Establishing Islamic Finance as one of the new pillars of growth for Singapore financial sector
In his opening speech at the recently concluded World Islamic Banking Conference: Asia Summit, Minister for Trade and Industry Mr Lim Hng Kiang strongly reaffirmed the Monetary Authority of Singapore’s (MAS) commitment to developing Islamic financial services.
Now in its fourth year, the summit brought together leaders in the Islamic Finance industry to discuss potential opportunities in Asia and strengthen ties with key Islamic Finance centres, especially those in the Arabian Gulf.
Mr Lim announced that the MAS was exploring ways to shorten the approval processes and provide greater clarity and certainty in the regulatory and tax treatment of Islamic finance products.
This news brings cheer, and is especially significant this year. Just four months earlier at Singapore Budget 2013, the Government announced plans to rationalise tax incentives for the Singapore Islamic Finance sector.
While details of the enhancements will only be known at a later date, the prospect of greater tax certainty is important. Current Islamic financing transactions or structures which fall outside existing tax legislation frameworks run the risk of being saddled with higher corporate tax rates and double or even triple stamp duties.
A maturing Islamic Finance sector in Singapore
Dedicated tax incentives for Islamic Finance were first introduced in 2008 and had an initial tenure of five years. They accorded a highly favourable five percent concessionary rate of tax for taxpayers engaged in qualifying Islamic financing transactions and offshore Islamic takaful (insurance) and retakaful (reinsurance) activities.
Unfortunately, the response and take-up by financial institutions and insurers to this tax incentive had been rather tepid since its inception. Against this backdrop, the subsequent decision by the authorities to allow these incentives to lapse in 2013 (without further extension) was understandable, albeit disappointing to the Islamic Finance market players.
The global Islamic Finance community might have wondered if Singapore had thus given up its long-held ambition to become the region’s Islamic finance hub. This is notwithstanding that following the rationalisation, Islamic Finance activities continues to enjoy schemes at concessionary tax rates ranging from 10 percent to 12 percent under other schemes targeted at promoting the Singapore finance sector. The announcement of impending tax and regulatory enhancements should allay such doubts and we offer our thoughts on how the authorities can resolve some of the issues currently affecting the Islamic finance sector.
Transiting to a principle-based framework
Islamic finance is a relatively new sector and the authorities have understandably taken a measured approach by defining, albeit narrowly, a growing but still modest number of Islamic financial transactions in the income tax legislation qualifying for tax certainty.
However, industry experience has demonstrated that a prescriptive legislative approach towards characterising Islamic finance transactions is unwieldy as such transactions evolve constantly and in some cases grow increasingly sophisticated.
On this note, KPMG, along with other industry observers, have been advocating for a migration of the Islamic finance tax legislation from a rule-based framework to one founded on broad guiding principles.
For example, by allowing all Islamic financing transactions deemed Shari’ah-compliant being accorded a certainty of tax treatment.
One of the first steps in the move to a new framework, would be the redrafting of existing tax regulations to describe the essence of various Islamic finance transactions rather than prescribing dictate individual steps required for a transaction.
A source for much angst among taxpayers undertaking Islamic Finance transactions is that any deviation from the prescribed steps had required approval of the tax authorities on a case-by-case basis, no matter how minor. This had resulted in transactional delays, slowing the time to market for Islamic finance products.
The transition to a principle-based Islamic tax framework should go some way towards meeting the authorities’ twin aims of shortening the approval process and providing certainty of tax treatment.
Defraying the higher costs of Islamic financing via enhanced tax deductions
Beyond the regulatory tweaks according upfront tax certainty for Islamic finance products, additional measures to mitigate the higher transactional costs associated with Islamic finance transactions in Singapore would certainly be welcome.
One reason for higher costs can be attributed to the shortage of skilled Islamic Finance professionals required to deal with the complexities of Shari’ah law. In some cases, these higher costs have been passed on to customers. Islamic finance transactions in Singapore are therefore less attractive when compared to conventional finance equivalents.
This is in contrast with Malaysia, which has a comprehensive tax incentive regime providing tax exemption on the income derived by financial institutions from qualifying Islamic banking, fund management and insurance activities. Some financial institutions in Malaysia have passed on the tax savings to their customers, putting Islamic financing on an extremely competitive footing relative to conventional financing.
Singapore has strived to ensure the neutrality of rules insofar as Islamic financing is similar to conventional financing in economic substance and risks.
However, the rationalisation of tax incentives may have inadvertently tilted the balance away from Islamic finance.
As an interim measure, borrowers utilising Islamic financial products could be provided enhanced tax deductions for financing costs. This should help put Islamic financial products on an even keel with their conventional cousins in Singapore.
Cultivating a deep pool of Islamic finance professionals
In the longer term, a strong local network of lawyers, accountants and tax advisers is a critical component of a vibrant local Islamic finance industry.
To strengthen local expertise the Islamic Finance sector, the Singapore Government can, for a start, consider awarding grants or subsidies to foreign Islamic scholars and renowned academics visiting our shores.
Such support from the authorities can help the local professionals narrow the knowledge gap with their foreign counterparts. It would encourage the knowledge transfer of expertise and market intelligence to local Islamic Finance professionals.
The rationalisation of tax incentives for the Islamic Finance sector and recently proposed enhancements to the tax and regulatory framework signals a positive shift by the authorities towards exploring non-fiscal means to boost the industry. More importantly, the prospects for the local Islamic Finance space remain bright. If anything, the 2008 global financial crisis only serves to remind us of the importance of this sector as an alternative capital market.
The authorities are well aware of the growing importance and contribution of Islamic Finance towards building a vibrant financial services sector in Singapore. As such, we are confident that the government will act decisively on the tax and regulatory front to encourage Islamic finance to form a new pillar of growth for the Singapore financial sector.
This article is contributed by Mr Alan Lau, Head of Financial Services, Tax, KPMG in Singapore and Chua Kong Ping, Senior Manager, Corporate Tax, KPMG in Singapore. The views expressed are their own.