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Positioning Malaysia as an Islamic Financial Centre

In line with the Malaysian Government’s efforts to promote Malaysia as an Islamic Financial Centre (IFC), the 2007 Budget announcements on the 1 September 2006 provided substantial tax incentives in the area of Islamic ?nance. The new incentives give an opportunity for Malaysia to capitalise on an in?ux of liquidity, particularly from the Middle East. Middle Eastern investors are looking into modes of ?nancing and investment that not only provide similar returns compared to conventional ?nancing and investments, but are also in compliance with Islamic religious principles.

As the demand for Islamic ?nancing products increases globally, more and more countries are realising the potential of Islamic ?nance. In seeking to develop this market niche, the Malaysian Government has provided numerous tax incentives to support regulatory policies in ensuring the country’s role as a leading Islamic ?nancial centre in the region.

Islamic Banking and Takaful Business

Islamic banking as a whole showed commendable growth in 2005, with pro?tability and assets surpassing, for the ?rst time, RM1 billion (US$272.4 million) and RM100 billion (US$27.24 billion) respectively. The Islamic banking industry also welcomed foreign participants into its fold with the issuance of three new Islamic banking licenses to foreign Islamic ?nancial institutions from the Middle East.

Islamic insurance, or Takaful, is also fast gaining popularity. Malaysia is the forerunner in terms of Takaful activities in Southeast Asia. Recently, Bank Negara Malaysia (BNM) granted six new Takaful licenses.

As part of the strategy to boost the country as an IFC, BNM announced that foreign and local banks and Takaful operators will be granted new conditional licenses to undertake a full range of Islamic banking and Takaful businesses in international currencies.

Complementing this regulatory policy, the 2007 Budget, proposed substantial tax incentives to boost the Islamic banking and Takaful industry in Malaysia. Some of the major proposals are as follows:

1. Tax exemption of Islamic banks and Takaful companies

  • 10-year tax exemption for Islamic banks and Islamic banking units licensed under the Islamic Banking Act 1983 on income derived from Islamic banking business conducted in international currencies, including transactions with Malaysian residents.
  • 10-year tax exemption for Takaful companies and Takaful units licensed under the Takaful Act 1984 on income derived from Takaful business conducted in international currencies, including transactions with Malaysian residents.

This incentive is effective from year of assessment 2007 to year of assessment 2016.

2. Exemption from withholding tax

Currently, paragraph 33 of Schedule 6 to the Income Tax Act 1967 provides tax exemption on:

“Income of any person not resident in Malaysia for the basis year for a year of assessment, in respect of interest derived from Malaysia (other than such interest accruing to a place of business in Malaysia of such person) and paid or credited by any person (whether the same person or not) carrying on the business of banking or ?nance in Malaysia and licensed under the Banking and Financial Institutions Act.”

Technically, this tax exemption would only apply to normal conventional banks and their Islamic windows, and not to Islamic banks licensed under the Islamic Banking Act 1983.

To streamline tax treatment on pro?ts received by foreign non-resident customers from all ?nancial institutions, it was proposed that pro?ts received by non-residents from ?nancial institutions established under the Islamic Banking Act 1983 – and other ?nancial institutions approved by the Minister of Finance – be exempt from tax as well.

It has also been con?rmed by the 2007 Budget that any pro?ts paid out by an Islamic bank to foreign non-resident customers need not be subject to tax in Malaysia, thus providing equal treatment with conventional bank foreign customers. This means that there will be no withholding tax on pro?t payments made by all licensed banks in Malaysia to non-resident customers.

This proposal was effective from 2 September 2006.

3. Facilitation of ?nancing transactions

Currently, the de?nition of partnership for tax purposes is very wide and includes all types of partnership. Hence any type of partnership, unless speci?cally excluded, would have to ?le tax returns. Such tax treatment does not promote ?nancing transactions such as Musharakah or Mudharabah, since it would technically mean that tax returns have to be submitted for each transaction.

In recognising and promoting Islamic ?nancing structures based on the concept of Musharakah or Mudharabah, it has also been proposed that such ?nancing transactions need not ?le partnership tax returns. The effective date is from year of assessment 2007.

Funds and Fund Management

It is important to recognise the role of the fund manager in promoting and growing the fund management industry, as well as attracting funds from customers. To this effect, the 2007 Budget provides for the following points listed below.

1. Tax exemption of fund managers

A 10-year tax exemption to local and foreign companies managing funds of foreign investors established under Shariah principles and approved by the Securities Commission (SC). This incentive is effective from year of assessment 2007 to year of assessment 2016.

It is hoped that this tax incentive will attract fund managers to establish operations in Malaysia speci?cally for managing funds based on Shariah principles. If reputable fund managers set up in the country, more Shariah funds and products will be created and marketed to foreign investors, making Malaysia the hub for attracting Shariah monies for reinvestment around the region.                                                             

2. Real Estate Investment Trusts (REITs)

REITs have also been provided with a further boost through several tax initiatives:

  • So long as a REIT distributes at least 90% of its income to investors, the REIT will not have to pay tax.
  • Distributions to certain investors will be subject to reduced tax for ?ve years, namely:

non-corporate investors, including resident and non-resident individuals who receive dividends from REITs listed on Bursa Malaysia, will be subject to a ?nal withholding tax of 15%; and


foreign institutional investors, especially pension funds and collective investment funds, who receive dividends from REITs listed on Bursa Malaysia, will be subject to a ?nal withholding tax of 20%.

Corporate investors (resident and non-resident) will continue to be subject to normal corporate income tax at 28% (to be reduced to 27% from year of assessment 2007).

Islamic Capital Market

The Islamic capital market has emerged as a signi?cant area of growth in Malaysia, representing a viable and competitive alternative to the conventional market. This is especially so for investors who are inclined towards investing and utilising products that conform to Shariah principles.

The 2007 Budget announced several tax incentives, including those outlined below.

1. Tax treatment of SPVs established solely for the purposes of issuing Islamic bonds

Under Islamic ?nancing transactions, a special purpose vehicle (SPV) is established purely to channel funds and facilitate the issuance of the Islamic bonds or funding. Although the SPV is merely a “pass through” vehicle in substance, the SPV is still required to submit a tax return and comply with all the administrative requirements of Malaysian tax legislation.

It is proposed that SPVs created speci?cally to facilitate Islamic funding become part of a scheme approved by the SC to be treated as “pass through” vehicles and are thus not required to comply with the administrative requirements under the Income Tax Act 1967. There are, however, certain requirements and conditions which need to be clari?ed.

This measure is effective from year of assessment 2007 onwards.

2. Extension of tax deduction on issuance costs of Islamic securities

Currently, expenses incurred from the issuance of Islamic securities based on leasing (Ijarah), progressive sales (Istisnah), pro?t sharing (Mudharabah) and pro?t and loss sharing (Musharakah) are allowed as tax deductions. This is provided for in the following regulations:

  • Income Tax (Deduction for Expenditure on Issuance of Islamic Securities) Rules 2005.
  • Income Tax (Deduction for Expenditure on Issuance of Islamic Securities Pursuant to Istisnah Principle) Rules 2005.

These incentives will expire in year of assessment 2007.

To ensure that Islamic securities continue to be competitive, it has been proposed that tax deductions on the expenses incurred in the issuance of Islamic securities based on Ijarah, Istisnah, Mudharabah and Musharakah be extended for another three years to 2010.

These incentives will also be accorded to all Islamic securities products approved by the SC.

3. Other

Other tax initiatives include:

  • Pre-commencement expenses of an Islamic stockbroking business will be allowed as a tax deduction so long as the business is commenced within two years of the SC approval.
  • Further stamp duty exemption of 20% on instruments used in Islamic ?nancing products approved by the Shariah Advisory Council of BNM or the SC for a period of three years. This means that Islamic transactions will suffer 20% less stamp duty compared to conventional ?nancing instruments.
  • SPVs established solely for the purpose of the issuance of Islamic bonds need not be subject to tax or tax administrative procedures.

Human Capital

In encouraging Malaysians to explore Islamic ?nance as a career choice, tax relief not exceeding US$1,362 (RM5,000) per annum is also provided on Islamic ?nance courses approved by BNM or SC at local institutions.


The 2007 Budget has certainly provided the much-needed ?scal incentives to spur the growth of the Islamic ?nance industry in this region.

With the stage all set, it is now up to the Government and the players to pro?le Malaysia internationally and to position the country as an international Islamic ?nancial centre.  

This article was authored exclusively for and published in Islamic Finance news (Volume 3, Issue 40).