In accordance with the powers conferred upon it under Section 61 of the Federal Inland Revenue Service Establishment Act, the Federal Inland Revenue Service (FIRS) last year released the Non-Interest Finance (Taxation) Regulations 2022 (“NIFTR 2022”), with a commencement date of 1st April, 2022, to provide a fulcrum for the taxation of financial institutions offering non-interest financial products and services in Nigeria.
It is recalled that the Central Bank of Nigeria (CBN) has published the Revised Guidelines for the operation of non-financial instruments aimed at providing a uniform set of rules for authorized institutions to access non-interest financial instruments. Read details here: CBN Guidelines
The NIFTR 2022 provides tax and regulatory guidelines for the operation of Non-Interest Financial Instruments provided by the CBN for authorised institutions operating under the auspices of Islamic Commercial Jurisprudence to ensure equal treatment of both conventional and non-interest financial services transactions in Nigeria. We now turn to the different parts into which the NIFTR 2022 is divided:
Sale Based Products: Murabaha
Murabaha, also known as “Cost Plus Mark-Up,” is a type of financing used in Islamic finance whereby a financial institution agrees to purchase an asset and then resell it to the customer at a higher price, with the understanding that the customer will pay the price in instalments over an agreed-upon period of time. The price increase represents the institution’s profit.
According to the NIFTR 2022, Murabaha is a contract of sale where an institution sells a particular asset to a customer in which the selling price is the sum of the cost price and an agreed profit margin. According to Para. 3, in all cases of a Murabaha transaction, the purchase price paid by the financial institution to the vendor is to be treated as a loan from the Financial Institution to the customer while the purchase price paid by the customer to the financial institution, markup excluded, is considered as a loan repayment which is exempted from Value Added Tax (VAT), Stamp Duties (SD) and Capital Gains Tax (CGT). Noteworthy is the fact that the markup is treated as interest payable on the loan and subject to withholding tax (WHT). In the same token, the any asset purchased in a Murabaha transaction shall be subject to the provisions of the VAT Act and withholding tax (WHT) regulations.
The key characteristic of a Murabaha transaction is that the profit earned by the financial institution is clearly stated and agreed upon by both parties at the outset. This contrasts with traditional interest-based finance, where the interest rate is usually not fixed and can change over time. Murabaha transactions are commonly used for financing purchases of goods, especially durable consumer goods such as cars and appliances. They are considered to be Shariah-compliant as they adhere to the principles of Islamic finance, which prohibits interest-based transactions.
Istisna or Parallel Istisna
Istisna, also known as “Parallel Istisna,” is a type of Islamic finance contract used for financing the production of goods or construction projects. Paragraph 4 provides that in an Istisna transaction, the customer enters into a contract with a financial institution to purchase a specific item or asset that has not yet been manufactured or constructed. The financial institution then funds the manufacturer or builder to produce the item or construct the asset.
In a parallel Istisna, two separate contracts are created: one between the customer and the financial institution and another between the financial institution and the manufacturer or builder. The customer pays the price of the item or asset to the financial institution in instalments, and the financial institution pays the manufacturer or builder for the production or construction. The financing arrangement with the customer is then treated as a loan, not subject to payment of VAT and WHT, but the transaction between the financial institution and the third party will be subject to VAT and WHT, respectively. It should also be noted that the repayment of the principal amounts/Istisna contract sum by the customer is treated in the same way as a loan repayment. In other words, only the markup is liable to WHT while the customer treats the capital portion and markup as qualifying capital expenditure (QCE) for income tax purposes, in line with the provisions of the Second Schedule to the Companies Income Tax (CIT) Act (as amended).
Istisna transactions adhere to the principles of Islamic finance, which prohibit interest-based transactions. They are commonly used for financing the production of large-scale items such as airplanes, ships, and infrastructure projects. The following are the key characteristics of Istisna or Parallel Istisna contracts:
Advance payment: The customer makes an advance payment to the financial institution for the purchase of an item or asset that has not yet been manufactured or constructed.
Manufacturing or construction: The financial institution funds the manufacturer or builder to produce the item or construct the asset.
Two separate contracts: In a parallel Istisna, there are two separate contracts: one between the customer and the financial institution and another between the financial institution and the manufacturer or builder.
Fixed price: The price of the item or asset is agreed upon and fixed at the outset of the transaction.
Payment in instalments: The customer pays the price of the item or asset in instalments to the financial institution.
Delivery and transfer of ownership: Once the item or asset has been manufactured or constructed, it is delivered to the customer and ownership is transferred.
Shariah-compliant: Istisna transactions are considered to be Shariah-compliant as they adhere to the principles of Islamic finance, which prohibits interest-based transactions. Istisna transactions provide a flexible financing solution for customers who need to purchase an item or asset that has not yet been manufactured or constructed.
Salam or Parallel Salam
According to Paragraph 5 of NIFTR 2022, Salem or “Parallel Salam,” is a type of Islamic finance contract used for financing the purchase of goods. In a Salem transaction, the customer enters into a contract with a financial institution to purchase goods that have already been manufactured or produced even though the delivery of the commodity is deferred to an agreed date in the future. The financial institution agrees to purchase the goods on behalf of the customer and the customer agrees to pay the price of the goods in instalments.
In a Parallel Salem, two separate contracts are created: one between the customer and the financial institution and another between the financial institution and the supplier of the goods. The financial institution pays the supplier for the goods and the customer pays the financial institution for the price of the goods in instalments. The agreement between the financial institution and the customer is treated as a loan agreement, and not liable to VAT and WHT but the transaction with the third party will be treated as a regular sales transaction, which will be subject to VAT and WHT accordingly.
Salem transactions adhere to the principles of Islamic finance by prohibiting interest-based transactions. They are commonly used for financing the purchase of goods such as raw materials, agricultural products, and consumer goods. The following are the key characteristics of Salem or Parallel Salam contracts:
Purchase of goods: The customer enters into a contract with a financial institution to purchase goods that have already been manufactured or produced.
Two separate contracts: In a parallel Salem, there are two separate contracts: one between the customer and the financial institution and another between the financial institution and the supplier of the goods.
Fixed price: The price of the goods is agreed upon and fixed at the outset of the transaction.
Payment in instalments: The customer pays the price of the goods in instalments to the financial institution.
Delivery of goods: The goods are delivered to the customer upon payment.
Shariah-compliant: Salem transactions are considered to be Shariah-compliant as they adhere to the principles of Islamic finance, which prohibits interest-based transactions.
Salem transactions provide a flexible financing solution for customers who need to purchase goods but do not have the funds to pay for them in full upfront. They are commonly used for financing the purchase of goods such as raw materials, agricultural products, and consumer goods.
Equity Based Products: Musharakah
The NIFTR 2022 also operates in a situation involving where a a joint venture or partnership between two or more parties with a view to financing the acquisition of an asset. In a Musharakah arrangement, each partner contributes capital to the business, and the profits and losses are shared in accordance with an agreed-upon ratio. Musharakah transactions are commonly used for financing small to medium-sized business ventures and real estate projects. Based on Paragraph 6, the financing of the acquisition isdeemed a loan and the financial institution’s share of profit is treated as interest on the loan and in a similar way as a conventional interest on loan (which is generally tax exempt) while the payments to acquire the financial institutions’ share in the joint venture shall be the loan repayment and not liable to VAT, SD, and CGT.
In a Musharakah arrangement, each partner has the right to participate in the management and decision-making of the business. The partnership can be dissolved at any time if one of the partners wishes to exit the arrangement. The assets of the business are sold and the proceeds are used to repay the partners’ capital contributions, and any remaining profits are distributed in accordance with the agreed-upon ratio. It need be stressed also that the instrument of transfer of interest of the financial institution to the customer as beneficial owner is subject to the Stamp Duties Act (SDA) but only the customer may treat the cost of the asset as capital expenditure in compliance with the provisions enunciated by the CITA.
The following are the key characteristics of Musharakah contracts:
Partnership: Musharakah involves a partnership between two or more parties to finance a joint business venture.
Capital contributions: Each partner contributes capital to the business.
Profit and loss sharing: The profits and losses from the business venture are shared among the partners in accordance with an agreed-upon ratio.
Management: Each partner has the right to participate in the management and decision-making of the business.
Dissolution: The partnership can be dissolved at any time if one of the partners wishes to exit the arrangement.
Repayment: The assets of the business are sold and the proceeds are used to repay the partners’ capital contributions, and any remaining profits are distributed in accordance with the agreed-upon ratio.
Shariah-compliant: Musharakah transactions are considered to be Shariah-compliant as they adhere to the principles of Islamic finance, which prohibits interest-based transactions.
Musharakah provides a flexible and cost-effective financing solution for business ventures, while also aligning with the principles of Islamic finance. It creates an opportunity for partners to collaborate and share in the risks and rewards of the business, making it an attractive option for entrepreneurs and small business owners, as well as investors seeking Shariah-compliant investment opportunities. The following are some of the advantages of Musharakah as a financing arrangement:
Shared risk: Musharakah spreads the risk of the business venture among the partners, reducing the risk for any one party.
Shared profits: The profits from the business venture are shared among the partners, creating an incentive for each partner to work hard to make the business a success.
Flexibility: The partnership can be dissolved at any time if one of the partners wishes to exit the arrangement.
Collaboration: Musharakah provides an opportunity for partners to work together and leverage each other’s skills and resources.
Islamic compliance: Musharakah is a Shariah-compliant financing arrangement that adheres to the principles of Islamic finance, which prohibits interest-based transactions.
Lower cost: Musharakah can be a cost-effective financing solution compared to traditional financing arrangements, as the partners share the cost of financing the business.
Customizable: The terms of the partnership, such as the ratio of profit sharing and the role of each partner in the management of the business, can be customized to suit the specific needs of the partners.
Musharakah is an attractive financing option for entrepreneurs and small business owners who are seeking flexible, cost-effective financing that aligns with their values and beliefs. It is also an option for investors who are looking for investment opportunities that are Shariah-compliant.
Diminishing Musharakah
Diminishing Musharakah is a financial partnership contract, similar to a mortgage, in which the bank and the customer both contribute funds to purchase an asset, such as a property, with the customer gradually buying out the bank’s share over time through rental payments. The customer’s ownership share of the asset increases over time, while the bank’s share decreases, and reallocated to the customer, who finally becomes the sole owner of the asset. The customer will have an exclusive right to possess and use the asset and pay the financial institution periodic rent and
a consideration to acquire its share in the asset. The customer can treat the asset as QCE for CIT purposes and claim capital allowances on the cost of the asset.
According to Paragraph 7 of the NIFTR 2022, the amount contributed by the financial institution is treated as a loan provided to the customer and shall not be subject to any tax but the periodic rent paid by the customer is treated as interest and subject to WHT. Also, the consideration paid to acquire the interest of the financial institution in the asset is treated as repayment of the principal and will not be subject to both VAT and WHT. On the other hand, the instrument executed between the customer and the financial institution to transfer the latter’s share of interest in the asset is subject to stamp duties. Here are some of the characteristics of Diminishing Musharakah:
Shared ownership: Both the bank and the customer own a share of the asset being purchased. The customer’s share increases over time, while the bank’s share decreases.
Gradual buyout: The customer gradually buys out the bank’s share of the asset over time through rental payments.
Risk sharing: The customer and the bank share the risk associated with the asset, with the customer assuming a larger share of the risk as their ownership share increases.
No interest: The arrangement is based on the principles of risk sharing and prohibits the payment or receipt of interest, which is considered usury in Islamic law.
Use of rental payments: The customer’s rental payments are used to gradually buy out the bank’s share of the asset, as well as to cover the costs associated with the asset, such as maintenance and property taxes.
Transparency: The terms of the arrangement, including the initial contribution of funds, the ownership share of each party, and the repayment schedule, are agreed upon and transparent to both the customer and the bank.
Mudarabah, as Deposit
The NIFTR 2022 is also applicable in a case where a customer provides capital to a financial institution, acting as a manager, and the financial institution applied the capital for the purpose of generating profit and both parties are entitled to a portion of the profit derived from the utilization of the capital provided in the transaction. Paragraph 8 prescribes that the payment made in respect of the customer’s share of profit shall be deemed in substance, a return on investment, and be treated with conventional return on investment(RoI).
Lease-Based Products: Ijarah wa iqtina (Finance Lease)
Ijarah Waa Iqtina is a lease-based financing product, a type of Ijarah, which is an Islamic contract for the leasing of an asset. In this arrangement, the bank leases an asset, such as a property, to the customer and agrees to sell it to the customer at the end of the lease term for a pre-agreed price. The customer makes regular lease payments to the bank during the term of the lease (which are subject to VAT and WHT), and at the end of the term, the customer can either purchase the asset or return it to the bank. Ownership and major maintenance of the asset devolve on the financial institution while the customer retains only the beneficial interest in the asset for the duration of the lease.
Under Paragraph 9 of NIFTR 2022, the Ijarah wa iqtina contract is treated in the same manner as a finance lease and so the customer will capitalise the lease repayment as QCE for CIT and any agreement executed between the parties for the transfer of the asset at the end of the lease period is subject to stamp dutiespayment.
This product is based on the principles of Ijarah, which prohibits the payment or receipt of interest, and is designed to provide customers with access to financing for assets that they may not have been able to purchase outright. It combines the benefits of a lease and a purchase, allowing customers to use the asset during the lease term and to ultimately own it if they choose to purchase it at the end of the term. Here are some of the characteristics of Ijarah Waa Iqtina:
Lease and purchase: The customer leases an asset from the bank and has the option to purchase the asset at the end of the lease term.
Regular lease payments: The customer makes regular lease payments to the bank during the term of the lease.
Pre-agreed purchase price: The purchase price of the asset is agreed upon at the start of the lease term and is not subject to market fluctuations.
No interest: The arrangement is based on the principles of Ijarah, which prohibits the payment or receipt of interest, and is designed to provide customers with access to financing for assets that they may not have been able to purchase outright.
Transparency: The terms of the arrangement, including the lease payments, the purchase price of the asset, and the repayment schedule, are agreed upon and transparent to both the customer and the bank.
Flexibility: Customers have the flexibility to use the asset during the lease term and to decide whether to purchase the asset at the end of the term or return it to the bank.
Ownership: If the customer chooses to purchase the asset at the end of the lease term, they become the owner of the asset.
Ijarah (Operating Lease)
ljarah (Operating Lease) involves the leasing of an asset, such as a property, equipment, or a vehicle, from the bank or financial institution to the customer. The customer pays a predetermined rental fee to the bank in exchange for the use of the asset during the lease term. At the end of the lease term, the customer may choose to return the asset to the bank or negotiate a new lease agreement. Here, there is no intention to transfer ownership of the asset to the customer at the end of the lease period. Under Paragraph 10, the periodic lease payments to the financial institution for the use of the asset is subject to VAT and WHT and the customer is entitled to claim the lease payments as allowable expenses for income tax purposes as long as that the asset is used for the purpose of generating the income that is subject to tax.
Ijarah prohibits the payment or receipt of interest, and is designed to provide customers with access to financing for assets that they may not have been able to purchase outright. It provides a flexible and cost-effective alternative to traditional financing arrangements and allows customers to use assets without assuming the full cost of ownership. The terms of the lease, including the rental fee, lease term, and responsibilities of each party, are agreed upon and transparent to both the lessor and the lessee. Some of the key characteristics of Ijarah are:
Asset ownership: The lessor retains ownership of the asset throughout the leasing period.
Right to use: The lessee has the right to use the asset for the agreed-upon period and cannot make any permanent alterations to it.
Rentals: Rentals are predetermined and payable on a regular basis, usually at the end of each period.
Purpose: The asset must be used for a permissible purpose according to Islamic law.
Risk: The lessee assumes the risk of use and maintenance of the asset.
Termination: The Ijarah contract can be terminated by either party upon the expiration of the agreed-upon period or upon the mutual agreement of both parties.
No interest: Ijarah is structured to avoid the payment or receipt of interest, which is prohibited in Islamic finance.
Profit and loss sharing: Ijarah contracts may involve profit and loss sharing between the lessor and lessee, in which the profits or losses generated by the asset are shared between the two parties.
Agency/Fee-Based Products: Takaful
Takaful is based on the principles of mutual cooperation and shared responsibility. The word “Takaful” comes from the Arabic language and means “joint guarantee.” In Takaful insurance, participants pool their funds together to create a collective pool of resources that can be used to provide financial protection for members against specified risks, such as death, injury, or property damage. The Takaful operator manages the pool and is responsible for the administration and distribution of the funds.
In line with Paragraph 11 of NIFTR 2022, any consideration paid to the Takaful Operator, whether as management fee or a share of return on investment of the fund on behalf of the members will be liable to VAT and any amount distributed as surplus of returns on investments by the Takaful Operator to the members is also subject to WHT. In the same vein, the agreement between the Takaful Operator and themembers for Takaful will be liable to stamp duties.
The major differences between Takaful and conventional insurance include:
Risk sharing: In Takaful, participants share the risk among themselves, rather than an insurance company assuming the risk.
No interest: Takaful prohibits the payment or receipt of interest, which is considered haram (forbidden) in Islamic finance.
Mutual cooperation: Takaful emphasizes the principles of mutual cooperation and mutual support, with participants helping each other in times of need.
Profit and loss sharing: Takaful operators may also participate in the profits and losses generated by the pool, which can help to ensure that the interests of both the operator and the participants are aligned.
Social good: Takaful also has a strong focus on social responsibility and contributing to the greater good, with some operators dedicating a portion of the funds for social and charitable purposes.
Some of the key characteristics of Takaful are:
Risk sharing: Participants pool their funds together to create a collective pool of resources that can be used to provide financial protection for members against specified risks.
No interest: Takaful prohibits the payment or receipt of interest, which is considered haram (forbidden) in Islamic finance.
Mutual cooperation: Takaful emphasizes the principles of mutual cooperation and mutual support, with participants helping each other in times of need.
Profit and loss sharing: Takaful operators may also participate in the profits and losses generated by the pool, which can help to ensure that the interests of both the operator and the participants are aligned.
Social good: Takaful has a strong focus on social responsibility and contributing to the greater good, with some operators dedicating a portion of the funds for social and charitable purposes.
Cooperative structure: Takaful operates as a cooperative or mutual organization, with participants sharing the costs and benefits of the insurance coverage.
Transparency: Takaful is transparent, with clear and open financial reporting, ensuring that participants are aware of the financial status of the pool and the Takaful operator.
Islamic principles: Takaful operates in accordance with Islamic principles, such as fairness, justice, and mutual cooperation, and is based on the principles of the Shariah.
Other Investment Products Sukuk
Sukuk is an Islamic financial certificate that represents ownership in an underlying asset, project, or business venture. The word “Sukuk” is derived from the Arabic language and means “certificate.” Sukuk are similar to bonds in conventional finance, but they are structured to be Shariah-compliant, avoiding activities that are prohibited in Islam, such as interest-based lending and speculation. Instead, Sukuk represents an undivided ownership in the underlying assets, and the returns to investors are generated from the rental or lease income generated by these assets.
The NIFTR 2022 expects that the securities issued under Sukuk are based on the principles of non- interest finance and approved by the Securities and Exchange Commission (SEC). The Sukuk arrangement istreated same way as conventional bonds, and subject to the same provisions provided under the CIT Act (as amended) and CIT (Exemption of Bond and Short Securities) Order 2011. This is so because only Sukuk issued by the Federal government will be exempt from CIT.
Sukuk are used as an alternative form of investment for individuals and institutions seeking to align their investments with their values and beliefs, and are increasingly popular in markets across the world as a way of accessing financing for infrastructure and real estate projects. Some key characteristics of Sukuk include:
Asset-backed: Sukuk represent ownership in an underlying asset, project, or business venture.
No interest: Sukuk are structured to avoid the payment or receipt of interest, which is prohibited in Islamic finance.
Profit and loss sharing: Returns to Sukuk investors are generated from the rental or lease income generated by the underlying assets, with the profits or losses being shared between the investors and the issuer.
to be concluded…
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