By Frank Obaro
The storm surrounding the introduction of Non-Interest Banking (NIB) commonly called Islamic banking is gradually settling down and it is important to begin to exhume the challenges that might crop up in its operations with particular reference to the taxation of the sub-sector by the relevant tax authorities, especially the setting of standards for the type of taxes that apply and that are to be collected from the transactions.
As the name implies, Non-Interest Banking (NIB) is a system of financial services that provide unique services in accordance with Islamic religious jurisprudence and Sharia principle and fully regulated by the relevant regulatory authorities as provided for in sections 9, 23 and 52 of the Banks and other Financial Institution Act (BOFIA) 1991 as amended. The CBN is empowered by law, to issue licenses to appropriate entities for the establishment of Non-Interest Banks provided they meet the regulatory requirements.
The establishment of an enabling ûscal and regulatory framework in the UK for Islamic Finance becomes more imperative today than ever. Though the Federal Inland Revenue Service (FIRS) technical Working Group on NIB is working assiduously to enunciate policies that will guide the tax regulation governance of this sub-sector it is also crucial for sector stakeholders to step in and make valuable contribution to engender a mutually acceptable tax system on the operations of Islamic Banking in the Country.
Islamic financial instruments continue to attract consumer attention, with the central element of being interest-free products in compliance with Islamic Sharia law. According to financial sources, the value of funds involved in Islamic banking worldwide grew by an average of 15% annually over the past three years.
Some analysts estimate Islamic banking to be worth some $500 billion, with the Middle East controlling a quarter of those assets. Kuwait is reportedly the biggest contributor, accounting for almost 29% of the sector’s value in the Gulf region. It is followed by Saudi Arabia with about 27%, and the UAE with 15.2%. Nigeria with its 160 million people should definitely not be left out of emerging business frontier. The unbanked population can be a key target.
There are a num ber of challenges that have to be addressed for the successful
Introduction and operation of Islamic banking in Nigeria. Indeed the challenges are numerous, the absence of skilled workforce and the technical capacity to even regulate Islamic financial institutions are lacking and must be resolved before we can witness a boom in this banking sub-sector.
Much has been said of the Lack of Sharia-compliant liquidity management instruments. Islamic banks cannot invest their excess liquidity in interest based instruments, which are the liquidity management instruments in the money market.
This puts them at a disadvantage side by side with conventional banks. The current interbank market and the instruments used by the Central Bank for monetary policy operations are all interest-based with no equivalent government securities or other money market instruments that are Shariah compliant , all of which are essential to avoid a liquidity bottleneck for Islamic banks when they come into operation.
Another key deficiency that has been hotly discussed is the lack of knowledge of accounting and auditing standards pertinent to Islamic financial institutions. The balance sheet structure of Islamic banks is unique, and even though the work of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) on accounting and auditing standards for Islamic banking products is available, there is the need to train conventional accountants and auditors in the application of the standards and how it can be used with the recent benchmark of the International Financial Reporting Standards (IFRS).
Should NIB products be taxed as conventional banking products? One of the best ways to understand Islamic banking is to gain an understanding of the products that are considered acceptable. The important thing to remember is, as it is with the Christian Bible, there are several differing interpretations of what the Holy Quran and the Hadith actually intend. As a result, not all of these products are universally acceptable (particularly those where the return is determinable in advance), but they are a useful guide. Several of these are covered below:
Wadiah (Safekeeping)-In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, when the depositor demands it. Mudarabah (Profit Loss Sharing) Mudarabah is an arrangement or agreement between a capital provider and an entrepreneur, whereby the entrepreneur can mobilise funds for its business activity.
Musharakah (Joint Venture), this concept is normally applied for business partnerships or joint ventures. The profits made are shared on an agreed ratio, while losses incurred will be divided based on the equity participation ratio. This concept is distinct from fixed-income investing (i.e. issuance of loans).Murabahah (Cost Plus), this concept refers to the sale of goods at a price, which includes a profit margin agreed to by both parties.
The purchase and selling price, other costs and the profit margin must be clearly stated at the time of the sale agreement. The bank is compensated for the time value of its money in the form of the profit margin. Bai’ Bithaman Ajil (Deferred Payment Sale), this concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties.
This is similar to Murabahah, except that the debtor makes only a single instalment, on the maturity date of the loan. By the application of a discount rate, an Islamic bank can collect the market rate of interest. Qardul Hassan (Benevolent Loan),t his is a loan extended on a goodwill basis, and the debtor is only required to repay the amount borrowed.
However, the debtor may,at his or her discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor. Ijarah Thumma Al Bai’ (Hire Purchase), these are variations on a theme of purchase and lease back transactions. There are two contracts involved in this concept. The first contract, Ijarah contract (leasing/renting) and the second contract, Bai’ contract (purchase) are undertaken one after the other.
Bai’ al-Inah (Sell and Buy Back Agreement)-The financier sells an asset to the customer on a deferred payment basis and then the asset is immediately repurchased by the financier for cash at a discount. The buying back agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency.
Sukuk (Islamic Bonds), in keeping with the prohibition of riba, a conventional bond is not permitted. A Sukuk bond, however, is asset-backed and the returns on it are not fixed, but are linked to the return on the assets purchased with the proceeds of the issue.
Interestingly there is no tax law specifically to regulate the NIB in Nigeria. The current tax legislation therefore has to be strengthened urgently to accommodate the operations of the NIB institutions. Aside the Jaiz Bank Plc and Lotus Capital currently operating non-interesting banking institutions in Nigeria non other exists. Clear tax legislation is the required to back the guidelines created by the Central Bank to spur up growth in this sector.
The key issues are; how would Company Income Tax be charged on Musharaka, Mudarabah and Sukuk (is it be charged like conventional bonds)? Or VAT on Ijara? The collection of taxes such as Company Income Tax, Value Added Tax, Capital Gains Tax, Withholding Tax and Stamp Duty need to be properly highlighted and guided by appropriate legislation to avoid multiple taxation of the sub-sector.
Does the purchase and then onward sale of assets by the Islamic financier result in any capital gains or other profit-based tax? What will be an equitable VAT framework on Islamic banking products? Issues remain unclear. Is VAT, which tends to be a key tax type with greater focus on delivery procedure in commodity murabaha/tawaruq transactions, be an issue? Islamic Finance requires proper documentary evidence of the transfer of title from the original supplier to the financier.
From a UK perspective, in light of the changes made by the government overtime, changes have been progressively incorporated into UK tax legislation since 2003 with particular changes relating to Sukuk in the 2007 Finance Act with more changes done in the 2009 tax legislation. These changes will bring Sukuk legislation in line with conventional corporate bonds and securitisations and address capital gains and capital allowances issues.
With the take-off of Islamic Banking there is a need to work with tax jurisdictions with established NIB tax legislation as a learning curve to guide the FIRS on the high-level tax implications of Shariah compliance, as well as on the day-to-day practical issues of complying with the intricacies of the existing Nigeria direct tax legislation.