Taxman to account for Islamic finance

South African Islamic investors and financiers are likely to be recognised by way of a new insertion in the Income Tax Act, consultancy Grant Thornton says.

The proposed new section of the act would take into account Sharia'h practices which involved profit and risk sharing and forbade 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," Tasneem Gangat, a tax consultant at Grant Thornton, said in a statement.

Interest was considered economically harmful by Sharia'h law as the extension of credit increased money supply, which stimulated demand for goods and services but did not always result in real,tangible economic activity.

"It believes interest-bearing transactions result in economic ills including issues such as high inflation and unemployment," Gangat said.

The proposed new section of the act stipulated that for investment account agreements, or Mudarabah, tax would be payable on any profits derived by the client as these would be deemed as interest, thus making them taxable at the hand of the client.

Any Murabaha financing transactions between a client and the financier would 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 purchased the bank's "portion" of ownership in the asset over time and the amount paid monthly to the bank included 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," Gangat said.

The changes would 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."

Gangat said the basis of Islamic finance was 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."

Gangat said the principles of investment management such as sector diversification, low risk versus high risk, and income versus capital growth, would still apply to an Islamic investor, but the manner in which these objectives were achieved, as well as the investments used, would differ from conventional finance.

"Islamic financing is available to the general public and not exclusively made to people of the Muslim faith and 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."

Gangat said Islamic finance was likely to become a permanent feature of the South Africa economic landscape.