Income tax treatment of shariah-based banking and financial institutions in Indonesia
As in Malaysia and in many European countries, many private conventional banks and financial institutions in Indonesia have opened a business unit based on shariah law (Islamic law). This trend to open shariah-related business activities is taking place to serve the increasing number of customers interested in the services of Islamic banking and financial institutions.
Before 2010, the Indonesian income tax laws and regulations did not clearly set out the income tax objective for Shariah-based commercial activities. This has resulted to disputes between the taxpayers and the tax authority in the implementation of the income tax law.
With the amendment of the Income Tax Law in 2010, the tax treatment of shariah-based businesses has been set out, and is governed by Government Regulation No. 25/2009. Under this regulation, the conventional treatment based on the Income Tax Law also applies to the income and deductible expenses on the commercial activities of shariah-based banks and financial institutions. This includes the obligation of the Islamic banks and financial institutions to act as the withholding tax agent.
The finance minister recently issued Regulation No. 137/PMK.02/2011, which took effect on August 19 2011 as implementing regulation of Government Regulation No. 25/2009.
The substance of Minister of Finance Regulation No. 137/PMK.03/2011 is as follows:
Income in whatever form and name such as bonuses, gain sharing, profit margin and other returns will be taxed in the same manner as interest.
Income derived by customers and depositors in whatever form and name from the placement of fund in the banks or the placement of fund abroad through a shariah bank in Indonesia will also be taxed as interest.
The bank expenses such as operational costs, including bonuses, gain sharing and returns paid or payable to the clients can be treated as deductible expense.
The depreciation on financial activity Ijarah Muntahiyah Bittamlik (similar to financial lease) is a non-deductible expense.
Shariah financial institution
The commercial activities performed by a shariah financial institution are as follows:
Islamic leasing activities are based on Ijarah (similar to operating lease) and Ijarah Muntahiyah Bittamlik (similar to financial lease). The income derived by institutions will be taxed on the income similar to the income received by a conventional operating lease or financial lease company.
Wakalah bil Ujrah (the Islamic factoring) will be performed in the form of Wakalah, Salam, Utisna (Islamic customer financing). The income received from these activities will be subject to tax on interest income.
Shariah (Islamic) credit card, the fees received or accrued will be taxable as income from conventional business.
The gain or profit sharing income derived by investors (shohibul mal) is treated as interest.
All expenses related to the operation of shariah financial institutions including profit sharing paid or payable to the investors (shohibul mal) are deductible expenses.
Since the transactions of Islamic banking and financial institutions in the country have been on the rise, the issuance of this Minister of Finance Regulation provides legal certainty that there is no difference in the tax treatment of shariah-based banking and financial institutions.