RMC No. 35-2022: Prescribes the tax treatment of Murabahah (Profit Disclosed Sale) and Tawarruq (Commodity Murabahah) as Islamic Banking Arrangements pursuant to the tax neutrality provision of RA No. 11439 (An Act Providing for the Regulation and Organization of Islamic Banks) and as implemented by RR No. 17-2020

Key points

1. Basis and general rule. Section 14 of RA No. 11439 seeks neutral tax treatment between Islamic banking and equivalent conventional transactions. Under Section 4.3 of RR No. 17-2020, references to interest cover gains or profits received and expenses incurred in Islamic arrangements, and these gains or profits are subject to tax.
2. Murabahah financing. The Islamic Bank or Islamic Banking Unit (IB/IBU) buys an asset and sells it to the client at cost plus an agreed profit margin, payable on a deferred lump sum or installment basis. Its economic substance is equivalent to a conventional mortgage loan.
3. Tax treatment of Murabahah. The IB/IBU’s gains or profits are subject to regular income tax and gross receipts tax, using the effective profit method. The client’s payments are not subject to withholding tax unless the payor is a top withholding agent, and the instruments are subject to DST. Transfer of real property from the vendor to the IB/IBU is subject to CGT or CWT and VAT, if applicable, plus DST, while transfer from the IB/IBU to the customer is exempt from CGT, CWT, VAT and DST under RR No. 17-2020.
4. Other assets. The same structure may apply to purchases of other assets, such as cars or industrial machinery, with similar tax treatment. The relevant indirect tax is normally VAT, and VAT on the vendor’s sale of a car to the IB/IBU is reimbursed by the customer.
5. Tawarruq financing. The customer buys a commodity from the IB/IBU at a deferred mark-up price, then sells it to a third party at a lower spot price to get cash. It is equivalent to a conventional cash line facility, with gains subject to regular income tax and gross receipts tax, no withholding tax on payments unless the payor is a top withholding agent, and DST on the instruments. Supply of the commodity and services is ignored for tax purposes under RR No. 17-2020.
6. Reverse Tawarruq. Commodity Murabahah may also replicate a term deposit, with the same tax treatment. The bank’s gains or profits are subject to regular income tax and gross receipts tax, and the depositor’s gains or profits are subject to final withholding tax, which does not apply when the instrument’s maturity exceeds five (5) years.

Who is affected

• All banks, including Islamic Banks and Islamic Banking Units of conventional banks
• Non-bank financial intermediaries performing quasi-banking functions
• Other non-bank financial intermediaries
• Internal revenue officers and employees