Are We Ready for Take Off?
"The best time to plant a tree was 20 years ago. The second best time is now!" This timeless wisdom highlights the importance of seizing the present moment to embrace opportunities, even if the ideal timing has slipped by. This concept is especially relevant to Tanzania’s rapidly evolving financial sector, where Islamic banking is increasingly making its mark. Although Islamic banking is not a new concept, its recent rise in popularity in Tanzania underscores a crucial opportunity for growth and development. By seizing the moment and acting decisively from a tax policy perspective, we can capitalise on the expanding potential of Islamic finance and shape a prosperous future for the nation’s financial landscape.
In the last ten years, Islamic banking in Tanzania has made significant progress with the establishment of dedicated Islamic banks and the introduction of Sharia compliant financial products by a number of financial institutions. These include products such as Murabaha (cost plus financing), Ijara (leasing), Sukuk (Islamic bonds), and Takaful (Islamic insurance). This shift mirrors a wider trend towards financial diversification and inclusion, providing alternatives to traditional banking for a diverse clientele. Nevertheless, this growth brings with it complex tax challenges. Islamic Finance (IF) operates on principles that forbid riba (interest) and gharar (excessive uncertainty), which present unique challenges for taxation.
Islamic financial products face various tax challenges as we do not have specific tax provisions to deal with the difference introduced by IF and therefore have to use provisions which were not specifically designed for them, thus sometimes resulting in distortion. For instance, Murabaha (cost plus financing) transactions are typically treated as sales of goods being subjected to VAT on the profit margin, and corporate tax on the bank's income. Sukuk, which represents asset ownership rather than debt thus challenges traditional income tax legislation/regulations designed for interest based securities. Ijara leases are liable for VAT on lease payments and corporate tax on rental income. The VAT implications for Ijara leases diverge from standard leases, requiring amendments to the VAT provisions to accommodate the profit margin structures inherent to IF. The taxation of IF products raises concerns, as traditional tax laws are devised for interest bearing returns, which does not adequately address the unique profit sharing and equity based returns prevalent in IF. This discrepancy leads to ambiguities and potential issues in the fair and accurate taxation of gains from Shariah compliant financial products, underscoring the need for tax regulations that are tailored to accommodate the unique features of Islamic banking. Takaful (Islamic insurance) contributions are typically exempt from VAT, whereas the income of Takaful operators is subject to corporate tax. As IF continues to grow, ongoing revisions to tax provisions are essential to effectively accommodate these distinctive financial instruments. Aligning tax policies with the distinct features of IF is crucial for promoting the growth of the sector and ensuring fairness.
With the maturation of the IF market, Tanzania can look forward to the introduction of innovative products such as Sukuk Al Ijara (leasing bonds) and Green Sukuk (environmentally focused bonds). To prepare, we must refine our regulatory framework, set forth clear tax guidelines for new products, and encourage dialogue between Islamic financial institutions and tax authorities. Such thinking will drive sector growth and maintain Tanzania’s competitive edge.
Looking at broader trends across Africa, Islamic banking has demonstrated notable growth in several countries. In Kenya, the introduction of VAT exemptions for Sukuk bonds has significantly boosted market activity. Nigeria has implemented tax incentives such as reduced tax rates and tax reliefs for Islamic bonds investors, making them more appealing. South Africa has established a comprehensive regulatory framework and explicit tax guidelines for IF, enabling smooth integration while Mauritius has implemented favourable tax measures, such as exemptions for Islamic financial services, establishing itself as regional frontrunner. Meanwhile, Egypt, with its deep rooted IF history, is continuously refining its tax policies to address emerging challenges and capitalise on growing acceptance. These examples underscore the critical role of clear and tailored tax policies in expanding Islamic banking.
Furthermore, the integration of Environmental, Social, and Governance (ESG) investing with IF presents a timely opportunity. The principles of IF resonate with ESG values, both prioritising ethical and sustainable practices. Islamic financial products like Sukuk bonds and Waqf (endowment) funds can be structured to support green and socially responsible projects, fitting seamlessly into ESG portfolios. This alignment allows Islamic banking institutions to capture a significant share of the growing ESG investment market while adhering to Sharia principles.
As digital Islamic banking and innovative financial products continue to emerge, we are poised for further growth. Tanzania’s evolving IF landscape presents a critical opportunity for integration with ESG investing. However, navigating the associated tax challenges will require continuous effort and collaboration. By addressing regulatory and compliance issues and seizing opportunities for improvement, we can fortify our Islamic banking sector and drive its progression. Moreover, by preparing for future financial products and leveraging the alignment between IF and ESG values, we can enhance our Islamic banking sector and support its ongoing development. Collaboration between the government, tax authorities, tax consultants and Islamic financial institutions will be essential to overcoming these challenges thus ensuring that Islamic banking takes off on firm, fair, and future ready ground.
By Cecylia Temba is a Senior Associate, Tax Services at PwC Tanzania
