Islamic financing and investment structures in Malaysia | Lexology

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Common structures

The following discussion on common structures used by the financial institutions in offering Islamic financial products or financing facilities is based on the BNM SAC’s rulings, which were published in the second edition of Shariah Resolutions in Islamic Finance in October 2010. The rulings must be followed by all local or foreign financial institutions offering such products or services in Malaysia.

i Consumer finance

Deposits typically involve contracts or arrangements under the shariah principle of wadiah, where property is deposited with a financial institution for safekeeping or protection, or mudarabah, which envisages the depositor as investor and the financial institution as entrepreneur, whereby the depositor contributes capital and the entrepreneur contributes expertise and operations. Profit earned is distributed according to agreement, but any losses suffered are borne by the investor.

As such it is permitted for (1) Islamic savings accounts to be established under the shariah principle of mudarabah; and (2) Islamic current accounts to be established under the shariah principles of mudarabah, wadiah and wadiah yad dhamanah.

Under the IFSA, there are two major classifications of products for the acceptance of money from customers, namely (a) Islamic deposits using shariah contracts with principal guaranteed features, applying the shariah principles of wadiah yad dhamanah, qard or murabahah; and (b) Islamic investment accounts using shariah contracts with non-principal guaranteed features, applying the shariah principles of mudarabah, musharakah or wakalah.

Given the above, investment accounts would not constitute debt obligations owed by the financial institution to its depositors, whereas in the case of Islamic deposits, whether the same constitute debt obligations owed by the financial institution to its depositors would depend on whether the financial institution’s obligation to fully repay is based on a debt obligation, such as in the case of accounts opened under the shariah principles described at (a) above. This duality also enables customers with higher risk appetites to place their funds in investment accounts that will in turn receive higher returns depending on the performance of the underlying portfolio. This is also a new source of funding that may be utilised by financial institutions to fund more entrepreneurial business opportunities.

Islamic credit cards are offered using two shariah concepts, namely bai al inah and wadiah. Two separate contracts must be entered into under the concept of bai al inah for sale and buy-back transactions of an asset. Financial institutions will sell an asset at a nominal value plus profit to the customer with an agreed deferred payment term and the customer will subsequently sell the same asset to the financial institution at a nominal value and payable on cash basis. The sale proceeds will be credited into the wadiah account to facilitate the purchases of goods or services by the customer.

The concept of ijarah thumma al-bai is applied in vehicle financing and involves two independent contracts: the ijarah contract and the al-bai contract. Under the ijarah contract, the financial institution will appoint the customer as an agent to purchase the vehicle identified by the customer and the former will then lease the vehicle to the latter for a specified period. The customer has the option to purchase the vehicle from the financial institution upon the expiry of the lease period. An al-bai contract will be entered into should the customer opt to purchase the vehicle.

ii Home finance

The principle of bai bithaman ajil (BBA) is commonly used in Islamic home financing facilities. BBA contracts are contracts of sale and deferred payment where a home is sold on a deferred payment basis at an agreed selling price that consists of the actual cost of the home and the profit margin agreed between the financial institution lender and the customer borrower.

Under BBA home financing, the agreed payment instalments remain fixed throughout the financing period as the selling price is fixed at the outset and the financing is not tagged to base lending rates. The latest Islamic home financing products allow customers to receive ibra (a rebate) on the monthly instalment amount if the home financing is linked to a mudarabah deposit account as long as the cost associated with the ibra is borne solely by the financial institution.

In addition, the concepts of ijarah mawsufah al-zimmah and musharakah mutanaqisah are used to finance homes that are still under construction. Based on the contract of musharakah mutanaqisah, both customer and financial institution share the rights over the home under construction. The financial institution will then lease its portion to the customer under the contract of ijarah mawsufah al-zimmah. The customer is required to pay advanced rent during the construction period of the home and will continue to pay full rent upon completion of the home.

iii Takaful

In Malaysia, takaful involves contribution of money based on the tabarru concept (voluntary contribution) by all takaful participants who agree to relinquish all or part of their contribution as donation to aid other takaful participants who suffer losses or difficulties. This is originated from the concept of ta’awun (mutual assistance). A takaful company will then be appointed as their agent to manage the takaful fund and will in return receive commission of fixed service fee under the wakalah contract. A retakaful business model based on tabarru and wakalah or based on the wakalah model with the element of wakaf is permissible.

iv Islamic private equity investments

The common structures used for shariah-compliant private equity or venture capital are musharakah, mudarabah and wakalah. The first Islamic venture capital fund established in Malaysia was based on the concept of musharakah, a risk-sharing partnership. In this partnership, the ratio of distribution of profits need not coincide with the ratio of participation in the financing of the business activity but all parties bear the loss in proportion to their share in financing in the event of loss.

The requirements for the registration of corporations undertaking Islamic venture capital and Islamic private equity activities are provided for in the Guidelines on the Registration of Venture Capital and Private Equity Corporations and Management Corporations dated 9 March 2015. Under these Guidelines, an applicant who wishes to undertake Islamic venture capital or private equity activities must appoint a shariah adviser to provide shariah expertise and guidance on all matters pertaining to the Islamic venture capital or private equities activities and ensure that all aspects of the activities are in accordance with shariah requirements, including resolutions issued by the SC SAC. In the case of investment in securities of any venture corporation by the registered corporations undertaking Islamic venture capital or private equity activities, the activities of the venture corporations must be shariah-compliant.

v Islamic real estate investment trusts

Malaysian Islamic real estate investment trusts (REITs) are governed by the SC but will also fall under the purview of Bursa if they are listed on the stock exchange. The SC revised the Guidelines on Real Estate Investment Trusts on 15 March 2018 (the Guidelines on REITs). and issued the Guidelines on Listed Real Estate Investment Trusts on 15 March 2018 (the Guidelines on Listed REITs) in relation to listed REITs.

Currently the number of listed Malaysian Islamic REITs remains at four as at 30 May 2019. These Islamic REITs specialise in different classes of assets and are as follows:

  1. Al-‘Aqar’ Healthcare REIT (healthcare);
  2. Al-Salam Real Estate Investment Trust (shariah-compliant properties that include retail, office, food and beverage, which consists of restaurant and non-restaurant outlets);
  3. AXIS-REIT (office buildings and industrial properties); and
  4. Kuala Lumpur City Centre (KLCC) REIT (first shariah-compliant stapled REIT where the existing shares of KLCC Property Holdings Berhad are stapled together with the units of KLCC’s three prime properties, namely Petronas Twin Towers, Petronas Tower 3 and ExxonMobil Tower).

In addition, the current Guidelines on REITs allow for the establishment of unlisted REITs. Malaysia also has its first shariah-compliant unlisted REIT, the ALPHA REIT of 2017, dealing with purely education-related properties.

For Islamic REITs, tangible assets will be acquired and rented out or leased to generate profits for the investors based on an ijarah contract. The owners of real estate sell assets to the Islamic REITs and a back-to-back asset lease arrangement will be entered into simultaneously. This helps to mitigate risks as an income stream is secured and the issue of securing a long-term tenant or buyer is solved.

Under these Guidelines, a shariah advisory committee must be established to oversee the shariah compliance of the REIT’s operations. The rental of real estate by I-REITs is permissible provided that the property is not used for non-permissible activities. Takaful schemes must be purchased to insure real estate and conventional insurance schemes can only be allowed if the former is unable to provide insurance coverage.

vi Investment funds

The shariah principle of musharakah, a joint venture profit and loss sharing arrangement, is commonly applied in investment and financing activities in Malaysia to provide working capital financing, trade financing and asset financing. There are two commonly used forms of musharakah-based financing: (1) a joint venture partnership where the facility sums will be credited (in a lump sum or in stages) into a joint account that is registered under the customer’s name but is managed by the financial institution in accordance with the musharakah principle; and (2) equity participation through establishment of a private limited joint venture company where the company’s management will be appointed by both parties to represent their interests and will be responsible towards the development of a project. For the second form of musharakah-based financing, the financial institution will disburse the facility sums in one lump sum through additional paid up capital of the private limited company. These financing approaches are allowed provided that there is no element of capital or profit guarantee by any of the partners on the other partners.

Further to the above, the shariah principle of istisna (a type of sale contract where a subject matter is transacted before it comes into existence) is commonly used to finance construction and manufacturing activities in Malaysia. According to istisna, the financial institution enters into an agreement to purchase the project or asset to be developed from the customer (istisna – purchase by order) and will immediately sell it back to the customer at a marked-up price under the principle of al-istisna (sale by order). The purchase price will only be released by the financial institution upon presentation of the requisite documents (such as a valid architect’s certificate) whereas the customer is required to settle the selling price by way of instalments within the agreed period or by redemption exercise. The BNM SAC has previously ruled that a conventional bond can be used as a security for financing of this type as it is not made for the purpose of ownership, but merely as a security.

vii Other areas – Islamic financial derivative instrumentsForward foreign currency exchange transactions

The concept of wa’d is widely used by the financial institutions to conduct forward foreign exchange transactions, whereby one of the parties to the contract promises to buy from or sell to the other counterparty a specific currency at an agreed exchange rate and settlement date. Aside from wa’d, BBA is also allowed to be used as the underlying concept for forward foreign currency exchange transactions as all the deferred payment sale transactions are conducted independently and not related to each other. The unilateral wa’d mulzim (binding promise) is permissible to be applied in a forward foreign exchange transaction as it is treated as a promise.

Islamic profit rate swap based on bai al inah

The shariah contract of bai al inah is used for Islamic profit rate swap (IPRS), and depending on the duration of the swap contract, there are several stages involved in this contract.

First, the financial institutions representing the swap counterparties jointly invest in a mudarabah interbank investment (MII) whereupon this investment will be used as the underlying asset in the swap transaction. The financial institutions will enter into an IPRS agreement with a third party to conduct a series of trade transactions on agreed dates (e.g., semi-annually during the swap contract period, which in this instance shall be assumed to be two years).

Second, the financial institutions will sell the MII to the third party at a deferred sale price payable every six months (i.e., semi-annually) and the third party will thereafter sell it back to the financial institutions at a sale price based on the fixed profit rate agreed in the swap contract. The settlement of the purchase price due from the third party will be offset against the payable amount due from the financial institutions, which results in the financial institutions being obliged to pay the fixed profit rate to the third party every six months during the two-year period. Third, the financial institutions will sell the MII to the third party at the price agreed in the swap contract, which is based on the prevailing floating profit rate and the third party will thereafter sell it back to the financial institutions at this agreed price.

The settlement of the purchase price due from the third party will again be offset against the payable amount due from the financial institutions and thus the financial institutions will only be required to pay the floating profit rate for every six months for the two-year contract period.

The difference between payment obligations of both contracting parties resulting from the final step at the second stage and the final step at the third stage will be paid to the receiving party. Finally, the third stage will be repeated at the agreed reset date, which will be determined every six months until the swap contract matures. This arrangement is allowed and the issue of sale of debt with debt (which is prohibited by shariah) does not arise as the transfer of beneficial ownership takes place automatically given that the underlying asset used in the transaction is the MII. The transfer will be reflected in the contract documentation and is shariah-compliant.


Both conventional and Islamic financial products are governed under the same taxation regime. However, tax incentives are offered from time to time by the Malaysian government to encourage growth in the Islamic finance sector and facilitate Malaysia’s aim towards becoming the regional Islamic finance hub. Some of the most significant and recent tax incentives are as follows:

i Malaysian Budget

The existing tax incentives announced under the Malaysian Budgets in 2016, 2017, 2018 and 2019 respectively comprise the following:

  1. companies enjoy single deduction on additional expenses incurred for the issuance of sukuk under the principles of ijarah and wakalah and enjoy double deduction on additional expenses incurred for the issuance of sukuk under the principles of mudarabah, musharakah, istisna, murabahah and BBA based on tawarruq until 2020;
  2. companies that issue sustainable and responsible sukuk will benefit from a tax deduction on their issuance costs until 2020;
  3. companies that provide shariah-compliant fund management services and are certified by the SC will also enjoy a tax exemption on statutory income from the provision of such services until 2020;
  4. recipients of green sustainable and responsible investment (SRI) sukuk grants enjoy income tax exemption for the purpose of financing the external review expenditure until 2020;
  5. investors enjoy stamp duty exemptions on contract notes for trading of exchange-traded funds and structured warrants until 2020;
  6. the fund manager managing an SRI fund approved by the SC will be given tax exemptions on management fee income from managing conventional and shariah-compliant SRI funds until 2020 to further promote fund management activities globally; and
  7. the following tax incentives that were provided pursuant to the MIFC Initiative from 2007 to 2016 have been further extended until 2020:
    • full tax exemption on income earned from Islamic banking business or takaful business conducted through the International Currency Business Unit in foreign currencies by licensed financial institutions or licensed takaful companies and takaful units; and
    • full stamp duty exemption on instruments executed pertaining to the above-mentioned activities.

Tax allowances and exemptions made under previous years’ budgets are discussed in Section VI.

ii Malaysian Income Tax Act 1967

While Section 2(7) of the Malaysian Income Tax Act 1967 (ITA) provides that any reference in the ITA to interest shall apply to gains or profits received and expenses incurred, in lieu of interest, in transactions conducted in accordance with shariah principles, Section 2(8) of the ITA provides that any reference in the ITA to the disposal of an asset or a lease shall exclude enabling transactions under a scheme of financing approved by BNM, the SC, the Labuan FSA or the Malaysia Co-operative Societies Commission.

iii Malaysian Stamp Act 1949

Sukuk issuances currently enjoy stamp duty exemptions in Malaysia by way of orders issued under the Malaysian Stamp Act 1949, which include the following: (1) Stamp Duty (Exemption) (No. 23) Order 2000, which provides that all instruments relating to the issue of, offer for subscription or purchase of, or invitation to subscribe for or purchase, debentures approved by the SC under Section 32 of the Securities Commission Act 1993 and the transfer of such debentures are exempted from stamp duty; and (2) Stamp Duty (Exemption) (No. 4) Order 2013, which provides that an instrument relating to the sale and purchase of retail sukuk as approved by the SC under the CMSA are exempted from stamp duty.

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