Asian Tax Review: Malaysia: An Oasis for Investors From Oil-Rich Gulf States

Transcription

1 Volume 41, Number 5 February 6, 2006 Asian Tax Review: Malaysia: An Oasis for Investors From Oil-Rich Gulf States by Linda L. Ng Reprinted from Tax Notes Int l, February 6, 2006, p. 441

2 F eatured Perspectives ASIAN TAX REVIEW Malaysia: An Oasis for Investors From Oil-Rich Gulf States Linda Ng is with the Asia-Pacific Tax Group of White & Case LLP in Tokyo. Recent high oil prices have been a bonanza for Middle East oil exporters; their total current account surplus is even larger than that of China and other Asian emerging economies combined, according to an International Monetary Fund (IMF) estimate. 1 Many economists believe that a large portion of those petrodollars has been funneled into U.S. Treasury securities and other relatively liquid U.S. dollar-denominated assets, helping to support the greenback and to push down bond yields. 2 However, Malaysia now is aggressively trying to lure footloose funds from the wealthy Persian Gulf states by offering innovative Islamic financial products 1 See IMF, World Economic Outlook: Building Institutions, September 2005, Chapter I, Economic Prospects and Policy Issues, pp. 1, 32, and 56, available, as of Jan. 25, 2006, at also, Recycling the Petrodollars, The Economist, Nov. 12, 2005, pp See Recycling the Petrodollars, The Economist, Nov. 12, 2005, p. 77, at p. 79. by Linda L. Ng and generous tax incentives, as well as dispatching bankers on road shows to the Middle East. 3 Malaysia s prime minister and minister for finance, Yab Dato Seri Abdullah Bin Haji Ahmad Badawi, has declared that the government is determined to make Malaysia the hub for Islamic financial services. 4 The government believes that the amount of wealth in the Middle East alone that is potentially available for Islamic investments globally is about US $1 trillion. 5 Furthermore, Islamic finance has been surging at a remarkable rate of 15 percent annually, according to the IMF s estimate. 6 3 See Abdulla Fardan, Focus: Malaysia Seeks Arab Investors in Islamic Products, Dow Jones Newswires, Dec. 19, See the fiscal 2005 budget speech (Sept. 10, 2004), p. 18, available, as of Jan. 25, 2006, at index.php?ch=12&pg=149&ac=181&lang=eng. 5 See the keynote address by Tan Sri Nor Mohamed Yakcop, Malaysia s minister of finance II, at the Standard Chartered Bank s Nov. 15, 2005, Seminar and Product Launch of Islamic Financial Engineering & Innovation, para. 8, available, as of Jan. 25, 2006, at index.php?ch=36&pg=126&ac= See Mohammed El Qorchi, Islamic Finance Gears Up, Finance and Development (a quarterly magazine of the IMF), (Footnote continued on next page.) Tax Notes International February 6,

3 No wonder even major Western banks are players in, and are trying to dominate, the booming Islamic financial sector. 7 Financial Products Islamic financial products are designed for investors who wish to comply with the Islamic laws (Syariah) 8 that govern a Muslim s daily life. Those laws prohibit riba (the payment or receipt of interest), maisir (gambling), ghara (ambiguity), and investments involving tobacco, alcohol, and other illicit items and activities. 9 Malaysia s prime minister has declared that the government is determined to make Malaysia the hub for Islamic financial services. Malaysia offers a wide array of Islamic financial products, ranging from Islamic bonds to Islamic equity indexes and investment funds. Judging from statistics published by the IMF, Malaysia s Islamic financial sector is flourishing. Islamic securities accounted for 42 percent of the total outstanding private debt securities in Malaysia by the end of 2004, and for 25 percent of total outstanding bonds. The number of Islamic investment funds increased from 7 in 1995 to 71 in 2004, and their share of net asset value as a percentage of total funds more than doubled over that 10-year period. 10 Islamic financial transactions, however, may be subject to higher taxation than conventional financial transactions because of their special requirements and characteristics. For example, because Islamic laws prohibit the giving or receiving of interest, a loan may instead be structured as a sale and leaseback of real property by the party that needs financing to a special purpose vehicle (SPV), December 2005, Vol. 42, No. 4 (the IMF article), p. 1, available, as of Jan. 25, 2006, at ft/fandd/2005/12/qorchi.htm. The author is the deputy division chief in the IMF s Monetary and Financial Systems Department. 7 See Owen Matthews, Money Talks; Major Western banks led by Citigroup are coming to dominate a booming global market in Islamic finance, Newsweek International, Aug. 8, 2005; also Assif Shameen, A Novelty No Longer; Islamicfriendly banking is spreading, even among Western institutions, BusinessWeek, Aug. 8, Also spelled Sharia or Shariah. 9 See the IMF article, supra note 6, p. 1; also, introduction to Islamic Capital Market, available, as of Jan. 25, 2006, at 10 See the IMF article, supra note 6, pp followed later by a resale of the same real property to that party. In the absence of special tax treatment, the Islamic financing transaction may be subject to higher income tax, real property gains tax, stamp duty, or other taxes than a conventional financing transaction in some jurisdictions. Tax Incentives The Malaysian government has played a key role in accelerating the development of the country s Islamic financial sector by announcing a slew of new tax incentives for Islamic finance in recent federal budgets. Furthermore, it is developing infrastructure, streamlining rules, promoting Labuan as an offshore center, and providing other strong support for the sector. Fiscal 2003 Budget In the fiscal 2003 budget, 11 the government introduced income tax deductions for expenses incurred in issuing Islamic private debt securities based on the principles of mudharabah (sharing), musyarakah (partnership), and ijarah (leasing) from year of assessment (YA) 2003 through YA To ensure that financing under Islamic banking is not subject to higher stamp duty than under conventional banking, the government also proposed a stamp duty exemption for new agreements for the sale or purchase of assets required for financing facilities under Islamic banking. The stamp duty exemption applies to the restructuring and rescheduling of the existing financing, to the extent of the outstanding balance, and also to the renewal of an Islamic revolving financing facility. Fiscal 2004 Budget In the fiscal 2004 budget, 12 the government recognized the need for a more comprehensive tax treatment of Islamic securities to help them compete with conventional securities. Thus, it proposed that transactions related to financing through the issuance of Islamic securities be given the following tax treatment under the Income Tax Act 1967 and the Promotion of Investments Act 1986: the sale of an asset by the party that needs financing to an SPV, and the resale of the asset to that party, will not be deemed to be sales for income tax purposes; 11 See the fiscal 2003 budget speech (Sept. 20, 2002), pp and appendices 14-15, available, as of Jan. 25, 2006, at 179&lang=eng. 12 See the fiscal 2004 budget speech (Sept. 12, 2003), pp and appendix 17, available, as of January 25, 2006, at 180&lang=eng. 442 February 6, 2006 Tax Notes International

4 13 See the 2005 fiscal budget speech (Sept. 10, 2004), pp and appendices 3, 10, 11, and 13, available, as of Jan. 25, 2006, at =149&ac=181&lang=eng. in cases involving a leaseback of the same asset by the SPV to that party, the lease will not be deemed to be a sale under the Income Tax Leasing Regulations 1986; the issuance of Islamic securities by the SPV will receive the same treatment as assetbacked securities; financing transactions carried out by the SPV will be given the same tax treatment as financing transactions carried out by any person under the Income Tax Act 1967; and the party that needs the financing will continue to enjoy the tax incentives and allowances under the Income Tax Act 1967 or the Promotion of Investments Act 1986, provided that it is still in the business of the approved activity. In addition, a gain from the disposal of an Islamic security that is a chargeable asset by an investor will be exempt from real property gains tax under the Real Property Gains Tax Act An instrument of transfer of an asset by the party that needs financing to the SPV for purposes of a leaseback related to financing through the issuance of Islamic securities will be exempt from stamp duty under the Stamp Act The party that needs financing will continue to enjoy tax exemptions under the Customs Act 1967, the Sales Tax Act 1972, and the Excise Act 1976, provided that it is still in the business of the approved activity. Tax deductions will be given from YA 2003 through YA 2007 for expenses incurred in the issuance of istisna securities, where the real property asset under construction can also be used to back the securities. Labuan offshore companies will be given an income tax rebate for zakat (a tithe) paid to the religious authority. Fiscal 2005 Budget To expand the domestic capital market, the government proposed, in the fiscal 2005 budget, 13 that a tax exemption be given for interest income derived by nonresident companies from ringgit-denominated Islamic securities and debentures (other than convertible loan stocks) approved by the Securities Commission, and for securities issued by the government of Malaysia. To further stimulate the development of Islamic financial and capital market products, and to ensure tax neutrality with conventional products, the government proposed that an exemption from any additional tax or duty or specific treatment be given, provided that the Islamic financial products are approved by the Syariah Advisory Council, Bank Negara Malaysia, or that the Islamic capital market products are approved by the Syariah Advisory Council, Securities Commission. The Islamic financial products include products offered by any other body outside the supervision of Bank Negara Malaysia, subject to the approval of the Syariah Advisory Council, Bank Negara Malaysia. A REIT that has been approved by Malaysia s Securities Commission receives flow-through tax treatment for specified income. The government proposed that income tax relief for contributions to an approved takaful (insurance program) be increased to develop the insurance industry. An income tax deduction also will be allowed for zakat paid by companies other than Labuan offshore companies to the respective religious authorities. Islamic REITs The government did not announce any new tax incentives specifically for Islamic finance in the fiscal 2006 budget. However, Malaysia s Securities Commission on November 21, 2005, issued what is believed to be the world s first set of guidelines for Islamic real estate investment trusts, 14 and established a global benchmark for the development of those REITs. The Securities Commission requires Islamic REITs to comply with both the January 2005 guidelines on REITs 15 and the November 2005 guidelines for Islamic REITs. 16 A REIT that has been approved by the Securities Commission receives flow-through tax treatment for specified income. A REIT is exempt from income tax on income that it has distributed to unit holders during the basis period for that YA. 17 Undistributed 14 See Guidelines for Islamic Real Estate Investment Trusts, issued on Nov. 21, 2005, and available, as of Jan. 25, 2006, at html. 15 See Guidelines for Real Estate Investment Trusts, issued on Jan. 3, 2005, and available, as of Jan. 25, 2006, at 16 See Guidelines for Islamic Real Estate Investment Trusts: Frequently Asked Questions, question 10, available, as of Jan. 25, 2006, at resources/fr_guide.html. 17 Section 61A of the Income Tax Act. Tax Notes International February 6,

5 income that has been taxed at the REIT level and is subsequently distributed to unit holders is subject to tax at the level of the unit holders, but the unit holders can claim a tax credit for the tax already paid by the REIT. 18 Gains on the disposal of real property to the REIT are exempt from real property gains tax, 19 and instruments of transfer of real property to the REIT are exempt from stamp duty. 20 Furthermore, the fiscal 2006 budget 21 proposed that fees for consultancy, legal, and valuation services incurred in the establishment of REITs be deductible for income tax purposes, effective from YA Competition According to statistics published by the IMF, there now are more than 300 Islamic financial institutions in more than 75 countries. They are concentrated in the Middle East and Southeast Asia, but also appear in Europe and the United States. 22 Currently, the two biggest Islamic financial hubs in the world are Bahrain and Malaysia. 23 Bahrain is the larger of the two, with nearly 30 banks and a large number of multilateral organizations. However, Malaysia s Islamic financial sector has been growing rapidly in recent years, and the headquarters of the Islamic Financial Services Board is located in Kuala Lumpur, Malaysia s capital. 24 Singapore, Malaysia s next-door neighbor, is another country to watch in Southeast Asia. It is trying to position itself as a hub for Islamic finance by capitalizing on its status as a major Asian financial center and, in particular, on its strengths in areas such as asset management, insurance, REITs, and 18 Section 110 of the ITA. 19 Real Property Gains Tax (Exemption) (no. 4) Order Stamp Duty (Exemption) (no. 4) Order See the fiscal 2006 budget speech (Sept. 30, 2005), p. 9 and appendix 12, available, as of Jan. 25, 2006, at lang=eng. 22 See the IMF article, supra note 6, p See id. 24 See MIDA News: Bahrain and Malaysia lead, adapted from the International Herald Tribune, Dec. 22, 2005, available, as of Jan. 25, 2006, from the industry news archives at project finance. 25 In the fiscal 2005 budget, 26 the Singapore government announced two new tax incentives for Islamic finance. First, the government waived the double imposition of stamp duties in Islamic transactions that involve real property. And second, it extended to sukuk (Islamic bonds) the same concessionary tax treatment that is available to conventional bonds, to encourage local and foreign issuers to issue sukuk. (For prior coverage, see Tax Notes Int l, Feb. 28, 2005, p. 759.) Although Singapore is a comparatively small player in the global Islamic financial market, some bankers say that it may become the lead player in Southeast Asia someday. 27 Conclusion The future looks bright for Malaysia s Islamic financial sector in light of the IMF s forecast of an average annual current-account surplus of US $470 billion for oil exporters over the next five years, if oil prices stay high (assuming an average oil price of US $59 a barrel). 28 Islamic financial institutions in Malaysia are gearing up for further expansion by continuing to develop, refine, and market innovative Islamic financial instruments on both the asset and liability sides. 29 Fortunately, they have the Malaysian government s strong backing in the form of generous tax incentives and other support. 25 See Bloomberg, Romancing the Middle East nations: Islamic financial products could open doors, says SM Goh, Today, Sept. 13, 2005; also, Governor s Table Panel Presentation by Ms. Teo Swee Lian, deputy managing director, Monetary Authority of Singapore, 12th Annual World Islamic Banking Conference, 11th December 2005, Kingdom of Bahrain, available, as of Jan. 25, 2006, at masmcm/bin/pt1governors_table_panel_presentation_by_ Ms_Teo_Swee.htm. 26 See Singapore s budget statement 2005 (Feb. 18, 2005), p. 10, available, as of Jan. 25, 2006, at budget_2005/budget_speech/index.html; also, Governor s Table Panel Presentation by Ms. Teo Swee Lian, Deputy Managing Director, Monetary Authority of Singapore, 12th Annual World Islamic Banking Conference, 11th December 2005, Kingdom of Bahrain, supra note Farhan Bokhari, The Banker: Special Supplement: Islamic Finance Malaysian Model, The Banker, Oct. 1, See Recycling the Petrodollars, The Economist, Nov. 12, 2005, p. 77, at p See the IMF article, supra note 6, p February 6, 2006 Tax Notes International