Revenue body attaches strings to tax on income from IFIs

KARACHI: The Federal Board of Revenue (FBR) will impose tax on net income from Islamic mode of financing only if financial institutions meet certain conditions and get auditor’s certification, it said on Monday. 

“In the light of the principle of tax neutrality explained in Income Tax Rules 2002, the net income (as opposed to gross receipts) from Islamic mode of financing namely Murabaha, Musawamah, Bai Muajjal, Bai Salam, Istisna, Tijarah, Istijara financing and Tawarruq/Commodity Murabaha should be considered as turnover for the purpose of levying minimum tax with the condition that tax neutrality condition is met and auditors also certify the requirement,” FBR said in a notification.

The government, in the budget for 2017/18, announced a measure to consider Shariah-compliant financial institutions at par with conventional banking in terms of tax liability on inter-bank transactions and when it comes to taxation on their investment products.

The apex tax authority was informed that receipts on account of Islamic financing products, namely Murabaha, being a transaction of sale and purchase of underlying goods, is treated as gross receipts for the purpose of levying minimum tax under Section 113 of Income Tax Ordinance.

FBR’s notification explained the interpretation of income tax treatment of various Islamic banking products in order to clarify the non-discriminatory environment for the Islamic financial system.

Islamic financial institutions enter into Ijara for assets given on lease under Islamic mode.  In terms of guidelines under Islamic Financial Accounting Standards (IFAS-2), gross rentals are accounted for in the accounts against which depreciation is charged on straight line basis over the lease period. 

As a result, net income from Ijara is recognised in the accounts.  The board received complaints that assets given in Ijara had been treated as finance lease on certain grounds, and depreciation was disallowed under the Seventh Schedule of Income Tax Ordinance, 2001.

It said the rationale of placing restriction on claiming depreciation upon the assets given on finance lease has not been appreciated properly.  “Banks are allowed depreciation on assets so they can claim depreciation on assets given on lease, including finance lease,” the FBR said. “Since in respect of finance lease, the income recognised in the accounts is finance income, therefore, as per income tax rules the depreciation would then not be allowed to the bank as lessor.”

In order to provide tax neutrality to assets given on lease under Islamic mode vis-à-vis conventional mode, FBR said profit implicit in the Ijara financing income should be recognised for tax purposes – as in case of finance lease by other banking companies – with conditions that Islamic banks fulfill the requirement laid down in the Ordinance.