Australia’s Board of Taxation released a Discussion Paper on 13 October 2010 as a first step in its Review of the Taxation Treatment of Islamic Finance Products. The Government announced terms of reference for the review on 18 May 2010, and the Board has been asked for a final report by June 2011.

The Discussion Paper includes:

  • A summary of Islamic finance principles and common Islamic finance products.
  • A discussion of the current Australian tax laws which apply to financing arrangements.
  • Eight case studies which are each an example of a common Islamic finance product with a summary (and often inconclusive) analysis of its treatment under current Australian law, including GST and duties as well as income tax rules, and in some but not all cases a broad suggestion of how it should be taxed under new rules. Each case study closes with a list of questions for which responses are sought as part of the consultation process.
  • A brief overview of approaches taken to the taxation of Islamic finance in seven other countries.

The eight case studies and the nature of the questions asked suggest that the Board is likely to approach this topic on a transaction-by-transaction basis, identifying in detail the characteristics of a particular form of transaction, and focussing any new rules strictly around that particular form.

In some cases, for example a project financing adopting a musharakah mutanaqisah (a partnership where one party has a diminishing interest over time) and an Islamic insurance arrangement known as a takaful (where parties use a collective investment vehicle to protect themselves from specific risks), the Board has asked “What is the potential demand for this product in Australia?” and “Can the potential demand be quantified?”. These questions suggest the Board are also, as a preliminary matter, seeking to ascertain whether particular Islamic finance structures would be popular enough in Australia to warrant particular attention.

It is hoped that the focus on particular case studies and the narrow scope of the questions asked does not lead to detailed and highly prescriptive legislative changes which limit rather than encourage the future development of shari’ah compliant financing products in Australia.

It is also worth bearing in mind that, as Islamic finance products are often asset-based, stamp duties are often a fundamental tax hurdle to their feasibility. While the Board of Taxation has been asked to include in its review state taxes (such as duties and land tax) which may impede development of Islamic finance products in Australia, any recommendations the Board makes as regards state taxes may prove difficult to implement without the support of the states, and a co-ordinated approach between the states is often hard to achieve.

Submissions are requested by 17 December 2010.

In the United Kingdom, Norton Rose LLP were very involved with the tax changes that were introduced to facilitate Islamic finance in that country. The end results were relatively straightforward changes to the tax legislation which sought to place Islamic finance transactions (although not referred to as such, but rather as “alternative finance arrangements”) on a similar footing to an equivalent conventional transaction.