National and Global Islamic Financial Architecture:
Problems and Possible Solutions for the OIC Member Countries
44
structure and requirements, information disclosure obligations, the protection of depositors
and other stakeholders, dealing with distressed banks, etc.
The capital market law covers various aspects to ensure the smooth functioning of the
securities markets. The law encompasses issues such as the conditions to issue securities to
the public, their registration and trading, and regulations related to organizations dealing with
the securities market such as brokers, dealers etc. Securities law reduces problems associated
with raising funds from markets by clearly specifying a contracting framework for issuing
securities. These laws also prevent self-dealing by instituting rules, incentives and penalties to
prevent such activities. An important aspect of protecting investors is the requirement by
securities law to disclose all relevant quantitative and non-quantitative information of listed
companies.
Financial and real transactions may be identified differently under business law. The unique
nature of Islamic financial products and organizations that are not covered by conventional
financial laws necessitate the coming up with of laws that can support the activities of the
former. As products of Islamic banks involve dealings with real goods and services, the law has
to provide for these institutions to carry out trading and investment activities. It will be
difficult for Islamic banks to operate under conventional banking laws as these do not
recognize the special features of Islamic banking practices. As a result, specific laws may be
required to enable Islamic banks to use financial products that are based on sale, leasing and
investments using risk-sharing modes. Similarly, insurance law defines the activities of the
insurance business that are qualitatively different from takaful. One key feature of takaful is
that the capital of the takaful operator is separated from the participants risk fund and the
participants have certain rights that are not recognized by conventional insurance laws. While
Shariah compliant stocks will fulfill certain sector wise and financial ratios criteria, the nature
of sukuk is very different compared to bonds. Thus, securities laws should cater to the unique
nature of Islamic securities and sukuk to not only protect the investors and stakeholders but
also for the sustainable growth of the Islamic capital markets.
3.1.2. Tax regimes and impact on Islamic finance
Most economic and financial transactions have tax implications that affect costs and/or profits.
Tax laws relevant to banking are related to income (profit, withholding), transactions (capital
gains and stamp duties) and goods and services (value-added tax). For example, while interest
paid on debt can be deducted as costs, dividends paid are considered taxable income in most
jurisdictions. Similarly, withholding taxes on interest and other income such as dividends can
be different so that Islamic financial instruments are taxed differently compared to their
conventional counterpart.
As Islamic financial products are based on sale, leasing and partnership contracts, the tax
implications can make these products more costly compared to their conventional
counterparts. For example, home financing and ijarah sukuk may involve double stamp duties
with the latter also having capital gains tax due to sale and buy-back features. Thus, there is a
need to change the tax laws to level the playing field for Islamic finance with conventional
finance. One way to do this is to consider the economic substance of Islamic financial products
as financing tools and applying the rules of interest to profit generated in financial
transactions. An example of this is in the UK where tax laws treat profit in a mudarabah