MALAYSIAN ISLAMIC FINANCE Issuers and Investors Forum 2006

Positioning Malaysia as an Islamic
Financial Center

By Jennifer Chang

In line with the Malaysian Government’s efforts to promote Malaysia as an Islamic Financial Center (MIFC), the 2007 Budget announcements made on the 1st September 2006 provided substantial tax incentives in the area of Islamic finance. The new incentives provide an opportunity for Malaysia to capitalize on an influx of liquidity, particularly from the Middle East. Middle Eastern investors are looking into modes of financing and investments that not only provide similar returns compared to conventional financing and investments, but are also in compliance with Islamic religious principles.

As the demand for Islamic financing products increases globally, more and more countries are realizing the potential of Islamic finance. In seeking to develop this market niche, the Malaysian Government has provided numerous tax incentives to support regulatory policies in ensuring the country’s role as a leading Islamic financial center in the region.

Islamic banking and Takaful business
Islamic banking as a whole showed commendable growth in 2005, with profitability and assets surpassing for the first time US$272.4 million (RM1 billion) and US$27.24 billion (RM100 billion) respectively. The Islamic banking industry also welcomed foreign participants into its fold with the issuance of three new Islamic banking licenses to foreign Islamic financial institutions from the Middle East.

Islamic insurance, or Takaful, is also fast gaining popularity. Malaysia is the forerunner in terms of Takaful activities in South-East Asia.

As part of the strategy to boost the country as MIFC, BNM announced that foreign and local banks and Takaful operators will be granted new conditional licenses to undertake a full range of Islamic banking and Takaful businesses in international currencies.

Complementing this regulatory policy, the 2007 Budget, which was announced on the 1st September 2006, proposed substantial tax incentives to boost the Islamic banking and Takaful industry in Malaysia. Some of the major proposals are as follows:
1. Tax exemption of Islamic banks and Takaful companies

• 10-year tax exemption for Islamic banks and Islamic banking units licensed under the Islamic Banking Act 1983 on income derived from Islamic banking business conducted in international currencies, including transactions with Malaysian residents.
• 10-year tax exemption for Takaful companies and Takaful units licensed under the Takaful Act 1984 on income derived from Takaful business conducted in international currencies, including transactions with Malaysian residents.
  
  These incentives are effective from year of assessment 2007 to year of assessment 2016.

2. Exemption from withholding tax
Currently, paragraph 33 of Schedule 6 to the Income Tax Act 1967 provides tax exemption on:

“Income of any person not resident in Malaysia for the basis year for a year of assessment, in respect of interest derived from Malaysia (other than such interest accruing to a place of business in Malaysia of such person) and paid or credited by any person (whether the same person or not) carrying on the business of banking or finance in Malaysia and licensed under the Banking and Financial Institutions Act.”

echnically, this tax exemption would only apply to normal conventional banks and their Islamic windows, and not to Islamic banks licensed under the Islamic Banking Act 1983.

To streamline tax treatment on profits received by foreign non-resident customers from all financial institutions, it was proposed that profits received by non-residents from financial institutions established under the Islamic Banking Act 1983 – and other financial institutions approved by the Minister of Finance – be exempt from tax as well.

It has also been confirmed by the 2007 Budget that any profits paid out by an Islamic bank to foreign non-resident customers need not be subject to tax in Malaysia, thus providing equal treatment with conventional bank foreign customers. This means that there will be no withholding tax on profit payments made by all licensed banks in Malaysia to non-resident customers.

This proposal is effective from the 2nd September 2006.

3. Facilitation of financing transactions
Currently, the definition of partnership for tax purposes is very wide and includes all types of partnership. Hence any type of partnership, unless specifically excluded, would have to file tax returns. Such tax treatment does not promote financing transactions such as Musharakah or Mudharabah, since it would technically mean that tax returns have to be submitted for each transaction.

In recognizing and promoting Islamic financing structures based on the concept of Musharakah or Mudharabah, it has also been proposed that such financing transactions need not file partnership tax returns. The effective date is from year of assessment 2007.
Human capital

In encouraging Malaysians to explore Islamic finance as a career choice, tax relief not exceeding US$1,362 (RM5,000) per annum is also provided for Islamic finance courses approved by BNM or SC at local institutions.

The 2007 Budget has certainly provided the much-needed fiscal incentives to spur the growth of the Islamic finance industry in this region. With the stage all set, it is now up to the Government and the players to profile Malaysia internationally and to position the country as an international Islamic financial center.