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Transcript of Islamic Finance: Integration into the Financial Mainstream Adapting Western Tax Systems to...
Islamic Finance: Integration into the Financial Mainstream
Adapting Western Tax Systems to Accommodate Islamic Finance
Mohammed Amin28 May 2008
Slide 2 PricewaterhouseCoopers LLP
28 May 2008
Mohammed Amin
Mohammed Amin is a tax partner at PricewaterhouseCoopers LLP and leads their Islamic Finance practice in the UK.
He is:
• a Council member of the Chartered Institute of Taxation
• a member of the Policy & Technical Committee of the Association of Corporate Treasurers
• a member of the Business & Economics Committee of the Muslim Council of Britain
• a member of HM Treasury’s Islamic Finance Experts Group, set up to advise the Government on Islamic finance strategy
Many of Amin’s previous articles and presentations on Islamic Finance can be found on his Islamic Finance blog at:
pwc.blogs.com/islamicfinanceTel: 020 7804 6703Fax: 020 7804 1001Mob: 07802 788 357
Email: [email protected]
Web: www.pwc.com
PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Agenda/Contents
Why Western tax systems can be challenged by Islamic Finance
The Swiss position
How the UK tax system has been adapted for Islamic Finance
PricewaterhouseCoopers LLP
Why Western tax systems can be challenged by Islamic Finance
Slide 5 PricewaterhouseCoopers LLP
28 May 2008
Assumed tax system
Assume equipment expenditure amortisable over equipment life on straight line basis.
When does amortisation start?
- When machine purchased
- After payment made
What constitutes a finance cost
Slide 6 PricewaterhouseCoopers LLP
28 May 2008
Illustrative transaction
Conventional purchase
-Machine delivered, cost 1,000
-Pay immediately by borrowing bank loan
-Two year bank loan @ 5% simple interest payable on repayment.
-Five year machine life
Islamic purchase
-Machine delivered now
-Payment due after two years
-Machine price 1,100
-Five year machine life
Identical cash flows
Slide 7 PricewaterhouseCoopers LLP
28 May 2008
Conventional purchase
Goods obtained Cost 1,000Finance cost 100
Bank
Goods supplier
Customer
1,000
Sale for immediatepayment
Cash loan 1,000
PricewaterhouseCoopers LLP
Loan repayment 1,100
Pay 1,000
Slide 8 PricewaterhouseCoopers LLP
28 May 2008
Conventional purchase tax deductionsAmortise from purchase, interest on accruals basis
Year Amortisation Interest Total
1 200 50 250
2 200 50 250
3 200 200
4 200 200
5 200 200
Total 1,000 1,100
Slide 9 PricewaterhouseCoopers LLP
28 May 2008
Islamic purchase
Goods obtained Cost 1,100Bank
Goods supplier
Customer
1,000Sale for
immediatepayment
Sale for 1,100. Payment deferred
by two years
PricewaterhouseCoopers LLP
Payment 1,100.
Implications of tax system type
Slide 10 PricewaterhouseCoopers LLP
28 May 2008
Legal evaluation of Islamic purchase
There is no cost of finance
The machine cost 1,100
Machine is paid for two years after delivery
Implications of tax system type
Slide 11 PricewaterhouseCoopers LLP
28 May 2008
Islamic purchase tax deductionsFollowing legal analysisAmortise from payment, no finance cost
Year Amortisation Interest Total
1 0 0 0
2 0 0 0
3 366 366
4 366 366
5 367 367
Total 1,100 1,100
Implications of tax system type
Slide 12 PricewaterhouseCoopers LLP
28 May 2008
Economic evaluation of Islamic finance purchase
Machine value on delivery 1,000
Agreed price 1,100
Excess 100 price must be finance cost
Payment due after two years
50 per year finance cost
Implications of tax system type
Slide 13 PricewaterhouseCoopers LLP
28 May 2008
Islamic purchase tax deductionsFollowing economic analysis
Year Amortisation Finance cost Total
1 200 50 250
2 200 50 250
3 200 200
4 200 200
5 200 200
Total 1,000 1,100
Implications of tax system type
Slide 14 PricewaterhouseCoopers LLP
28 May 2008
Tax systems classified
Implications of tax system type
Legal approach Economic approach
USA NetherlandsUK
Specific tax law needed for Islamic finance
Zero or limited need for specific tax law
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The Swiss position
Slide 16 PricewaterhouseCoopers LLP
28 May 2008
Tawarruq or Commodity Murabaha
Party A (Bank)
Commodity seller Commodity buyer
Party B
100Sale for
immediatepayment
Sale for deferredpayment
110
Sale for immediate paymentSale 100Cost 110
Slide 17 PricewaterhouseCoopers LLP
28 May 2008
Tawarruq – basic Swiss tax questions
Can Party B deduct loss? – Yes if for business purposes.
Party A’s income may be treated as trading or financial income.
No automatic Permanent Establishment if Party A non-Swiss.
Slide 18 PricewaterhouseCoopers LLP
28 May 2008
Diminishing Musharaka
Bank Eventual Owner
75% share, diminishing
Asset
25% ownership share, increasingSole occupier
Payment to vendor for 25%
Payment to vendor for 75%
Payments to increase ownership
Rent on bank’s 75% (diminishing) share
Slide 19 PricewaterhouseCoopers LLP
28 May 2008
Diminishing musharaka – Swiss tax questions
Rent deductible if for business purposes.
Rent taxable in Switzerland due to Swiss real estate, even if bank foreign.
Real estate transfer taxes on each transfer.
Slide 20 PricewaterhouseCoopers LLP
28 May 2008
Sukuk (Diagram 3)
$50,000 share capitalXYZ Sukuk
Ltd
$500mInvestorsCharity
Shareholders
XYZ TradingCompanyMudarabah
Agreement
Trust
SukukCertificates
Periodic Paymentslimited to
6%
Purchased Assets used in XYZ Trading Company’s business
$500m to buy assets
Mudarib 1%
Rab al-maal 99%
Slide 21 PricewaterhouseCoopers LLP
28 May 2008
Sukuk – Swiss tax questions
Legal form for sukuk transaction needs review. No Swiss law of trusts.
35% withholding tax if over 10 investors.
No automatic permanent establishment.
PricewaterhouseCoopers LLP
The UK tax system’s approach to Islamic finance
Religion neutralDeeming approachOverride of specific obstacles
Slide 23 PricewaterhouseCoopers LLP
28 May 2008
Religion neutral
• No mention of Islamic finance• Key concepts
- Purchase and resale- Deposit- Profit share agency- Diminishing shared ownership- Alternative finance investment bond
PricewaterhouseCoopers LLP
The UK tax system’s approach to Islamic finance
Slide 24 PricewaterhouseCoopers LLP
28 May 2008
Deeming approach
• “Equate(s), in substance, to the return on an investment of money at interest”
• If within statutory definitions- Customer’s expense treated for tax purposes in the same
way that interest is treated- Same for financial institution
• Tax definitions are precise
PricewaterhouseCoopers LLP
The UK tax system’s approach to Islamic finance
Slide 25 PricewaterhouseCoopers LLP
28 May 2008
Override of specific obstacles
• Anti-avoidance rules to stop equity finance being disguised as debt- ICTA 1988 s.209(2)(e)(iii) “securities under which... the
consideration given… is … dependent on the results of the company’s business”
- interest treated as “distribution” ( = not tax deductible)• Specific override in “Islamic finance” legislation
PricewaterhouseCoopers LLP
The UK tax system’s approach to Islamic finance
PricewaterhouseCoopers LLP
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
© 2008 PricewaterhouseCoopers LLP. All rights reserved. 'PricewaterhouseCoopers' refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.
The extent to which a tax system needs to be adapted for Islamic finance depends upon the extent to which it taxes the economic reality or the legal form of transactions.