10 Dec 2014
Australia, Islam and the $2 trillion dollar industry
From the initial attempts in the late seventies to reconcile the ancient teachings of Islam with modern finance, Islamic finance has grown into a global industry worth approximately US$2 trillion today.
To those in finance, Shariah compliance is a recognised component of Islamic financing.
"Islamic finance can readily accommodate financing of key areas for Australia's development."
Bryan Paisley, Partner, Baker and McKenzie
Such financing is far from a niche offering: the governments of the UK and Luxembourg have issued Shariah-complaint instruments along with major corporates such as GE, HSBC and Nomura.
So in finance, what does being shariah compliant mean? Certain transactions are ruled out on the basis of the inherent nature of the underlying business being inconsistent with the teachings of Islam rather than the returns they may bring. So Shariah compliance precludes investment in gambling and alcohol in the same way as secular ethical investment would rule out investment in armaments.
But the key distinguishing factor of Islamic finance is the absence of interest - Shariah-compliant returns need to come from risk and profit sharing.
Islam is not alone in this regard in the Abrahamic faiths - charging interest on moneys lent was banned under Christian theology until the growth of commerce during the Renaissance led to ecumenical change.
In modern Islamic finance, structuring is used to provide an interest-like return while remaining shariah compliant.
One of the most common forms of Islamic financing is murabaha (costs plus financing) which can be used for a residential property financing. The financier buys the property and pays the vendor in full. The financier then sells the property to the customer who pays the financier over a period of time the cost of the property plus a profit margin with the deferred cost being secured by a mortgage in favour of the financier.
The determination of whether or not a transaction is shariah compliant is made by Islamic scholars who assess the deal or financial product and confirm whether it is halal (permitted), much in the same manner as ratings agencies opine on the creditworthiness of debt issue.
While the structuring of transactions can make them shariah compliant, the multiple layering of transactions can (unsurprisingly) also result in adverse tax consequences.
For example, if we take the Islamic residential mortgage above, under the laws of most states and territories, stamp duty would be payable both on the sale to the by the vendor to the financier and on the sale by the financier to the buyer. This places a particularly onerous tax burden on shariah-compliant structuring.
The consequences of the Australia tax system for Islamic finance were subject to a report by the Board of Taxation in 2010. This was part of an attempt, encouraged by then trade minister Chris Bowen, to encourage Australia to take part in the international development of Islamic finance.
This push was partially attributable to the drive to develop Australia as a regional financial hub. However, it was also evident in the wake of the financial crisis and the withdrawal of a number of European institutions from the Australian market that it was important to diversify funding sources for business.
As an Austrade report at the time indicated, Islamic finance can readily accommodate financing of key areas for Australia's development such as infrastructure, mining projects, property development and agribusiness.
The changes to the federal and state tax regimes which would be needed are technical but non-discriminatory. Victoria amended its stamp duty regime in 2004 to provide for Islamic mortgages without double taxation but the legislation does not refer to shariah or the practice of Islam. Rather, it describes the legal structure and it is open to any entity to use this structure without reference to faith.
Since 2010, Islamic finance has moved down the political agenda as abundant liquidity quantitative easing and exceptionally low interest rates has led to receding fears of a financing drought.
This is a mistake on both economic and inclusion grounds.
A developed economy should encourage funding from as diverse a range of sources as possible. Markets remain skittish and the changes necessary to accommodate Islamic finance in Australia are technical but will need some time to implement. Consideration should be given to commencing this process sooner rather than later.
Bryan Paisley is a Partner at Baker & McKenzie.
Photo: Steven Bostock / Shutterstock.com
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.