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Agenda
Introduction
Concepts of Islamic Finance Common Tax Issues in Islamic Finance Tax treatments in Various Jurisdictions Tax Treaty Issues Summary Appendix
Introduction
Introduction
Introduction
Potential tax liability and tax inefficiencies will affect any financing structure
In Islamic Finance, due to the underlying asset within each transaction, tax neutrality as well as the tax treatment of profits need to be resolved Unlike Malaysia and most middle east countries, Islamic Finance instruments are relatively new in most other Asian jurisdictions Tax neutrality has been achieved in some countries such as Malaysia, UK and Singapore However, tax neutrality has not been sorted out in most Asian jurisdictions
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Company A
(2) Ijarah (Lease)
SPV
(2) Funds
Investors
Sukuk is issued based on asset being sold to the SPV who will leaseback the asset to the owner Due to the underlying disposal of asset and lease transaction, the tax issues are more complex compared to a conventional transaction
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Example - Islamic bond issuance based on Ijarah (contd) Some common tax issues 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 the 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 VAT or GST ?
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Company A
(2) Asset repurchase / Ijarah (Lease)
SPV
(2) Funds
Investors
Due to the additional underlying asset transactions required for Syariah 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
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Bank
2
Customer purchases commodity from Bank on deferred instalment basis ($150)
Customer
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Example - Bai Bithaman Ajil (BBA) Financing-I (contd) Some common tax issues to consider
Would the Bank be seen to be buying and selling properties for tax purposes? What is the timing of the recognition of the profits to the Bank ? Would the customer be able to claim a tax deduction on the periodic profits paid to the bank (i.e. $150 - $100 = $50) ? Would there be additional or double stamp duty payable as a result of the underlying asset purchase and sale ? Would there be other taxes such as VAT or GST ?
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Treatment of Profits
Tax neutrality would mean that the profits embedded in the installments paid by customer to the Bank is treated as interest for tax purposes
Therefore, all tax rules relating to interest, such as interest tax deduction, withholding tax or exemptions will equally apply on the profits
Supplier
1
Bank purchases commodity from Supplier ($100)
Bank
Islamic Financing
2
Customer purchases commodity from Bank on deferred instalment basis ($150)
Stamp duty or VAT treatment would also need to be in line with conventional financing
This ensures that Islamic financing is provided with the same treatment as conventional financing
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Customer
Purchased property which is charged to the Bank
Flow of commodity Flow of funds
Tax Neutrality
Slide 12
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Global Trends
Increasing linkages between OIC financial centres such as Kuala Lumpur, Dubai and Bahrain
UK - Tax neutrality announced in 2006. Early 2007, the UK government announced legislation in Finance Bill 2007 to facilitate the UK issuance and trading of Sukuk.
Singapore - removal of double stamp duty hit on Murabaha and Ijara contracts; tax incentives granted to qualifying debt securities extended to approved Islamic bonds; no stamp duty on the transfer of asset to SPV set up for Islamic Financing purposes
Hong Kong - 2 MOUs signed by Hong Kong Monetary Authority (HKMA) with Bank Negara Malaysia and Dubai International Financial Centre Authority (DIFC Authority) - Sept 09, and May 08 respectively aimed at fostering co-operation in the development of Sharia-compliant financial products and the financial infrastructures More interest being shown by other Asian countries such as Japan, Korea, China, Thailand and Australia in Capital Markets products
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Ijarah Structure
Investors 1a
Sukuk
Company in country
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Rental payments on Ijarah financing fall under the category of interest for withholding tax purposes
VAT treatment based on Sovereign Sukuk Law: Transfer assets from the government to SPV and vice versa subject to VAT of 10% Income received by investor from the issuance of sukuk is not categorised as interest but as rental income subject to 10% VAT If Central Bank can confirm Islamic Finance transaction as financing, the DG of Taxes shall view no VAT of 10%.
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Tax Treaties
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Tax Treaties
Thai Company
(2) Ijarah (Lease)
Malaysia SPV
(2) Funds
Investors
If the asset is a property in Thailand, apart from the tax issues in Thailand for the sale and leasback of asset, would we refer to Article 11 on Interest or Article 16 on Income from Immovable Property for tax treaty purposes ?
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Tax Treaties
(b) interest arising in Malaysia may be taxed according to the laws of Malaysia, but if the recipient is a resident of Thailand, the tax so charged shall not exceed 15 per cent of the gross amount of the interest.
8. The term "interest" as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures, as well as income assimilated to income from money lent by the taxation laws of the Contracting State in which the income arises.
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Tax Treaties
Tax Treaties
(1) Funds
Korean Company
(2) Ijarah (Lease)
Malaysia SPV
(2) Funds
Investors
Korea has recently announced that legislative changes will be made to ensure tax neutrality is provided to facilitate Islamic Bonds to be issued
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Tax Treaties
4. The term "interest" as used in this Article means income from Government securities, bonds or debentures, whether or not secured by mortgage and whether or not carrying a right to participate in profits, and debt-claims of every kind as well as all other income assimilated, to income from money lent according to the taxation laws of the Contracting State in which the income arises.
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Summary
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Summary
Summary
Sale of asset may trigger capital gains tax or VAT in certain countries In some countries, stamp duty for the acquirer could also be an issue How would leaseback be treated - Lease payments ? Or would whole transaction be seen as financing ? In some countries (i.e. HK, Malaysia, Singapore), there will be zero withholding tax on approved bonds but for most other Asian countries, there will still be withholding tax on interest on bonds Even if the SPV is in Malaysia where all the tax incentives are available, there is still a need to resolve the potential issue of taxes in each country should there be a sale of asset or returns relating to assets located in each country Korea has proposed changes to legislation which will facilitate issuance of Islamic Bonds based on Ijarah and Murabahah There is therefore a need for tax certainty for Islamic Finance in each country as well as tax treaties
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Contacts
Florence Yip / David Kan Partner / Director PricewaterhouseCoopers Hong Kong 21/F Edinburgh Tower, 15 Queen's Road Central, Hong Kong tel +852 2289 1833 mobile +852 9881 5678 Email:- florence.yip@hk.pwc.com Email:- david.kh.kan@hk.pwc.com Jennifer Chang Senior Executive Director Level 10, 1 Sentral Jalan Travers Kuala Lumpur Sentral 50706 Kuala Lumpur Malaysia Phone:- +(603) 2173 1828 Email:- jennifer.chang@my.pwc.com Ornjira Tangwongyodying / Orawan Fongasira Partner / Director PricewaterhouseCoopers Thailand 15th Floor Bangkok City Tower 179/74-80 South Sathorn Road Bangkok 10120 Thailand Phone:- +(662) 344 1118 Email:- ornjira.tangwongyodying@th.pwc.com Email:- orawan.fongasira@th.pwc.com Stuart Porter / Nobuyuki Saiki Partner / Senior Manager PricewaterhouseCoopers Japan Kasumigaseki Bldg. 15F 2-5, Kasumigaseki 3-chome Chiyoda-ku, Tokyo 100-6015 Phone:- +813 5251 2570 David Sandison Partner PricewaterhouseCoopers Singapore Tel: (65) 6236 3675 Fax: (65) 6236 3715 Email: david.sandison@sg.pwc.com
Margie Margaret Partner PricewaterhouseCoopers Indonesia Jl. H.R. Rasuna Said Kav. X-7 No.6 Jakarta 12940 - INDONESIA Telephone +62 21 5212901, 52890862 (direct) Facsimile +62 21 52905555 / 52905050, 52905555 (direct) Mobile +62 816 893645 Email:- margie.margaret@id.pwc.com
Matthew Wong Partner PricewaterhouseCoopers China 1/F PricewaterhouseCoopers Center 202 Hu Bin Road Shanghai 200021, PRC Phone:- +86 21 2323 3052 Email:- matthew.mf.wong@cn.pwc.com
Kyu-Dong Kim Senior Manager 15th Floor LS Yongsan Tower 191, Hangangro 2-ga, Yongsan-gu Seoul, South Korea
2009 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers.
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Principle 1
Definition Concept Principle 2 Definition
Concept
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Principle 3
Prohibition of riba
Riba means an excess. It is defined as an increase or excess which accrues to the owner in an exchange or sale of a commodity, or, by virtue of a loan arrangement, without providing equivalent value to the other party. Perception of it being unjust and not being productive. Can be divided in two namely:i. Riba Al-Duyun which arises from debts or financing (i.e. late payment) ii. Riba Al-Buyu - due to differences in quantity, quality or time (i.e. fixing in advance of return on financing as a reward for waiting is prohibited)
Definition
Concept
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Definition
Concept
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Principle 5
Definition
Concept
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Islamic Product Concepts Some of the more common product concepts:Murabahah Trade with mark-up or cost-plus sale
Salam
Istisna Ijarah Mudharabah Musharakah Bai Bithaman Ajil BBA
Advance purchase
Purchase order Leasing Profit-sharing, loss borne by capital provider Joint-venture Deferred payment sale
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The selling price being acquisition cost (purchase price plus other direct costs) plus an agreed profit margin
In Murabahah for Purchase Orderer (MPO) arrangement, the IFIs will purchase and acquire assets as specified by the customer
This is based on a PP (promise to purchase) by the customer which can be a binding or non-binding PP (depending on the documentations)
This asset will later be sold to the customer at cost-plus
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This refers to selling a commodity with the same specification as the purchased commodity under a Salam contract to a party other than the original seller.
It allows the IFIs to sell the commodity for future delivery at a predetermined price (thus hedging the price risk on the original Salam contract) and protects the IFIs from having to take delivery of the commodity and warehousing it.
* A commodity is defined as a physical product which is and can be traded on a secondary market, e.g. agricultural products, minerals (including oil) and precious metals (excluding gold and silver). June 2009
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Profits generated by that enterprise or activity are shared in accordance with the terms of the Mudharabah agreement.
Losses are to be borne solely by the IFI unless the losses are due to the Mudaribs misconduct, negligence or breach of contracted terms.
Types:
- a restricted basis - capital provider allows the Mudarib to make investments subject to specified investment criteria or certain restrictions such as types of instrument, sector or country exposures; or - an unrestricted basis, where the capital provider allows the Mudarib to invest funds freely based on the latters skills and expertise.
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