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ISLAMIC FINANCE IN BRUNEI: Tax Issue

Posted by Connie R. Aponte on February 13, 2014 in Finance |

Tax Issue

Unnecessary hurdles from taxation perspective need to be abolished. Previously, there are complaints that the Stamp Act, Cap. 34 (based on the English Stamp Act of 1819) and the Land Code, Cap 34 (enacted in 1909), might hinders the growth of Bruneian Islamic finance industry by creating and maintaining an unequal playing field with conventional banks: and should therefore be updated.

Regulatory treatment is necessary to ensure the success of Islamic finance. Tax incentives have played an important role in creating a level playing field for Brunei’s Islamic finance industry. Previously, the taxation imposed on Islamic banking was similar to that levied on its conventional counterparts, resulting in Islamic financial institutions being subjected to a 30 percent corporate tax and an additional 2.5 percent zakat contribution.

The conventional financial system differentiates equity-based financing and investments, and credit financing or loan. Since under Islamic finance, usury or interest is prohibited, this cause some obstacles when it operates in a system tailored for the conventional system as the regulatory and legal framework favor credit financing and loan by providing many initiatives:

More specifically, tax law could be quite problematic to Islamic banks, especially since tax law has always treated equity finance and debt finance differently. This means that Islamic banks will not have the same tax treatment as conventional banks, which are based on debt finance There are two aspects of the taxation problem regarding the financial products of Islamic banks: first, the extra taxes generated by Islamic bank transactions; and second differentiation made between interest and profits .. ,

A new legal framework is needed for Islamic financial product to avoid extra taxation:

[T]he Murabaha (mark-up) contract is used by Islamic banks to replace personal loans offered by conventional banks. The Murabaha agreement includes two purchasing options, which are taxable transactions although both purchased contracts belong to one transaction, it is still due double stamp duty this means that the cost of this service offered by Islamic banks is far more than that which a customer of a conventional bank would pay for the same service. The same problem can be addressed with regard to Islamic mortgages, where stamp duty land tax will be charged twice: once when the Islamic bank buys the property; and again when the customer completes purchasing all ‘units’ from the banks and obtains the legal title There could also be stamp duty land tax on the lease to occupy the property.37

Under conventional legal framework, interest is given special treatment, can be offset against the payment of tax and in other words, it is tax deductible. Since the interest element is totally eliminated from Islamic finance Islamic banks have no deductions to make in their tax bill. Furthermore, the rewards achieved by equity finance structures to offer similar services to conventional banks, are taxable.

In order to avoid extra taxation and unfair treatment to Islamic financial institutions, established Islamic financial hubs like Malaysia and Iran has long created a level playing field by taking initiatives to ensure fairness.

However, other jurisdictions that are relatively new to Islamic finance are still developing the legal and regulatory framework in relation to taxation. One example is Australia. On 26 April 2010, the then Australia’s Assistant Treasurer and the Minister for Financial Services, Corporate Law and Superannuation announced that a comprehensive review of Australia’s tax laws on Islamic finance will be made.38 On 18 May 2010, the then Assistant Treasurer announced the terms of reference for the Board’s review and the Discussion paper elaborated that the Board has been asked to39:

• ‘Identify impediments in current Australian tax laws (at the Commonwealth, State and Territory level) to the development and provision of Islamic financial products in Australia;

• Examine the tax policy response to the development of Islamic financial products in other jurisdictions (including the United Kingdom, France, South Korea and relevant Asian jurisdictions); and

• Make recommendations (for Commonwealth tax laws) and findings (for State and Territory tax laws) that will ensure, wherever possible, that Islamic financial products have parity of tax treatment with conventional products.’

In conducting the review, it was reported that the Board should consider the following:

• The tax treatment should be based on economic substance of the products rather than form.

• Where an Islamic financial product is economically equivalent to a conventional product, the tax treatment should be the same.

Tax incentives are important. Tax incentives play an important role in creating a level playing field for Brunei’s Islamic finance industry. Previously, the taxation imposed on Islamic banking was similar to its conventional peer which exposed Islamic financial institutions to 30% corporate tax and an additional 2.5% zakat contribution.

Currently, Islamic financial instruments are subject to 2.5% Zakat contribution from the required 30% corporate tax. With Zakat receiving an exemption from the stamp duty, this creates a level playing field on a par with conventional instruments. Brunei formulated the Credit Bureau in September 2012 to improve the risk management practices of banks and finance companies.

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