Does Islamic banking need tax-break pick-ups to lubricate the sector?
A panel discussion in Malaysia included a discussion of whether tax incentives for Islamic finance should be continued (they were first introduced in 2004/05). Some of the tax incentives are provided to make Islamic finance competitive with conventional finance, and these should eventually be phased out, so that Islamic finance focuses on its competitiveness and offering customers with a valuable product, rather than developing sophisticated political power to entrench the tax incentives.
On the other hand, incentives that place Islamic and conventional finance on equal footing should be maintained. For example, eliminating double taxation where the structure of an Islamic financial product would lead to extra taxation compared to a similar conventional product that would be subject to lower taxes.
There is certainly a role for both placing Islamic finance on equal ground with conventional finance, as well as providing temporary incentives that allow Islamic financial institutions to grow to a scale that makes them more competitive, where they can spread costs across a larger institution and minimize the cost gap with conventional financial institutions. However, Islamic finance now makes up more than 20 per cent of the banking industry in Malaysia, so it might be time to start phasing out the subsidies (tax incentives) that solely benefit Islamic finance without addressing some inequality (e.g. double taxation of Islamic products).
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