Big boost for Islamic financing in Pakistan

Islamabad - Tax rebate will attract more firms toward Islamic economy

Taking full advantage of rising popularity of Islamic financial system, Pakistan announced a two per cent tax cut for all Shariah-compliant companies.
The tax relief expected to have multi-dimensional effect on the economy. More companies are likely to switch from conventional to Islamic banks and Islamic modes of financing, selling, or leasing. The Islamic banks will expand in size, volumes, spreads, profits and numbers. More individuals will turn to Islamic banking because their companies and associates will be working for these companies or their associates.
The welcome tax rebate became effective from July 1, as the current fiscal year has just started, and the new national budget has just been approved by the Parliament of Pakistan.
"In order to incentivise listed manufacturing companies, the federal government has introduced a two per cent rebate for Shariah-compliant companies through the Finance Act 2016," the Ministry of Finance announced.
The Finance Act also covers the entire national budget for fiscal 2017 that includes the period from July 1 to June 30, 2017.
"The tax rebate, decided upon on the suggestion of the Security and Exchange Commission of Pakistan (SECP - the financial market regulator) - is part of the reforms being introduced for elimination of 'Riba' and for promotion and development of Islamic capital market," the official announcement said. "In this connection, a new clause 18 (b) has been inserted in the Second Schedule Part II of the Income Tax Ordinance, 2001 through the Finance a Act 2016," it also explained.
The latest decision to expand the programme followed a report by the State Bank of Pakistan (SBP), which confirmed a continuing spread of the Islamic banking system in Pakistan. In a short span after its introduction, the Islamic banks by now have a 13 per cent share of the conventional banking in he country. "The spread of the Islamic banks is steady and fast," a senior conventional banker said. 
Further work on the two per cent tax rebate is currently being done by SECP, the SBP, and the Federal Board of Revenue (FBR), which are preparing a list of the companies, seeking to get the tax rebate after screening of their operations. The stock market-listed companies deriving their income from the manufacturing activities and having declared their taxable income for three consecutive years and which have had paid dividends for the past five consecutive years can qualify, and apply for the tax rebate.
Minister for Finance Ishaq Dar, said: "The tax incentive will attract new listings of companies on the Pakistan Stock Exchange (PSX) and add depth to it."
The Karachi-based Pakistan Stock Exchange (PSX) is currently in a constant boom mode and its shares are zooming up day by day, reflecting the strength of the economy.
The financial market regulators, according to the announcement, also hope "the rebate decision will crate a vibrant primary and secondary markets".
"It will capitalise the limited capital base, mobilise resources through channeling of faith-based investor savings, counter market anomalies and malpractices due to lager free floats, create employment and generate revenue for the national exchequer in terms of additional direct and indirect taxes," the regulator said.
The data on which the tax rebate decision was taken indicates a number of companies, of which eight big stand out, can immediately qualify the criteria for Shariah-compliance and avail the two per cent tax rebate - as their interest-bearing debt or gearing is zero per cent, provided they convert their interest income from investments to income from Shariah-compliant capital market equity and debt securities.
The data analysts also pointed out six more companies, with gearing ratios of up to 10 per cent, can easily become eligible for the tax rebate - but "subject to the condition that the interest income and financing be related to Shariah-compliant modes of financing investments."
"At the same time, other companies, which are leveraged by conventional borrowings, may also avail the discount in corporate tax by structuring on Islamic modes," the analysts said.
While introduction of rebate, it appears that the overall income of the government in the form of tax revenues will decline. But the fact is that, on the contrary, the overall income will go up. Despite the likely impact of the rebate additional funds will be available for distribution as dividends on which Withholding Tax can be realised. The SECP, alongside the SBP and FBR, is considering additional conditions for the companies to maintain a minimum of 25 per cent free-float, conduct business that is "halal", and interest-free income and financing. 
"It is a big step forward for Islamisation of the economy. We will continue the process," Finance Minister Ishaq Dar said.
Views expressed by the author are his own and do not reflect the newspaper's policy.