Hong Kong Eases Tax on Islamic Bonds

Hong Kong's Inland Revenue Department has issued its Interpretation and Practice Notes on the Inland Revenue and Stamp Duty Legislation (Alternative Bond Schemes) (Amendment) Ordinance 2013, which was enacted in July 2013, and which gave effect to tax and stamp duty relief for transactions underpinning the issuance of sukuk (Islamic bonds).

Shariah law precludes the payment or receipt of interest. As a result, the issuance of sukuk involves more complex structures to achieve a similar Shariah-compliant outcome as conventional bond issues, often using special purpose vehicles and multiple asset transfers. Without concessionary provisions for sukuk, their issuance may attract additional profits or property tax exposure, or stamp duty charges.

The Government had observed that other jurisdictions, such as Malaysia, the United Kingdom, Singapore, Japan, and France, have amended their tax laws to facilitate sukuk issuance.  

It has been stressed, however, that the legislation does not confer concessionary treatment for sukuk – classified as an "alternative bond scheme" – but instead seeks to ensure that financial instruments of similar economic substance are afforded similar tax treatment. The amendment is said to establish an equivalent tax regime for Islamic finance arrangements that are economically equivalent to debt arrangements, while also providing stamp duty relief.

Though commonly called Islamic bonds, sukuk are considered, in essence, to be trust certificates backed by Sharia-acceptable assets. The form of the documentation and the issue process are similar to those of an issue of conventional bonds. However, the instrument – rather than being a debt obligation – confers rights on its holders as beneficiaries under a trust of the relevant asset backing the deal.

The holder's return is, therefore, structured as profit derived from their beneficial ownership of the asset, rather than interest accruing on a debt. Many sukuk are therefore economically equivalent to conventional bonds, but some sukuk are non-debt arrangements (e.g. equity instruments).

As an additional matter, the Notes specify that – with alternative bond schemes being regarded as debt arrangements, in spite of their legal form of not being a loan, – the definition of "interest" in the interest article of double taxation agreements entered into by Hong Kong should also be applicable to additional payments and investment return made under sukuk bond and investment arrangements.