Authors: Ai Mee Ching and Simon Tucker, Moore Stephens Melbourne
On 13 October 2010, the Board of Taxation (the "BOT") released a discussion paper entitled "Review of the Taxation Treatment of Islamic Finance". The discussion paper was released subsequent to the Government's request for a review 'in order to ensure that Islamic financial products have parity with conventional products, having regard to their economic substance'.
Islamic finance refers to banking and financial products or arrangements that are compliant with the principles of Shariah law. One of the major differences between Western and Islamic finance systems is the notion of interest (i.e. charging for the use of borrowed money), which prohibited under the principles of Shariah law. Other prohibitions include financing of industries deemed unlawful by Shariah law such as weapons, pork and gambling.
The discussion paper presents a series of case studies that illustrate the current Australia tax treatment (Federal and State) on Islamic financial products in comparison to the tax outcome arising on the finance arrangements commonly available in Western financial markets.
Under the current taxation laws, there are various approaches to the treatment of financial products, which can be the legal form based approach, the economic substance based approach or a mix of these approaches. For example, it is not unusual for the Islamic financial product to have the same economic substance as the Western financial product but due the intrinsic legal difference between the two the products are taxed differently (i.e. as it is common for tax provisions to look to the legal form of an arrangement to understand its economic substance). As such the existing tax framework will often lead to uncertainty tax outcomes and sometimes even double taxation as well as the prohibition of certain deductions.
In 2004 the Victorian government recognised that the Islamic financial products should be treated equally with conventional finance products. Consequently one major change is removing double stamp duty charges on property purchases. Other changes included recognising the principle of profit sharing and allowing Islamic contracts to avoid certain terms which are not permitted, such as interest. At the time of writing, no other states has provided special exemptions for Islamic financing transactions.
The discussion paper is currently open for submissions on issues raised until Friday 17 December 2010. It is important to note that if amendments to the existing tax law are required, the Board will consider whether adjustments can be made to existing tax frameworks rather than the development of specific provisions directed solely at Islamic financial products and arrangements.
If you wish to discuss the issues raised in the BOT discussion paper or if you require further details please contact the authors of your Moore Stephens relationship partner.
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