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This paper investigates the challenges faced by the Islamic banking industry in Tanzania, particularly related to multiple taxes on financing products. It recommends the review and adjustment of financial legislation to support the legal and competitive operation of Islamic banking.
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TAX CHALLENGES A BASIS FOR REGULATORY FRAMEWORKPrepared by: Abdallah Y. Tego (PhD)Deputy Vice Chancellor (Academic)Muslim University of Morogoro
Introduction • Financial depth and diversity can affect economic growth positively, and that development and competitiveness of the financial system are closely related to economic growth. • Financial diversity provides the opportunities for individuals and organizations engage in various economic activities. • The introduction of Islamic banking industry into a wider sector of finance in Tanzania must be viewed as a positive step towards financial inclusion and diversity.
However, this sector has been facing several challenges including multiple taxes simply by using different arrangement with similar effect as of conventional. • This paper investigates this challenge and recommends the review and adjustment of existing financial and banking legislation to allow Islamic banking offers financial services legally and competitively.
Financing products under the discussion are: Murabaha (cost plus mark-up) which is widely used; 100% by NBC and KCB-T, 96% by Amana bank, and 80% by PBZ. • Musharaka(partnership) and Ijarah (leasing) which are also used by Amana bank and PBZ as their financing products.
Objective of the Study • The growth of Islamic banking industry depends on number of factors including availability of support services. • There are no restrictive and injunctive regulations to govern Islamic financial structures.
The broad objective of this study was to evaluate the need of regulatory framework for competitive Islamic banking industry in Tanzania. • This in turn will assist relevant authorities to come up with financial legislature that will also accommodate the peculiarities of Islamic banking industry in Tanzania.
Significance of the Study • The study on the challenges of multiple taxes is essential as may draw the attention of relevant authorities to see the need to accommodate specificities of Islamic banking within financial regulations.
Empirical Evidence • In 2010, the Board of Taxation of Australia did a comprehensive review of Australia’s tax laws to ensure they do not inhibit the expansion of Islamic finance, banking and insurance products in Australia. • The measures suggested were to follow the United Kingdom approach and intended to apply from 1st July 2018.
The United Kingdom reviewed Stamp Duty Land Tax or Land Transaction Tax to mirror a conventional mortgage financial purchase so the appropriate tax will be payable on the first sale by the seller to the bank on the Islamic financial products.
In June 2017, the International Monetary Fund warned the government of Kenya of loopholes in banking regulations and therefore advised it to refine its prudential regulations to cater for Islamic banking industry. • President Kenyatta signed into law some of the proposed amendments, including a retirement of the Stamp Duty Act to provide for tax neutrality of Islamic finance products to enable them compete with similar conventional products in Kenyan market.
In 2018, the government of Uganda approved the 18-page document of regulations covering Islamic banking as part of wider efforts to level playing fields between conventional and Islamic banking industries in Uganda. • Before the start of Islamic banking industry in Zambia, the government decided to enact an Islamic Banking Act to govern financial institutions offering Islamic financial services. • South African regulators have also taken various measures to develop and promote the industry including amending tax laws to create an equitable and level playing field for Islamic finance.
Islamic Banking in Tanzania • Islamic banking refers to a system of banking through which finance is mainly provided in the form of permissible (halal) goods and services delivered in return for a commitment to repay their value at a future date. • Islamic financial structures avoid gambling style speculation and interest rates, and all trading, loans and investing have to involve real assets.
In 2008, the Bank of Tanzania granted permission to Kenya Commercial Bank for the start of limited Islamic financial products in the country. • In spite of this, the Bank of Tanzania did not amend the Banking and Financial Institutions Act. • As a result, the new financial industry was compelled to operate within the conventional banking rules and regulations.
The existing financial legislature does not define or regard Islamic financing products as banking products and subject them to multiple taxes. • Currently there are four commercial banks namely; KCB-T, NBC, PBZ, and one fully-fledged Amana Bank (ABL) offering Islamic banking services in Tanzania.
The Challenge of Multiple Taxes on Islamic Financing Products • Murabaha which is defined as acontract of sale in which seller declares his cost and profit to the buyer. • Murabaha is still not covered within financial regulations of the country. • This implies that this financing product must be operating outside financial jurisdiction.
On the other hand, Murabahafacility must become expensive as opposed to conventional facility of similar effect. • The price under Murabaha supposes to include the amount of VAT in the profit margin and income tax in the transfer of ownership to the clients whereas conventional loan remains cheaper as it attracts tax from interest only. • The amount of VAT included in the profit margin and income tax in the transfer of ownership to the clients is leading to higher prices of the product.
The word Musharaka is defined as a contract whereby parties agree to combine financial resources to undertake any type of business venture and share the profit or loss that may arise thereof. • The modern days Islamic financial institutions have been applying Musharaka in the form of declining ownership of their shares and this is known as diminishing Musharaka.
In a declining Musharaka, the share of a partner in the equity is diminished through partial return of capital. • The partner receives periodic profits based on its reduced equity share that remains invested during the period. • The share of other partner(s) in the capital steadily increases overtime, ultimately resulting in complete ownership of the enterprise.
Diminishing Musharaka is frequently used for project, infrastructure and asset financings. It is an equivalent arrangement to a conventional loan of home finance. • At present time, if diminishing Musharaka is applied it seems likely that asset to be acquired through this facility becomes expensive than in conventional equivalent arrangement due to additional amount of taxes.
The rent and amount of equity sales will attract VAT and income tax whereas in conventional finance only interest is to be taxed. • The rent paid in diminishing Musharaka consists of principal and profit which would be interest in conventional. • In addition the amount of equity to be sold to the customer does also attract VAT which again makes the asset under this financial scheme more expensive.
In the Civil Transactions Act of Sudanese Law of 1984 defined Ijarah contract as follows: “Ijarahis allowing possession by means of a lessor to the lessee (the hiring person), of an intended benefit from the hired thing, for a certain period, versus a known compensation.
In the Islamic jurisprudence, the term Ijarah is used for two different situations. • In the first place, it means to employ the service of a person on wage given to him as a consideration for his hired services. • The second type of Ijarah relates to the transfer of usufruct of assets and properties to another person in exchange for a consideration. In this case, the term Ijarah is analogous to the English term “leasing”.
Modern day’s Islamic financial institutions often purchase and own the assets which are going to be hired and sold afterwards. • In this arrangement the Islamic financial institution owns the asset and leases it to the customer in a way the client ultimately acquires ownership of that asset after paying rent.
The rent amount paid in this facility is equal to the principal and interest in conventional loan. • However, this arrangement is probably not possible in Tanzania because of prohibitions stipulated in the Banking and Financial Institutions Act of 2006 that states:
“No bank or financial institution shall purchase, acquire or lease fixed assets, except where it is necessary for the purpose of conducting its business as a bank or financial institution, including reasonable provision for anticipated future expansion and housing of its officers or employees”
From tax perspective, Ijarah transaction is likely to be expensive as it attracts significantly more tax than its conventional loan equivalent facility. • Value Added Tax will be payable on three occasions in Ijarah whereas payment for tax purposes will be made once in a conventional loan equivalent arrangement.
First, the Islamic financial institution purchases the asset and then leases it before transferring the ownership of that asset to the customer. • Second, there will be additional stamp duty payable on the Ijarah due to the additional documentation. • The third area is the amount of the basic rent will be taxable, even though the rent is really a composite of principal and profit.
Conclusion • The challenge of multiple taxes on Islamic financing products pressing the need for refining financial regulations to cater for Islamic banking industry. • Ignoring such a fact would leave the Islamic financial sector exposed to the danger of collapse. • The peculiarities of Islamic banking industry necessitate the review and adjustment of existing financial legislation or introduce another legal framework.
