Chasing Islamic finance: a framework to assess the potential benefits of Australian tax reforms to facilitate Islamic finance.
Based on recommendations by the Australian Financial Centre Forum, the Australian government is pursuing an agenda of reforms to provide for greater facilitation of Islamic finance--the banking and finance systems based on Islamic beliefs (Sherry, 2010; Bowen, 2009). It has been argued that the greater facilitation of Islamic finance is critical for Australia to achieve its aspiration of becoming a financial services hub (Australian Financial Centre Forum, 2009). Potential tax reforms are seen as a critical part of this facilitation (Board of Taxation, 2010). However, what are the potential benefits of Islamic finance for Australia?
This paper sets out to provide a framework of analysis so the arguments for tax reforms can be considered. The framework considers the dynamic factors of national interest, legal compatibility, equity and neutrality, fiscal, constitutional, regulatory, political and social considerations. It is only on such a comprehensive framework that due consideration about the future of reforms for Islamic finance can be assessed.
The emergence of Islamic banking and finance (referred to as 'Islamic finance') is a relatively new phenomenon in global financial markets (Van Greuning and lqbal 2008). Essentially, it refers to banking and finance systems whose financing models and operations are based on Islamic beliefs (shariah law) in direct contrast to banking and finance systems whose models and operations are based on secular principles (referred to as 'conventional finance') (Yaqubi, 2005).
In recognizing developments in global financial markets, the Australian government has tentatively sought to facilitate the entry of Islamic finance in Australia. To this end tax reforms that may result in positive economic outcomes have been recommended as being necessary. Particularly, following the recommendations of the Australian Financial Centre Forum (Australian Financial Centre Forum, 2009), the Australian government announced that the Board of Taxation would undertake a comprehensive review of Australia's tax law in order to identify impediments in the current law against the development and provision of Islamic finance, banking and insurance products (Sherry, 2010). More recently the Board of Taxation released a 'Discussion Paper' inviting submissions in regards to its terms of reference in pursuance of that brief (Board of Taxation, 2010).
In particular it has been suggested that reforms are necessary if Australia is going to realize the stated policy goal of becoming a financial services hub, particularly in South East Asia (Australian Financial Centre Forum, 2009). However, how can the case to justify tax reforms in Australia be assessed? This paper seeks to provide such a framework of analysis to which the arguments for reforms can be analyzed.
The paper is structured as follows. Firstly, the meaning and principles of Islamic finance will be canvassed, and its growth in global financial markets. Secondly, reflections on potential tax anomalies with Islamic finance products will be discussed. Then a framework will be outlined and discussed. The framework will consist of the notions of: national interest; legal compatibility; equity and neutrality; fiscal, constitutional, regulatory, political, and social considerations. It is against this framework that the arguments for reforms to facilitate Islamic finance will be considered.
It will be argued that while the direct benefits of Islamic finance may be limited--the facilitation of faith-based financial products (such as Islamic finance) is an important component of Australia becoming a financial services hub.
The Meaning and Size of Islamic Finance
Islamic finance may be conceived as an economic system premised on ethical rules and norms that, when properly practiced and adhered to, are intended to satisfy a moral purpose. The ethical rationale is compliance with the shariah (Islamic law) (Yaqubi, 2005). The corpus of the shariah emanates from its primary canons, namely the Qur'an and the prophetic traditions (hadith). These sources underpin the law on financial transactions and are complemented by independent legal decision-making (ijtihad) in the form of analogical deductions, legal precedents, presumption of continuity and juristic consensus (Doi, 1984; Kamali, 2004). As such, the shariah sets parameters within which Islamic finance may endure, such as: recognizing the use of money and capital as a means of exchange and not a tradable commodity; prescribing acts that are lawful, and those that are prohibited (al-Qaradawi, 1984); defining the relationship between risk and profit (EI-Gamal, 2009) and setting out the social responsibilities of parties in financial dealings (Vogel and Hayes, 1998). One principle is freedom from riba (interest) in Islamic financial products.
Compliance with these principles had led to the development of a number of Islamic financial products, some of which share charactertics to those used conventionally. Some of the Islamic finance products include: murabaha (cost-plus) financial transactions; ijara contracts (leasing contracts); mudarabah contracts (trustee partnership); musharaka contracts (forms of limited partnership); sukuks (Islamic bonds), and takaful (mutual insurance arrangement).
Islamic finance is estimated to be worth more than A $1 trillion (U.S $822 billion) (The Banker, 2009)--with growth estimated by the International Monetary Fund (IMF) (IMF, 2007) at between 10-15 percent annually and expanding (Standard and Poor's, 2009). Currently, most Islamic financial services are facilitated through a combination of pure Islamic banks, conventional western banks with Islamic windows, and hybrid institutions offering both conventional and shariah-compliant banking and investments (Australian Financial Centre Forum, 2009). A large proportion of Islamic finance activity is comprised of issuances through the Islamic bond (sukuk) market, with global sukuk issuances totalling U.S. $30.94 billion in 2007 and U.S. $23.6 billion in 2008 (Millikan, 2009). Under-utilized oil revenue, sovereign wealth institutions and private investment portfolios of high net-worth families and individuals drive much of this capital market activity (Nathif and Abdulkader, 2005).
The current reach of Islamic finance in global capital and equity markets suggests there is potential for Australia, through multi-lateral trade and financial services, to facilitate Islamic finance by expanding opportunities within and beyond its borders (Australian Financial Centre Forum, 2009). However, Australia's tax laws have been identified as one of the potential burdens for the expansion of Islamic finance.
Tax Anomalies with Islamic Finance
Complying with the strictures and principles of shariah law means that an Islamic financier may have an 'equity' compared to a 'debt' investment with a financed project. That is, the Islamic financier participates as an equitable partner in the project or venture, with an entitlement to a share of 'profit,' as opposed to investing by way of a debt obligation that often promises capital guarantee and interest returns. Also ownership of a financed asset may be shared between the financier and the borrower, with the borrower over time gaining a greater ownership interest.
This participation by the Islamic financier can lead to tax anomalies due to differing treatment of equity and debt for Australian tax purposes. For example, returns on equity, such as dividends, are generally non-deductible for the entity making the payment. In comparison, returns on debt are normally in the form of 'interest', which is of a revenue nature and therefore more likely to be deductible (depending upon the precise use of the borrowed funds). Also problematic may be the timing and the quantum of when the Islamic financier has to realize income.
With conventional finance it has been observed that the financier does not normally 'participate in the project or enter into trade with the borrower' (Savona and Mofakhami, 2009). Instead, the conventional financier receives a return or reward for the funds provided to the borrower in the form of interest. This interest is payable regardless of the success of the endeavour--that is, there is no contingency of the borrower's obligation to pay. Furthermore, the conventional financier does not normally own the underlying assets being financed; instead, the financier is able to protect its position and minimize the risk of default by taking various securities (Savona and Mofakhami, 2009). For instance, the conventional financier could take a registered security interest--such as registered mortgage over real property--to ensure preferential realization of the security against competing creditors. Other securities could be in the form of a fixed and floating charge over business assets and personal guarantees.
The prohibition of interest (riba) means that the use of loans as a financing device is not available for an Islamic financier. It is important to acknowledge that there is some overlap between the financial products used by conventional and Islamic financiers--such as hire purchase arrangements. However, the Islamic financier is restricted to the variety of products that can be used to ensure Shariah compliance. This disparity is one of the main reasons for conventional banks' reluctance to enter the Islamic finance market proper (Ibraham, 2010).
The different participation of Islamic financiers can lead to tax anomalies between conventional and Islamic finance for Australian tax purposes. In particular, is the 'profit charge' embedded in an Islamic financial product deductible in a similar manner to interest charged by a conventional financier? Also, do Double Tax Agreement (DTA) Treaty concessions for international payments of interest apply to this profit charge -or is the profit charge subject to higher rates of tax impost? Furthermore, if the Islamic finance product allows for the staged transfer of an asset, what are the capital gains tax and stamp duty outcomes of this?
It is for these reasons that Australia's current tax system is seen as problematic for the expansion of Islamic finance. However, should the Australian government be concerned that there can be inadvertent tax impost for taxpayers under Islamic finance arrangements? It is argued that it is imperative that a framework of understanding be utilized to assess whether tax reforms are justified.
A Framework for Tax Reform
Why should reforms proceed? It is argued that the need for reform is driven by a combination of reasons of which the requirement for tax parity is a significant element. Given the complex issues involved, the reform process may be conceptualized through a framework that reflects the collective influence of several factors as depicted in Exhibit 1.
Exhibit 1 suggests that the factors that drive tax reform (represented on the outer circles) may manifest as single or composite considerations such as: meeting the national interest criteria; law; equity; fiscal, constitutional, regulatory, political, and social considerations. The rationale of this framework is that faith-based considerations alone cannot determine changes to tax law--the necessity must be driven by a combination of core considerations (represented in the inner-circle) based on 'need and urgency and circumstances.'
Drivers of tax reform
The following is a discussion of each of the drivers for reform outlined in the outer boxes of Exhibit 1.
Any reform of tax law must in the first instance meet the 'national interest' criteria, which refers to the notion that the reform must benefit the nation as a whole and not just a select group. The national interest is best served if anticipated changes enhance economic value and creates social good. This results-based argument suggests (for example) that tax changes resulting in net private investment in the economy serves the national interest, such as providing more efficient debt/equity alternatives of addressing housing finance.
The 'legal compatibility' driver advocates that proposed changes to tax law must be accomplished within the existing legal framework with minimal adjustments. This refers to reforms that are required to rectify anomalies or uncertainties.
The 'equity and neutrality' consideration refers to the concept that fairness and justice must prevail. Changes may be conceived as equitable if they result in non-discriminatory outcomes. For instance, changes to facilitate 'ijara' (Islamic lease) financing should not impinge on current treatment of lease arrangements and must result in tax neutral outcomes.
'Fiscal' considerations relate to reforms that do not result in revenue loss and that revenue-positive outcome may be achieved through increased economic activity. That is, the net effect of facilitating Islamic finance ought not to result in revenue leakage but carry the potential to raise additional revenue through competition and innovation. Such considerations are necessary as some reforms may initially result in too high ancillary costs--for example, increased administrative costs.
The 'constitutionality' consideration refers to the requirement that the proposed changes must be consistent with the Australian Commonwealth.
The 'regulatory' consideration argues for a 'whole-of-industry' approach in the sense that Islamic financial practices must conform to requirements administered by the Australian Securities and Investment Commission (ASIC), the Australian Prudential Regulation Authority (APRA) and the Reserve Bank. This factor also suggests that reforms could be implemented by legislation or administrative power granted to a Minister or delegated through government agencies.
The 'political' factor acknowledges that in the democracy professed in Australia, there are various political factors at work, including the ideology of various parties, people and groups. Thus, even if Islamic finance may be touted as essential to Australia for political expediency, that desire must first satisfy the 'national interest' criteria. It is essential, therefore, that the facilitation of Islamic finance is not one driven by the need to appease a section of the population. For this reason, the 'social' factor must ensure that social needs reflect the desire of the whole community, and not be predicated on religious beliefs only.
Relationship between drivers of reform and tax imperatives
It is argued that one or a combination of the drivers may determine whether tax reform should be pursued. However, the imperatives for reforms must be driven by the core considerations of 'need', 'urgency' and 'circumstances' (represented by the inner circle in Exhibit 1).
'Needs' refer to the requirement and maintenance of a sound and efficient tax regime in which every taxable entity must contribute towards the fiscal revenue (Smith, 1789). 'Urgency' refers to time criticality for changes to be implemented (Henry, 2008). 'Circumstances' refers to the economic and financial circumstances in which Australia finds itself, in terms of the global economy and financial markets (Australian Trade Commission, 2010) It also encapsulates social realities and the demands for tax changes driven by domestic and foreign complexities in the world: for example, combating social exclusion (International Financial Services, 2008).
Tying all these considerations together, the 'needs and urgency' consideration suggests that the national interest is served by making Australia more dominant in global markets and maintaining a competitive edge over rivals. Also, attracting Islamic finance from overseas should be seen to provide openness and flexibility to ensure a strong revenue base for growth and prosperity. This is evident from the following facts. As previously outlined, it is estimated that Islamic finance is worth more than U.S. $822 billion with estimated growth over 10% annually. Globally, shariah-compliant assets are projected to reach U.S. $1 trillion in 2010 and U.S. $1.6 trillion by 2012 (Wyman, 2009), with the Islamic bond (sukuk) market accounting for a large proportion of this (Millikan, 2009).
In relation to the 'circumstances' consideration, the openness to global markets for Australian financial services will be stymied if present financial skills are unable to compete. Furthermore, given the fluidity of capital markets, if Australia does not implement timely tax reforms, then a significant proportion of potential Australian-centred Islamic finance is likely to flow elsewhere--possibly to more tax friendly jurisdictions. The current reach of Islamic finance in global capital and equity markets suggests there is potential for Australia, through multilateral trade and financial services, to facilitate Islamic finance by expanding opportunities within and beyond its borders. Potential economic benefits include, but are not limited to, Islamic stand-alone banking operations in Australia; capital raising in foreign markets; managing, lead underwriting and maintaining books of shariah compliant securities for new issue; exporting specialist financial services, as well as conventional banks providing shariah-compliant investment and financing products across the Asia Pacific and Gulf regions. Also, investment in Australian assets and business by overseas shariah investors may be facilitated particularly from 'petrodollar liquidity' (Crean, 2010). This 'liquidity' refers to oil rich nations' domestic economies being too small to absorb all capital inflows from oil revenues, thereby allowing them greater opportunities to invest their excess liquidity elsewhere Other opportunities relate to services provided to, and investments made by, shariah-compliant managed funds. It has been observed that the notion of Australia emerging as a regional financial hub may be possible due to a number of inherent characteristics of Australia's current financial market. For example, 7.5% of Australia's Gross Domestic Product (GDP) is made up directly of finance and insurance sectors (Australian Financial Centre Forum, 2009). Furthermore, in terms of free market capitalization, Australia's equity market ranks seventh in the world, and second within the Asia area. However, a further consideration is that the current tax system makes it unattractive for foreign capital to flow into Australia, as more attractive tax changes have been introduced by the United Kingdom and Malaysia in terms of Islamic finance.
In relation to the 'legal compatibility' consideration, there is currently a need for equal tax treatment of Islamic vis-a-vis conventional finance contracts. While it may not be urgent, the longer reforms take, the greater the probability that other jurisdictions may gain greater competitive advantage. This argument is premised on considerations that payments on 'profit participation loans' in Islamic equity products are now treated as 'finance charges' in many jurisdictions. If equivalent treatment is not implemented, then investment inflow could be lost. The 'circumstances' argument is that the cost of debt finance is deductable for conventional finance, while 'profit' distribution in Islamic finance is not deductable, even though it may be argued that economically similar outcomes are achieved. That is, while the form of the finance transactions may be different, the substance of the transactions over time is similar. Such tax asymmetry led to reforms in Australia to encourage private equity investment through tax transparency for venture capital.
The relationship between the 'equity and neutrality' considerations to the 'needs and urgency' concepts in Exhibit 1 are that the economic outcomes of Islamic finance must be similar to conventional finance. However, because they are structured differently the Australian tax impost can be greater. It is preferable that reforms are introduced to improve tax neutrality, as this discrepancy is accentuated when international finance is involved. The need for Australia to respond to this trend is compounded as there is an increase in the international integration between a country's economy with financial capital that is largely internationally mobile (Quiggin, 2001). Commentators have stated that this increasing economic globalization will translate into an increasingly competitive environment for businesses, including Australian businesses (Pinto, 2002). Governments are recognized as having a key role in facilitating or inhibiting this competition. The Henry Review recently highlighted the significance of globalization on tax planning:
Increasing globalization, particularly among more developed economies means social systems and economic infrastructure are becoming more uniform and tax settings may become relatively more important in decisions about where to invest and work (Australia, 2008).
Indeed, what appears to be replacing the fear of lost revenue from international tax competition is revenue loss from an uncompetitive international tax system (Speed, 2003). This is because the poor co-ordination of countries' tax systems can produce international double taxation through asymmetrical tax treatment (Radaelli, 1999). This is of concern, given the previous discussion about the disparity between equity and debt in Australia.
Furthermore, for a capital-importing country such as Australia, it is important to realize that it is inefficient to levy a tax burden on factors of production which are in perfectly elastic supply (Sorensen, 1998). One such elastic factor is capital. Due to the mobility of capital, breaches of import-export neutrality may lead to unduly high levels of overall tax, which could lead to capital being invested elsewhere. For example, the higher level of tax imposed on equity returns as opposed to interest, illustrates how the 'cost' of investing into Australia could be considered to be too high. Investment capital is more mobile and more sensitive to tax asymmetries and tax arbitrages. Capital is then seen as having no ultimate loyalty to any country or community, with its main purpose to generate profits (Sikka, 2008). It is this 'elasticity' that is an important consideration in terms of facilitating Islamic finance in Australia.
Both large and small countries can no longer set economic policies without considering, firstly, how their decisions affect others, and secondly, how the decisions of others affect them (Hallerberg and Basinger, 1998). This may mean economic choices being severely constrained by decisions which are taken outside countries' borders (Owens, 1993). Owens argues that this greater interdependence between countries could severely limit the freedom of domestic policy-makers to determine their own economic policies irrespective of what is happening outside their borders.
What this means is that globalization demands a much more pro-active and ongoing process of tax reform than has been practiced in the past. The Australian Government needs to consider whether its tax system results in unforeseen asymmetrical tax treatment (Ernst and Young, 2002). For this reason, Swank and Steinmo argue that policy makers face intensifying pressure to reform tax policies to promote tax neutrality in terms of import-export neutrality (Swank and Steinmo, 2002). This goal has led some commentators to state that economic policies across countries have begun to converge (Hallerberg and Basinger, 1998).
The need for equity and neutrality means that changes to facilitate Islamic finance must not result in unequal tax burdens; taxes must be distributed in an equitable fashion with no taxpayer made worse off by making some better off. New tax laws must apply equally to all transactions of the same genus regardless of whether they are shariah compliant or not. Of particular importance is that there must be certainty of treatment, as there is currently a lack of consensus on the correct treatment of Islamic finance products under current international standards. Given such 'circumstances' it may be noted, for instance, that pursuant to the United Kingdom's tax reforms, 'returns' and income are treated as 'as if interest' to accommodate Islamic profit and loss concepts.
Much of the concessional treatment afforded to interest is due to a 'policy of encouraging flows of capital from abroad' and thereby reducing 'borrowing costs for Australian businesses, (Australian Financial Centre Forum, 2009). For Australia, there is not a lot of difference in the rate of withholding tax ('WHT') for interest when comparing Double Tax Agreement ('DTA') and non-DTA countries. This may be explained by the desire to enhance Australia's potential to be a financial services center (Crean, 2010).
In comparison, the WHT rate for dividends can vary dramatically if the non-resident is in a treaty country. However, the rate of WHT could be nil if the exemption for publically offered company debentures applies. Also, Australia's DTA's with a number of selected countries (the United States of America, the United Kingdom, Japan, France, Norway, Finland and South Africa) can reduce the WHT rate down to nil pursuant to the financial institution exemption (Crean, 2010). While this is good for Islamic finance originating from the United Kingdom, this means that the Islamic finance hubs of Malaysia and Singapore cannot benefit from this exemption. Nor would this benefit Islamic finance sourced from the non-DTA countries in the Gulf region.
Focusing on the 'fiscal' consideration in Exhibit 1, the 'needs and urgency' factor argues that if changes are not implemented, then an opportunity will be lost to generate a new finance source and, consequently, ongoing economic growth. Another potential benefit of Islamic finance is diversification. For example, due to the ethical aspects of Islamic finance (such as risk sharing, restriction on short selling) Islamic finance has been viewed by some as 'more resilient' in the face of the Global Financial Crisis ('GFC') of 2008/2009 (Australian Trade Commission, 2010). Secondly, Islamic finance may provide diversification by providing better alternative sources of funding-especially when the capacity of banks to provide debt to businesses can be restricted due to the GFC placing funding pressures on institutions. Indeed, other Australians could benefit through Islamic finance providing an alternative mechanism for housing purchases. The United Kingdom's experience demonstrates Islamic finance has contributed to the real economy through choice and diversity and the financial potential it holds out for the future. However, it should be acknowledged that reforms may lead to concerns about avoidance and/or abuse (HM Treasury, 2008).
The need to maintain tax efficiency means rules to facilitate Islamic finance must ensure compliance and collection costs are minimized, and that changes should aim to minimize revenue leakage. However, it should be acknowledged that not all commentators consider that significant returns would flow from the necessary investment of public monies to create the infrastructure and regulatory system to support Islamic finance--particularly if tax concessions are provided (Dabner, 2008). The 'circumstances' are that Islamic finance provides alternative sources of finance--an opportunity to be seized given Australia's geographical location to a large Muslim population in Asia. Demographically, the potential for Australia is accentuated by the fact that there are over a billion Muslims living in the Asia-Pacific region. This is complemented with the high regard of Australia's financial sector--with Australia's financial system and capital market ranking second among 55 leading nations in 2009 (World Economic Forum, 2009).
Currently, the major centers for Islamic finance include the United Arab Emirates, Bahrain and Malaysia (Board of Taxation, 2010). However, there is significant activity occurring in the United Kingdom and other parts of Europe, Africa and Indonesia. Table 1 lists the top ten countries in terms of the value of Shariah-compliant assets, demonstrating that Malaysia is third largest, with the United Kingdom eighth. In Malaysia, prominent Islamic financial institutions include Bank Rakyat, Maybank Islamic Berhad, BIMB Holdings, CIMB Islamic Bank Berhad and Public Bank Islamic Berhad. Indeed, Malaysia and Bahrain have been credited as the most active in developing dual systems where Islamic and non-Islamic financial institutions operate alongside each other (Australian Trade Commission, 2010).
Table 1: Top Ten Countries: Shariah-compliant assets Rank Country Sharjah-compliant Shariah-compliant assets US$bn End 2007 assets US$bn End 2008 1 Iran 235.3 293.2 2 Saudi Arabia 92.0 127.9 3 Malaysia 67.1 86.5 4 United Arab 49.1 84.0 Emirates 5 Kuwait 63.1 67.6 6 Bahrain 37.4 46.2 7 Qatar 21.0 27.5 8 United Kingdom 18.1 19.4 9 Turkey 15.8 17.8 10 Bangladesh 5.7 7.5 (Source: The Banker. (2009). Top 500 Islamic Financial Institutions, November, at p 4)
There is also the 'need' to ensure that proposed tax reform for Islamic finance is constitutional. For reforms to be constitutionally valid, it is critical to determine the relationship between religious freedom provided in s 116 and the Commonwealth's power to tax under s 51 within the Australian Constitution. Even though s 116 has been interpreted narrowly, there is judicial commentary to indicate that s 116 is an 'overriding provision applicable to all instruments of laws' (Puig and Tudor, 2009). However, it appears that while the power to tax would be subject to an overriding prohibition of religious freedom, provided that the tax law is of general application then s 116 will not invalidate it (Freudenberg and Nathie, 2011).
Another 'circumstance' is that the present state of Australia's tax law creates increased costs to entry. If legal impediments are removed it may create enforceable rights and obligations that will encourage foreign Islamic banking institutions to enter the market.
Turning to 'regulatory considerations', the 'needs and urgency' consideration is that taxation is not the only issue that must be considered to increase Islamic finance. There is need for a joint regulatory approach and strategy for the Treasury, the Reserve Bank of Australia (RBA), Australian Securities and Investment Commission (ASIC), and the Australian Taxation Office. This includes considering consumer and depositor protection and standardization of financial arrangements. For example, there could be the need to amend or clarify banking regulation, accounting reporting, application of corporations' law investor protection, and the relationship of the boards of Islamic banks and their Shariah scholars (Australian Financial Centre Forum, 2009). Also, reform by the States will be required in terms of the application of stamp duties. This includes consideration of the insurance market, as in addition to banking, there are opportunities in the Islamic insurance market known as 'Takaful'. Particularly, it is seen that with Australia's number of highly regarded actuaries in the Asia-Pacific region, internationally Australia could be well placed to assess such insurance products in terms of risk assessment and underwriting.
This should, as far as practical, aim for a level playing field for both Islamic and conventional finance. The 'circumstances' is that there is currently, in terms of Islamic finance, a perceived lack of education, training and skills. While there is currently some Islamic finance activity in Australia, it is considered that there is currently, in terms of Islamic finance, a perceived a lack of education, training and skills. While there is currently some Islamic finance activity in Australia, it is considered that there is large potential for this to be expanded as the operations of Muslim Community Co-operative (Australia) Limited (MCCA) and submissions made by it indicate. MCCA has been providing various Islamic financial products since 1989 in Australia, and currently has approximately $425 million worth of finance written or managed by it. The need for such pro-activeness is highlighted by the fact that other countries such as the United Kingdom, Malaysia and Singapore are already introducing reforms to their finance and tax laws to recognize and facilitate the use of Islamic finance. Other financial service providers include the Islamic Cooperative Finance Australia and Iskan Finance, both based in Sydney, that provide financial products to assist with home purchases and education expenses (Board of Taxation, 2010).
The relationship between 'political' drivers and the 'needs and urgency' considerations is that reform must be necessitated by the need to ensure economic advantage. The Austrade report demonstrates that the urgency for encouraging Islamic finance is driven by necessity and political expediency. Experience with changes to Victorian stamp duty law demonstrated a positive impact on home financing stemming from the removal of multiple stamp duty. Many countries have migrated wholly or partially toward Islamic finance without disturbing religious norms and customs: examples include Malaysia, the United Kingdom, Singapore and South Africa. The 'circumstances' is that currently there is some political will to implement reforms to facilitate Islamic finance, albeit limited to small pockets of positive interest groups. However, it needs to be acutely aware that there is some fear that Islamic finance will undermine the Australian way of life largely driven by 'Islamaphobia'. Furthermore, Australia may exert (or have exerted on it) market and prudential influence through multilateral financial engagements.
Finally, in considering the 'social' driver of reform, the 'need and urgency' consideration includes the realization that Australia has a greater diversity of religions and faiths. However, the need for change must not be exclusively for the benefit of Muslims, but for the benefit of all in society. Tax law should not differentiate between religious groups. For example, the United Kingdom tax law is specifically designed to remove this bias. In assessing tax treatment one merely looks at the tax law and not to other realities. Also the 'need' consideration must ensure that welfare loss is minimal. Given the housing affordability crisis in Australia, the social need for housing may be assisted through alternative Islamic financing products in assisting with housing affordability. The 'circumstances' are that 'such an amendment would send a message to potential Islamic investors signalling Australia's cultural understanding and tolerance of Islam and inviting engagement' (Dabner, 2008).
Within Australia there is also a growing Muslim community, with 365,000 Muslims, representing 1.7 per cent of Australia's population (Australian Trade Commission, 2010). Contextualized, there are approximately 1.57 billion Muslims world-wide representing approximately 23 per cent of the world's population (Pew Research Centre, 2009). It is estimated that Islamic finance represents only 1 per cent of global finance. It is because of this dichotomy that commentators argue there is potential for growth (Australian Trade Commission, 2010). These arguments are based on the emergence of a strong middle class, rising oil revenue and strong economic growth of GCC countries, demand from Muslim and non-Muslim investors, and low penetration levels (Jaffer, 2006). This is complemented by the ethical character and financial stability of Islamic products.
Using the conceptual framework in Exhibit 1, there is a strong argument for reforms to facilitate Islamic finance to proceed. Indeed, arguments for accommodating Islamic finance through tax reform are evident from private and institutional submissions at tax conferences and seminars (Sherry, 2010). The arguments put forward in these submissions suggest that changes to Australia's current tax structure must be more reflective of tax equity and market and societal realities. However, none of these submissions have suggested a comprehensive approach on how best this might be achieved.
While there has been some activity in Australia in advancing Islamic finance, this is still largely in the formative stages. One notable reform has been the efforts of the Victorian government which introduced provisions to limit the imposition of double stamp duty on Islamic financing arrangements for home purchases, thereby allowing equal tax treatment with conventional financing arrangements. The Victorian stamp duty changes were in response to Islamic financial products being offered by MCCA.
However, there has been a conspicuous lack of enthusiasm by Australia's conventional banking sector to tack into this emerging market. Some tangible support did emerge in June 2009 when the NAB bank announced its intention to offer Islamic loans (Gardner and Russell, 2009). Most recently, in February 2010 Westpac Banking Corp announced it would offer a commodity-trading facility aimed at overseas investors that operate in accordance with Islamic Law (Johnston, 2010). However, this move does not address the Islamic retail, banking, fund management and capital markets. Accordingly, there is some ground for Australia to expand the momentum of Islamic finance occurring. It is argued that the potential for Islamic finance to deliver financial benefits to Australia deserves greater attention--especially if the tax reforms provide greater tax neutrality for financial products regardless of whether they are faith based or not.
This paper has sought to explore whether tax reforms are justified to provide for facilitation of Islamic finance in Australia. The paper initially considered the meaning and principles of Islamic finance and demonstrated the potential tax anomalies that exist currently in Australia's tax framework.
Then, to determine whether tax reforms should be pursued to address the breaches of tax neutrality, a 'framework' for tax reform was proposed. Through consideration of the dynamics between the inner factors of this framework (needs and urgency, and circumstances) with the drivers of reform (national interest, legal compatibility, equity and neutrality, fiscal, constitutionality, regulatory, political and social considerations)--it was argued that Australia should pursue the implementation of tax reforms to facilitate greater Islamic finance.
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Brett Freudenberg, Griffith University, Australia
Mahmood Nathie, Griffith University, Australia
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|Author:||Freudenberg, Brett; Nathie, Mahmood|
|Publication:||Review of Business|
|Date:||Jun 22, 2012|
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