Islamic Financing in simple terms is a form of finance that is governed by Shariah or the body of Islamic law. Its transactions are tied to certain ethical values such as fairness, transparency and risk-sharing.
In certain circumstances, it may be similar to conventional financial products but the fundamental principles remain different.
For instance, every Shariah-compliant financial transaction is not based on usury (interest), must be supported by an underlying economic activity and cannot be linked with elements that are considered threats to the moral of a society such as gambling, liquor and arms trades and use of all conventional derivative instruments for speculative transactions which are contrary to Islamic values.
Islamic Finance products could be in the form of savings/transactional accounts, safekeeping, consumer finance, corporate finance, investment banking, corporate sukuk (Islamic bonds) issuances, sovereign sukuk issuances, fund management, securities trading, takaful, retakaful, and co-operatives and/or savings institutions.
Through the 2017 Budget Speech and The Finance Bill, 2017 the Cabinet has sought to revise various Financial Services Regulations to provide for products that could be offered under Islamic Financing.
Apart from the Income Tax Act, various stamp duty exemption orders have been issued to ensure that Islamic financing transactions are not adversely taxed as compared with the rest.
In a nutshell, for Islamic finance transactions, due to the underlying asset within each transaction, tax neutrality as well as the tax treatment of profits need to be resolved as tax issues could easily arise.
Tax neutrality is a form of tax incentive whereby a relief is given to the tax charges imposed. There is always a need for tax neutrality so that Islamic finance is put on equal tax treatment compared to conventional finance.
This is also evidenced by the many incentives to Islamic Financing contained in the Finance Bill 2017. Otherwise, Islamic finance will not be attractive.
Finally, the compliance check for Islamic Financing products will be brought under scrutiny by the regulators to ensure that investors are not partaking of Islamic Financing benefits while offering conventional products. A good example on this would be takaful insurance products.
But the idea gets diluted when takaful companies, for example, insure their own risk with conventional re-insurers instead of re-takaful companies.
Even in the light of the proposed amendments, a lot will need to be done for Kenya to realise a fully functional end-to-end Islamic Financial Sector. Regulatory measures have not been evened out to fully accommodate the Islamic finance sector.
Stanley Ngundi and Yasmin Mohamed are Tax Professionals with Ernst & Young.