Islamic Finance to the Fore!

Introduction

The 2007 Malaysian Budget announced by YB Dato’ Seri Ahmad Abdullah Badawi, the Prime Minister and Finance Minister of Malaysia, on 1 September 2006 brought forth good news to corporations doing business in Malaysia through the reduction of corporate income tax rate from 28 per cent currently to 27 per cent for YA2007 and to 26 per cent for YA2008 respectively.¹

Further tax incentives were made available by the government to biotechnology companies in order to accelerate the development of the biotechnology sector.

Arguably the biggest beneficiaries of the 2007 Budget are the market participants in the Islamic finance and takaful² industries as a host of incentives were made available to them. We will discuss some of these incentives in this article.

Takaful Industry

Presently, takaful companies and takaful units licensed under the Takaful Act 1984 are permitted to transact takaful business in international currencies but do not enjoy any tax incentives for doing so. Commencing from YA2007, such takaful companies and takaful units will be given full tax exemption for 10 years on any income derived from takaful business conducted in international currencies, whether with residents or non-residents.

Islamic Finance

As in the case of takaful business discussed above, Islamic banks and Islamic banking units licensed under the Islamic Banking Act 1983 (‘IBA’) may transact Islamic banking business in international currencies but do not receive any tax incentives for doing so. Commencing from YA2007, such Islamic banking companies and units will be given full tax exemption for 10 years on income derived from Islamic banking business conducted in international currencies, whether with residents or non-residents.

Prior to the 2007 Budget, interest on income received by non-residents from financial institutions licensed under the Banking and Financial Institutions Act 1989 was exempted from tax whereas profits received by non-residents from financial institutions licensed under the IBA were subject to tax. This anomaly has been eliminated as of 2 September 2006 and interest or profits received by non-residents from institutions which are licensed under either legislation are now tax exempt.

Fund Management for Foreign Islamic Funds

Prior to the 2007 Budget, management fees received by licensed local and foreign fund management companies³ from managing funds of foreign investors were subject to income tax at a concessionary rate of 10 per cent.

The 2007 Budget has increased the benefits accorded to these fund management companies by giving a full tax exemption for 10 years from YA2007 until YA2016 on management fees received by such companies for managing funds of foreign investors that are established under Syariah principles, provided that such funds have been approved by the Securities Commission of Malaysia (‘SC’).

Islamic Stockbroking Company

An Islamic stock broking company will be given tax deduction on expenses incurred before commencement of business if it submits an application to the SC for a dealer’s licence under the Securities Industry Act 1983 between 2 September 2006 and 31 December 2009 and commences business activities within two years from the date of approval by the SC. Presently, only certain types of incorporation and pre-commencement expenses are tax deductible.

Islamic Capital Market

The existing benefit of allowing tax deduction for expenses incurred in the issuance of Islamic securities based on leasing (Ijarah), progressive sales (Istisna), profit sharing (Mudharabah) and profit and loss sharing (Musyarakah) which is due to expire in YA2007 has been extended for three years until YA2010. The range of products that qualify for such deduction has been extended to include all other Islamic securities products approved by the SC.

Commencing YA2007, special tax treatment will be accorded in relation to special purpose vehicles (‘SPV’) established solely for the purpose of channelling funds into an Islamic capital market financing transaction approved by the SC as follows:

1    the SPV will not be subject to income tax but income received by it will be deemed to be received by the company that established the SPV and be subject to tax; and

2    the company that established the SPV will be given a tax deduction on the costs incurred by the SPV in issuing the Islamic bonds.

Stamp Duty Rebate

Islamic financing instruments which are presently subject to ad valorem stamp duty⁴ will be given 20 per cent rebate on such duty from 2 September 2006 until 31 December 2009 if the Islamic financial product is approved by the Syariah Advisory Council of Bank Negara Malaysia (‘BNM’) or the Syariah Advisory Council of the SC.

Conclusion

Malaysia’s aspirations to establish itself as a regional leader in Islamic finance and an international Islamic capital market centre have been outlined in the BNM’s Financial Sector Masterplan and the SC’s Capital Market Masterplan.⁵ The tax incentives extended to the Islamic finance and takaful industries under the 2007 Budget represent further steps towards achieving these objectives.

Kok Chee Kheong

Skrine
E-mail: KCK@Skrine.com

Notes

1    For the purposes of this article, the expression ‘YA’ refers to Year of Assessment.

2    ‘Takaful’ is a form of mutual guarantee or insurance business based on Islamic principles.

3    Section 15A, Securities Industry Act 1983.

4    The ad valorem rate is 0.5 per cent of the amount secured by the instrument.

5    Both of the Masterplans were launched in 2001.