Islamic Finance

Islamic finance, also known as Shari’ah-compliant financing, is a financial system that operates in accordance with Islamic law. It adheres to fundamental principles such as the prohibition of interest, fair and transparent dealings with avoidance of speculation and uncertainty, real economic activity with underlying assets, and ethical investments.

Key Differences Between Green Bonds & Sukuk

One element of Islamic finance are sukuk, financial certificates that comply with Islamic Shari’ah law and provide investors with partial ownership of the issuer's assets. The basic principle behind sukuk is that the holder has an undivided ownership right in a particular asset and is therefore entitled to the return generated by that asset. It might be useful to compare sukuk to green bonds, where governments and companies issue bonds to raise capital for eco-friendly initiatives. These financial instruments are purchased by investors who want to fund projects aimed at environmental reform while generating returns.

Green bonds are typically fixed income. The issuer raises a fixed amount of capital from investors over a set period, repaying the capital when the bonds mature and paying an agreed amount of interest along the way.

Green bonds and sukuk offer various benefits focused on addressing climate change. By financing sustainable projects, they allow individuals and organizations to contribute actively to achieving the UN's Sustainable Development Goals (SDGs), in line with COP28 goals.

Investing in green bonds and sukuk is helping Gulf Cooperation Council Countries strengthen their reputation for environmental responsibility and building trust.

With corporate tax effective from 01 June 2023, there are corporate tax considerations which need evaluation.

Impact of Corporate Tax – UAE

From Investors’ perspectives

A. Taxability of income from Islamic Financial Instruments

  • In case of individuals (including non-residents): As per Cabinet Decision No. 49 of 2023, individuals earning personal investment income (which shall include income from Islamic financial instruments) shall not be subject to the UAE Corporate Tax.
  • In case of taxable persons (other than individuals): Income from Islamic financial instruments shall be subject to the UAE Corporate income tax at the rate of 9%.

B. Withholding tax implications (if any)

  • There is no withholding tax rate (as of date of this article) on payment of returns made to investors of Islamic Financial Instruments.

From Issuers’ perspectives

1. Taxability of business

  • Islamic finance business operations will be subject to corporate income tax at 9% for their first tax period that commences after 30 June 2023.

2. Deductibility of payments of returns made to investors of Islamic Financial Instruments

  • It is imperative to evaluate whether the payment of returns shall draw contour from interest, or any other term as defined under the Federal Decree-Law No. 47 of 2022 on the ‘Taxation of Corporations and Businesses’ (hereinafter referred to as the ‘UAE Corporate Tax Law’).
  • It is pertinent to note that the definition of interest has been enunciated under Article 1 of the UAE Corporate Tax Law as: Any amount accrued or paid for the use of money or credit, including discounts, premiums and profit paid in respect of an Islamic financial instrument and other payments economically equivalent to interest, and other amounts incurred in connection with the raising of finance, excluding payments of the principal amount.
  • On perusal of the above, it may be inferred that payment of returns made to investors of Islamic Financial Instruments is a form of consideration paid in connection with raising of finance and shall fall within the ambit of ‘interest’ payment as defined under Article 1 of the UAE Corporate Tax Law.
  • Further, under Article 4 of the Ministerial Decision No. 126, it has been stated that 'the interest equivalent component on Islamic Financial Instruments shall be treated as Interest for the purposes of the General Interest Deduction Limitation Rule’.

Accordingly, the payment of returns for Islamic Financial Instruments shall be deductible up to 30% of the Earnings Before the deduction of Interest, Tax, Depreciation and Amortisation (EBITDA) in the hands of issuing entity as per General Interest Deduction Limitation Rule under Article 30 of the UAE Corporate Tax Law. However, the above limitation shall be subject to De Minimis threshold of AED 12 million as laid under Article 8 of the Ministerial Decision No. 126 (i.e., no disallowance shall be made until the payment of returns does not exceed AED 12 million).

It is pertinent to note that 30% cap will not be applicable in case Banks are issuing such instruments.

As businesses navigate the complexities of UAE corporate tax provisions, a clear understanding of key definitions and regulations becomes vital. Delving into the meanings of terms like interest and Islamic financial instruments, as well as shedding light on the treatment of interest components will equip businesses with valuable insights to navigate the UAE tax landscape confidently.

Zayd Maniar
Zayd Maniar

International Liaison Partner

Zayd Maniar is an International Liaison Partner with Crowe UAE and part of the UAE Management Team. Zayd Maniar is a Chartered Accountant and has almost 20 years’ experience in providing Audit and Assurance services in the UK and UAE.

Rakesh Nair
Rakesh Nair

Director

Rakesh is a Director with the Corporate tax practice of Crowe UAE. Rakesh is a Chartered Accountant with more than 10 years of experience in corporate tax, International Tax and Transaction Tax matters catering to a number of industry verticals.

Karan Vora
Karan Vora

Chartered Accountant

Karan Vora is Chartered Accountant with focused oriented on auditing under IFRS, Taxation and Due Diligence with more than 9 years of experience. He has experience in Transfer Pricing and International Taxation, Conduction Risk base Audits (RBAs), Valuation of Intangibles, Financial due diligence for Tax and Regulatory matters.

Punyapal Shah
Punyapal Shah

Chartered Accountant

Punyapal Shah is a Chartered Accountant with more than 13 years of experience in handling complex audits for manufacturing, automobiles and textiles industries. He has experience in international and Corporate Tax matters as well.