncertainty)

Gharar

Tax Treatment on Islamic Finance in Malaysia

Islamic Finance Transactions


Commonly, Islamic financial transactions involve the following:

Islamic Financial Transactions


Sale-based Principles
Bai (Sales) Bai-Salam Istisna Debt-based financing BBA Murabahah

Profit-sharing Principles
Equity-based financing Mudarabah Musharakah

Lease-based Principles
Debt-based financing Ijarah (leasing) Operating Financial

Fee-based Principles
Wakalah (agency) Jualah (commission)

Free-ofcharge Principles
Qard Hassan

Supporting Contract / Security


Kafalah Rahnu Hiwalah

The above diagram is generally some common types of Islamic finance contract. For a contract1 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. 2. There are at least two parties in an Islamic contract; There is offer and acceptance by both parties (i.e. seller or buyer or vice versa) on the purpose and terms of the contract; 3. 4. The purpose of the contract must not be haram (forbidden) or offensive to Shariah; and The subject of the contract must change hands upon completion of the contract.

BBA, Murabahah and Ijarah are the most common type of debt-based financing contract whereas Mudarabah and Musharakah are the equity-based financing contract which are less popular as the former is in a way similar with the conventional financing and due to familiarity. A Mudarabah financing contract is where the bank only provides capital to the lender for a project based on a profit-sharing ratio. If profits are generated, the profits are distributed according to the pre-agreed profit-sharing ratio whereas, any losses are entirely absorbed by the bank. Under a Musharakah financing contract, the bank and the lender will become joint-venture partners where both parties will contribute capital and decide on a profit-sharing agreement. In our Malaysia jurisdiction, the Islamic finance services that are available would be savings/ transactional accounts, consumer finance, corporate finance, investment banking, corporate sukuk issuances, sovereign sukuk issuances, fund management, securities trading, takaful, retakaful, and co-operatives and/or savings institutions.

1 A contract is an agreement between two or more parties that creates an obligation to do or not to do any particular thing. It is legally-enforceable by the law where the agreement was made and upon fulfilment of certain conditions. Tax Treatment on Islamic Finance in Malaysia

Differences between Conventional and Islamic Finance Transactions - Examples


This table show some of self-explanatory differences between the Shariah-compliant financing transactions and products compared to common conventional financial instruments are as follows:

CONVENTIONAL 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 banks base lending rate (BLR), and both the margin and the BLR are variable from time to time. Leasing Arrangement Types: 1. Operating leases An agreement between: a) a lessor who owns an asset and who wants to earn return without losing ownership; and b) a lessee who needs to use the asset and who cannot afford to buy it or does not want to own it. 2. Financial leases a) b) The lessee has the option to purchase the asset at the end of the lease. The ownership of the asset is transferred to the lessee at the end of the lease term. Ijarah

SHARIAH-COMPLIANT 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 banks 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 banks selling price will not change throughout the tenure of the financing.

Some of the rules that Islamic leasing observed: The lessor continues to own the asset during the lease period i.e. the risk and obligations of ownership are borne by the lessor whereas the risk and obligations of use are borne by the lessee. The rental amounts must be determined and fixed at the start of the contract for the whole duration of the lease. The lease begins only when the leased asset is delivered to the lessee ant not at the point when payment is made or the lease contract is signed.

Tax Treatment on Islamic Finance in Malaysia

Differences between Conventional and Islamic Finance Transactions - Examples


(continued)
CONVENTIONAL Types: 1. Operating lease In an Ijarah agreement, a bank or financier buys a property for a customer and then leases it to him over a specified period, thus earning profits to the bank by charging rentals. The duration of the lease and the fee are set in advance. 2. Al-Ijarah-Thumma Al-Bai (AITAB) or Ijarah Muntahia Bittamleek (IMB) [ similar to a hire-purchase contract in conventional finance] Al-Ijarah-Thummal Al-Bai (AITAB) AITAB is an arrangement to transfer the ownership of the underlying asset by or at the end of the lease is by means of a sale; also called ijara wa iqtina, in other word is a lease that ends with a sale. Ijarah Muntahia Bittamleek (IMB) In IMB, the lessor has four options to transfer the legal title of the assets to the lessee whether as a gift, for a token of consideration, consideration prior to end of lease termor through gradual transfer; in other word is a lease that ends with ownership transferred. * Note: AITAB is more popular in South-East Asia while IMB is more accepted in the Middle East. SHARIAH-COMPLIANT

Tax Treatment on Islamic Finance in Malaysia

Differences between Conventional and Islamic Finance Transactions - Examples


(continued)
CONVENTIONAL Conventional Insurance Conventional insurance is associated with riba and major gharar, both of which are forbidden by Islamic principles, for instance: shareholders profits. 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. Basically, it based on two main concepts: An and insurance the contract based on Mudarabah means that policy holders insurance operator share risk by agreeing to a profit-sharing arrangement; Insurance based Wakalah (agency) means that the policyholders appoint the insurance operator as an agent to operate the insurance scheme at a fee and does not share in the profits; Takaful products can also run on tabarru (donation) or non-profit basis or; A hybrid of profit- sharing and agency. own the insurance company. The objective is to maximise SHARIAH-COMPLIANT Islamic insurance or Takaful It 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.

Tax Treatment on Islamic Finance in Malaysia

Islamic Finance Transactions: Reporting Standards in Malaysia


In view of the rapid acceptance of Islamic finance in the global market and as a way to achieve sizeable critical mass before the sector can offer comprehensive alternatives to conventional banking products and financial services, there is an urgent need to address issues on accounting and financial accounting, auditing and governance framework for Islamic finance. The Accounting for (AAOIFI) and Islamic Auditing Financial was

Financial

Organisation Institutions

which

established in 1990 located in Bahrain has, ever since its inception, issued more than 60 accounting, auditing, governance and Shariah standards for Islamic institutions. Despite AAOIFI being a pioneer in the Islamic standardsetting, 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. Thus, MASB has not approved AAOIFI financial accounting standards for use by entities under its purview (extracted from MASBs website www.masb.org.my). This simply means that an entity may not apply AAOIFI recognition and measurements that depart from MASB requirements. However, the inclusion of additional disclosures required under AAOIFI standards, if appropriate, may be acceptable. 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. Thus far, the MASB accounting standard requirement has no violation of the Shariah principles. As such, in the event where, under extremely rare circumstances, there is a Shariah prohibition to MASB requirement, that requirement need not be complied with and MASB will undertake to issue alternative guidance. Hence as at todate, MASB does not issue separate Islamic accounting standards for this purpose.

10

Tax Treatment on Islamic Finance in Malaysia

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. To date, the MASB has issued four (4) Technical Releases as guidance as follows: Statement of Principles i-1 (SOP i-1) Financial Reporting from an Islamic Perspective: SOP i-1 serves to inform that MASB approved accounting standards shall apply to Islamic financial transactions, unless there is a Shariah prohibition. Technical Release i-1 (TR i-1) Accounting for Zakat on Business: when an entity pays zakat on business, TR i-1 requires it to be recognised as an expense of the entity. This is to differentiate between zakat paid by an entity in its own legal capacity and zakat paid on behalf of its shareholders. Technical Release i-2 (TR i-2) Ijarah: TR i-2 confers a lessee with the right to use an asset while ownership of the underlying assets remains with the lessor. Technical Release i-3 (TR i-3) Presentation of Financial Statements of Islamic Financial Institutions: TR i-3 mainly concerns presentation of information relating to contracts used by Islamic financial institutions. Technical Release i-4 (TR i-4) Shariah Compliant Sale Contracts: TR i-4 is to clarify the recognition and derecognition requirements for items acquired or transferred through a Shariah compliant sale contract. In addition to this, MASB is the Leader of the Asian-Oceanian Standard Setters Group (AOSSG)2 Islamic Finance whose other members comprise standard-setters from Australia, China, Dubai, Korea, Pakistan and Saudi Arabia. The Working Group was set-up with the objective to facilitate AOSSG members to provide input and feedback to the International Accounting Standard Board on the adequacy and appropriateness of proposed and existing IFRS to Islamic financial transactions and events.

AOSSG is a group of accounting standard-setters in the Asia-Oceania region, within which there are several working groups to provide input into topics that are of importance to the region.
2

Tax Treatment on Islamic Finance in Malaysia

11

Malaysian Tax Legislation


Generally, there is no specific tax legislation governing Islamic financial instruments. However the Income Tax Act 1967 (the Act) has made certain provisions on Islamic transactions as identified below: SECTION Section 2(7) PROVISION IN THE ACT 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(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.

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Tax Treatment on Islamic Finance in Malaysia

Malaysian Tax Legislation (continued)


Apart from the Income Tax Act, various stamp duty exemption orders have been issued to ensure that Islamic financing transactions are not adversely taxed as compared with the conventional financing transactions. The identified stamp duty exemption orders are: STAMP DUTY EXEMPTION ORDER Stamp Duty (Exemption) (No. 8) Order 2000 DESCRIPTION Exempted 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. Stamp Duty (Exemption) (No. 9) Order 2000 All 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. Stamp Duty (Exemption) (No. 38) Order 2002 Exempted 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 under Stamp Duty (Exemption) (No. 2) Order 2004 the Banking and Financial Institutions Act 1989; the Islamic Banking Act 1983; development financial institutions supervised under Section 2 of the Development Financial Institutions Act 2002; or any institution approved by the Central Bank of Malaysia.

All 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.

Stamp Duty (Exemption) (No. 3) Order 2004

All 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.

Tax Treatment on Islamic Finance in Malaysia

13

Tax Neutrality
In a nutshell, for Islamic finance transactions, due to the underlying asset within each transaction, tax neutrality as well as the tax treatment of profits need to be resolved as tax issues tend to arise in most countries. Tax neutrality is a form of tax incentives whereby a relief is given to the tax charges that was supposed to be imposed onto the Islamic financial transactions. In fact, Malaysia was among the first country to accord tax neutrality to Islamic finance instruments and transactions to reduce cost of transferring assets in Islamic finance. This measure has promoted a level playing field between conventional and Islamic financial products. Section 2(8) of the Act essentially allows the underlying sale of assets or leases to be ignored for tax purposes so that any additional tax as a result of the underlying transaction would not arise. It enables Islamic financing to continue without any tax issue relating to asset transfer or lease, as such placing the Islamic financing on the same footing as conventional financing. Approval for the Islamic financing has to be granted by the relevant authorities namely Bank Negara Malaysia, Securities Commission and the Labuan Financial Services Authority. The impact between no tax neutrality and tax neutrality is tabulated as below:

No Tax Neutrality Disposal of assets/ properties may be subject to income tax or capital gains tax.

Tax Neutrality 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 deduction.

in

respect

of

what

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.

a company can take as a tax

[Source: PricewaterhouseCoopers] There is always a need for tax neutrality so that Islamic finance is put on equal tax treatment compared to conventional finance. Otherwise, Islamic finance will not be attractive or competitive compared to conventional finance.

14

Tax Treatment on Islamic Finance in Malaysia

Governments Initiatives towards Islamic Finance


The Government up various Malaysian has steps taken and

initiatives to facilitate the transition of Malaysia to become an international Islamic and that hub; well supported with a vibrant comprehensive includes major and financial Islamic financial system international domestic institutions. For instance, of the the

establishment Malaysia

International

Islamic Financial Centre (MIFC) in year 2006 was aimed at promoting Malaysia as a key global player in Islamic finance which offers in extensive Islamic knowledge and practical experience finance. Besides MIFC, the establishment of Islamic Financial Services Board (IFSB) provides guidance that is intended to promote global prudential standards and guiding principles for the Islamic banking and insurance industry and capital markets. The International Centre for Education in Islamic Finance (INCEIF) was set up with the main objectives of making Malaysia the leading centre for Islamic finance education and developing human capital for the global Islamic finance industry. In addition, the International Shariah Research Academy for Islamic Finance (ISRA) was established in year 2008 to promote applied research in the areas of Shariah and Islamic finance.

Tax Treatment on Islamic Finance in Malaysia

15

Tax Incentives
Undoubtedly, tax incentives are clearly an important aspect in developing and promoting the Islamic financial market. Basically, tax incentives can be broadly categorised into:a. b. c. Tax incentives to diversified players such as Banking, Takaful and Fund Management Tax incentives to facilitate Islamic finance transactions in Malaysia Tax incentives on Expertise

A wide range of tax incentives across the Islamic finance spectrum in promoting Malaysia as an international Islamic financial centre are identified below (which are not exhaustive):

Tax Incentives Tax exemption of Islamic banks and takaful in companies transacted currencies international

Notes Tax exemption of 100% from Year of Assessment (YA) 2007 to YA 2016 for Islamic banks and Islamic banking units licensed under the Islamic Banking Act 1983 on income derived from Islamic banking business conducted in international currencies, including transactions with Malaysian residents; and Tax exemption of 100% from YA 2007 to YA 2016 for takaful companies and takaful units licensed under the Takaful Act 1984 on income derived from takaful business conducted in international currencies including transactions with Malaysian residents.

Exemption from withholding tax

Interest income (other than such interest accruing to a place of business in Malaysia) received by non-residents from financial institutions established under the Islamic Banking Act 1983, or any other financial institutions approved by the Minister of Finance are exempted from tax. Profits paid in respect of Islamic securities/ debentures issued in Ringgit Malaysia, other than convertible loan stock which are approved by the Securities Commission (SC) to non-residents are exempted from witholding tax. This includes non-Ringgit instruments approved by SC or Labuan Financial Services Authority (Labuan FSA). Similarly, any profits paid on non-Ringgit Islamic securities to residents are also exempted if approved by SC or Labuan FSA.

Exemption Real Gains (RPGT)

of Tax

Chargeable gains accrued on the disposal of any chargeable assets in relation to the issuance of private debt securities under Islamic principles are exempted from RPGT. This also applies to the disposal of any chargeable assets in relation to the Sukuk Bank Negara Malaysia (BNM) - Ijarah which are issued or to be issued by BNM Sukuk Berhad.

Property

16

Tax Treatment on Islamic Finance in Malaysia

Tax Incentives (continued)


Tax Incentives Personal relief tax Notes Tax relief not exceeding RM5,000 per annum is also provided on Islamic finance courses approved by Bank Negara Malaysia (BNM)or SC at local institutions of higher learning including INCEIF. I s s u a n c e of Islamic securities Exemption Stamp Duty of Tax deduction on expenses incurred on the issuance of Islamic securities based on principles of Mudharabah, Musharakah, Ijarah, Istisna and other Islamic securities approved by SC or Labuan FSA up to YA 2015. Further extension of stamp duty exemption of 20% on instruments of Islamic financing products approved by the SAC of BNM or SC up to 31 December 2015. 100% stamp duty exemption up to 31 December 2016 on foreign currency instruments executed by International Currency Islamic financial institutions. Others Pre-commencement expenses of an Islamic stockbroking company will be allowed as tax deduction which commences its business within two (2) years from the date of approval by the SC. Applications have to be received by SC before 31 December 2015. Special purpose vehicles (SPV) established under the Companies Act 1965 or Offshore Companies Act 1990 which elects to be taxed under the Income Tax Act 1967, solely to channel funds for the purposes of issuance of Islamic securities, is not subject to tax or tax administrative procedures, subject to approval from SC. Double deduction on certain expenses3 incurred for the purpose of promoting Malaysia as an International Islamic Financial Centre (MIFC) is extended until YA 2015.

Expenses eligible for double deduction include expenses incurred on market research and feasibility studies, cost of preparing technical information to a person outside Malaysia relating to the type of services offered, expenses directly incurred for participating in an event or events verified by MIFC secretariat i.e. a secretariat established by Bank Negara pursuant to the MIFC initiatives; accommodation expenses up to RM300 per day and sustenance expenses up to RM150 per day for company representatives who travel overseas for business; cost of maintaining sales offices overseas as approved by MIFC secretariat and publicity and advertisement expenses in any media outside Malaysia. Event here means a Global Islamic Financial Forum (GIFF) organised by or on behalf of MIFC Secretariat or any exhibition, conference, promotional fair, seminar, summit, road show or meeting or any participation in relation to GIFF.
3

Tax Treatment on Islamic Finance in Malaysia

17

Common Practical Tax Issues - Example


Islamic bond issuance based on Sukuk Ijarah (Leasing)
1) Funds

Company A

1) Sale of Asset 2) Ijarah (Lease)

SPV

2) Sukuk Issuance 2) Funds

Investors

2) Ijarah Payments [Source: PricewaterhouseCoopers] Note: Sukuk is issued based on asset being sold to the SPV who will leaseback the asset to the owner. Due to underlying disposal of asset and lease transaction, the tax issues are more complex compared to a conventional transaction. Some common tax issue to consider Would the sale and lease be seen as separate sale and leaseback transactions for the purpose of tax? Would there be issues as far as tax depreciation is concerned on the disposal of assets (i.e. claw back on tax depreciation claimed previously)? Would tax incentives be affected by an Islamic financing structure due to disposal of assets? Would there be additional or double stamp duty payable as a result of the underlying asset transfer? Would profits on such Islamic Finance transactions be tax deductible? Would there be other taxes such as Value Added Tax (VAT) or Goods and Services Tax (GST)?

Tax Neutrality Provisions


1) Funds

Company A

1) Sale of Asset 2) Asset repurchase / Ijarah (Lease)

SPV

2) Sukuk Issuance 2) Funds

Investors

2) Deferred consideration / Ijarah Payments

[Source: PricewaterhouseCoopers]

Due to the additional underlying asset transactions required for Shariah financing, tax neutrality rules would mean that the underlying transactions would be ignored for tax purposes. This will mean that the Sukuk will be treated to be similar as any conventional bonds so that it is not treated worse off.
Tax Treatment on Islamic Finance in Malaysia

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Malaysian Institute of Accountants (MIA)s Initiatives to Support the Growth of Islamic Finance Industry
MIA through various initiatives and collaborations aims to showcase Malaysias expertise in Islamic Finance and promote its accountants marketability locally and internationally. 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. Specifically, MIA engaged with Bank Negara Malaysia to provide input from the industrys perspective on the Shariah Audit Framework for Islamic Financial Institutions (IFIs). The views and feedback were shared with Bank Negara Malaysia through several discussions held throughout 2011. It is envisaged that a more practical and useful guidance will be issued which will enhance the efficiency of the Islamic Finance market. 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. In addition, MIA would identify suitable courses that could be offered for the benefit of members. This initiative is aimed to enhance the value of future and existing accountants by embedding relevant knowledge into their education system and continuous professional development. This will provide a ready supply of IF-competent accountants to support the development of this rapidly growing economy and promote Malaysian accountants marketability internationally.

Tax Treatment on Islamic Finance in Malaysia

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References
Asian-Oceanian Standard-Setters Group website at www.aossg.org Bhupalan, R., 2009. An Introduction to Islamic Finance and the Malaysian Experience. [online] Available at <http://www.taxand.com.my> [Accessed 30 August 2012] Choong, K.F., 2011. Advanced Malaysian Taxation: Principles and Practice (13th Edition). Malaysia: Infoworld. International Centre For Education In Islamic Finance website at www.inceif.org International Shariah Research Academy for Islamic Finance at www.isra.my Kasipillai, J., 2010. A Guide to Advanced Malaysian Taxation. Malaysia: McGraw-Hill, 2010. Malaysia International Islamic Financial Centre website at www.mifc.com Malaysian Accounting Standards Board website at www.masb.org.my Naim, A., 2010. Malaysia: The Tax Haven For Islamic Finance. [online] Available at <http://arzim. blogspot.com> [Accessed 30 August 2012] PricewaterhouseCoopers, 2010. Gateway to Asia: Malaysia, International Islamic Finance Hub. Malaysia: PricewaterhouseCoopers PricewaterhouseCoopers, 2011. Practical and Legal Tax Issues for Cross-Border Financial Activities. Malaysia: PricewaterhouseCoopers Vicary Abdullah, D. and Keon, C., 2010. Islamic Finance: Why It Makes Sense. Singapore: Marshall Cavendish Business.

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Tax Treatment on Islamic Finance in Malaysia

The Malaysian Institute Of Accountants (MIA) MIA is a statutory body established under the Accountants Act, 1967 to regulate and develop the accountancy profession in Malaysia. As at November 2012, MIA has close to 29,000 members. For more information please visit: www.mia. org.my

Vision To be a globally recognised and renowned institute of accountants committed to nation building.

Mission To develop, support and monitor quality and expertise consistent with global best practice in the accountancy profession for the interest of stakeholders.

Objectives 1. To promote & regulate professional & ethical standards 2. To develop & enhance competency through continuous education & training to meet the challenges of the global economy To enhance the status of members To lead R&D for the enhancement of the profession To inculcate a high sense of social responsibility

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The Use of the Word Accountant In Malaysia, the word accountant is protected as provided for under the provisions of the Act which states that no one can hold himself out or practise as an accountant unless he is registered as a member of MIA.

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This document contains general information only and MIA is not, by means of this document, rendering any professional advice or services. This document is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a professional advisor. Whilst every care has been taken in compiling this document, MIA makes no representations or warranty (expressed or implied) about the accuracy, suitability, reliability or completeness of the information for any purpose. MIA, its employees or agents accept no liability to any party for any loss, damage or costs howsoever arising, whether directly or indirectly from any action or decision taken (or not taken) as a result of any person relying on or otherwise using this document or arising from any omission from it.

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Dewan Akauntan No. 2, Jalan Tun Sambanthan 3 Brickfields, 50470 Kuala Lumpur Malaysia [phone] +603 2279 9200 [fax] +603 2274 1316 [web] www.mia.org.my [email] technical@mia.org.my