16 August 2010 | Category: Tax
South African Islamic investors and financiers are likely to be recognised by way of a new insertion in the Income Tax Act. One of the benefits is that it should attract further foreign investors to the country’s financial markets.
Islamic finance is derived from the Sharia’h and it essentially involves profit and risk sharing and forbids the paying or receiving of interest or investment in certain industries.
The proposed new section of the Act brings three types of Islamic financing transactions into the tax net – the investment account agreement called Mudarabah, the financing transaction known as Murabaha and joint ownership financing which is termed Diminishing Musharaka, all removing interest from the equation.
“Interest is considered economically harmful by Sharia’h law as the extension of credit increases money supply, which stimulates demand for goods and services but does not always result in real, tangible economic activity,” says Tasneem Gangat, a tax consultant at Grant Thornton Johannesburg. “It believes interest-bearing transactions result in economic ills including issues such as high inflation and unemployment.”
The proposed new section 24 JA takes into account three types of Islamic financing and will be aligned to Sharia’h law. For investment account agreements, or Mudarabah, tax will be payable on any profits derived by the client as these will be deemed as interest, thus making them taxable at the hand of the client.
Any Murahaba financing transactions between a client and the financier will see “marked up” amounts within the agreement as the taxable amount payable in favour of the bank for tax purposes. For joint ownership financing – known as Diminishing Musharaka – the client purchases the bank’s “portion” of ownership in the asset over time and the amount paid monthly to the bank includes both the premium payable and taxable amount owed to the bank.
South Africa joins Australia, Hong Kong, the United Kingdom and a growing number of other non- Muslim countries developing their Islamic finance sector by changing regulations to attract investors who can only put their money in Sharia’h compliant assets. The changes will be effective from a date to be announced by the Minister of Finance.
Sharia’h law states that the emphasis on economic activity must ensure that money changes hands (from provider to user), accompanied by an increase in trade, manufacture, service provision and, as a result, employment.
The basis of Islamic finance is equity through profit and loss sharing schemes and rental income, usually mutually developed through agreements between the bank and client. The Islamic financier will assume the risk of the purpose of the funds he is investing and share in pre-agreed ratios in profit or loss which result from the transactions.
“The principles of investment management such as sector diversification, low risk versus high risk, income versus capital growth etc, will still apply to an Islamic investor, but the manner in which these objectives are achieved, as well as the investments utilised, will differ from conventional finance,” says Gangat.
Islamic financing is available to the general public and not exclusively made to people of the Muslim faith. Even though Islamic finance is still a young concept, it is a way forward as entrepreneurs realise the scope of the potential market for Islamic products.
“Judging by this success of ethnical funds worldwide, the need to bolster GDP in SA and the intense focus on business ethics, Islamic finance is likely to become a permanent feature of SA economic landscape,” concludes Gangat.
Further information on Islamic finance transactions
Notes to editors
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