Malaysia tax incentives chase stringent funds

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(Oct 14): Malaysia is extending tax breaks on sukuk structures that are acceptable to Middle Eastern investors as it seeks to attract more money from the oil-rich region.

Issuers of Ijarah and Wakalah bonds will be excluded from sales taxes for a further three years to 2018, Prime Minister Najib Razak said in his Oct. 10 budget speech that didn’t include the renewal of the incentive for Tawarruq. The former securities are recognized by the Accounting and Auditing Organization for Islamic Financial Institutions, which sets industry standards that have been adopted in markets such as Bahrain, Qatar and the Dubai International Financial Centre.

Malaysia is encouraging Shariah-compliant debt offerings by foreign issuers after overseas sales accounted for less than 5 percent of 2014’s 48.7 billion ringgit ($14.9 billion) total, approaching 50 billion ringgit for only the second time ever. Tax exemptions on more globally acceptable structures suggest Najib is promoting some form of conformity amid the varying interpretations of Islamic law across boarders, according to RHB Research Institute Sdn.

“This would be a good way for the government to attract more foreign participation,” Fakrizzaki Ghazali, Kuala Lumpur- based credit strategist at RHB Research, a unit of RHB Capital Holdings Bhd., said by phone yesterday. “Ijarah and Wakalah are widely acceptable among the scholars so this could attract sukuk investors globally,” particularly from the Middle East and Gulf Cooperation Council, he said.

Shariah Interpretations

Malaysia pioneered Islamic finance more than 30 years ago and is now the world’s biggest sukuk market. Sales reached 49 billion ringgit last year and a record 95.8 billion ringgit in 2012, data compiled by Bloomberg show.

Islamic bonds are issued under various principles and are usually backed by an underlying asset to comply with the religion’s ban on interest. Scholars tend to have differing opinions on what is considered Shariah compliant across the various jurisdictions, prompting the industry’s leading institutions to push for common standards.

Ijarah is a contract where one party purchases an asset on behalf of another and leases it back at a markup, while Wakalah is an agreement between an agent and a principal for services rendered for a fee.

Tawarruq, or the more commonly used term of commodity Murabahah, is where a customer buys an asset from an Islamic bank at a markup and then sells the asset on, with the full price to be repaid later. This type of contract has drawn criticism from some Shariah experts who say it’s too similar to interest-bearing loans.

Right Direction

“The tax exemptions for sukuk based on Wakalah and Ijarah structures are a step in the right direction as it will do away with Tawarruq and allow issuers to tap liquidity in the Middle Eastern market,” Mohamed Azahari Kamil, chief executive officer at Asian Finance Bank Bhd. in Kuala Lumpur, said in a phone interview yesterday. “It will also encourage more issuers to sell sukuk.”

While Malaysia’s focus on the two Islamic structures will attract more foreign investors to the ringgit sukuk market, the nation has sufficient funds of its own to absorb issuance, said Badlisyah Abdul Ghani, chief executive officer of CIMB Islamic Bank Bhd., a unit of CIMB Group Holdings Bhd.

Shariah-compliant banking assets rose 9.7 percent to an unprecedented 580.8 billion ringgit as of July from a year earlier and accounted for 25 percent of the total market, according to the finance ministry’s annual economic report released on Oct. 10 to coincide with the budget.

The Bloomberg-AIBIM Bursa Malaysia Corporate Sukuk Index, a benchmark that tracks the nation’s most-traded local-currency notes, gained 2 percent this year to a record 107.25 after advancing 2.8 percent for all of 2013.

‘Profiling Exercise’

Najib also announced during his parliamentary speech that Malaysia’s Islamic and conventional government bonds can now be listed and traded on an exchange rather than the over-the counter-market that connects buyers with sellers. The move will help create more depth and liquidity, said Mohamed Azahari at Asian Finance Bank.

The listing of Malaysian government securities is a “good profiling exercise” and will increase trading, CIMB’s Badlisyah said in a phone interview in Kuala Lumpur yesterday.

“This would create a level playing field for sukuk and conventional bonds,” Badlisyah said. “By offering incentives to only two of the Islamic structures, the government is sending out signals that the sukuk market is ready to stand on its feet.”