Islamic Banking in the Philippines: License Requirements and Sukuk Tax Rules

Islamic banking in the Philippines is governed by Republic Act No. 11439, which allows the Monetary Board to authorize Islamic banks, Islamic banking units of conventional banks, and foreign Islamic banks. An Islamic bank is licensed and regulated in the same manner as a universal bank, must meet the capitalization required of a universal bank, and must constitute a Shari'ah advisory council. On sukuk, the tax neutrality rule in Section 14 applies: gains or profits are subject to a 20% final withholding tax if maturity is less than five years, while sukuk maturing in five years or more are exempt from income tax.

How an Islamic bank is authorized in the Philippines

Under Section 3 of R.A. 11439, the Monetary Board may authorize the establishment of Islamic banks. It may also authorize conventional banks to engage in Islamic banking arrangements through a designated Islamic banking unit, provided the bank maintains a system for segregating the unit's transactions from its conventional banking business.

Foreign Islamic banks may also enter. The Monetary Board may authorize them to establish Islamic banking operations in the Philippines under the modes of entry provided in Republic Act No. 7721, the law liberalizing the entry and operations of foreign banks. The Monetary Board may regulate the number of participants in the Islamic banking system, considering the needs of the economy, the stability of the system, and healthy competition.

The Bangko Sentral ng Pilipinas exercises regulatory powers and supervision over Islamic banks and issues the implementing rules and regulations on Islamic banking, as provided in Section 4.

Licensing standards and capitalization

Section 10 states that Islamic banks shall be licensed and regulated in the same manner as a universal bank. The Bangko Sentral prescribes prudential regulations and standards covering capital adequacy, liquidity, corporate governance, risk management, related party transactions, maintenance of reserve funds, prudential reporting, investment ceilings, prevention of unlawful use, and consumer protection.

On ownership, Section 7 provides that Islamic banks must comply with laws applicable to a private corporation engaged in banking, such as the Corporation Code, and that their capitalization requirements are equal to those prescribed by the Bangko Sentral for a universal bank.

Section 8 requires prior Monetary Board approval before any person acquires shares resulting in ownership or control of more than ten percent (10%) of the voting stock of an Islamic bank. Without that approval, the transfer has no legal effect and cannot be recognized in the bank's stock and transfer books or in government records.

Section 9 directs the Monetary Board to prescribe, pass upon, and review the qualifications of directors and officers, and to disqualify those found unfit under the fit and proper rule.

The Shari'ah advisory council requirement

Section 5 makes it the responsibility of an Islamic bank to comply with Shari'ah principles. For this purpose, the bank must constitute a Shari'ah advisory council composed of persons qualified in Shari'ah or with knowledge or experience in Shari'ah and in banking, finance, law, or related disciplines. The council renders advice and reviews applications of Shari'ah principles, but does not involve itself directly in the bank's operations or engage in any activity that may give rise to a conflict of interest. The law also allows the establishment of a centralized Shari'ah Supervisory Board.

What Islamic banks may offer, including sukuk

Section 6 lists the banking services Islamic banks may perform, including accepting current, savings, and investment accounts, accepting foreign currency deposits, providing Shari'ah-compliant financing contracts and structures, and undertaking investments allowed by Shari'ah principles.

With prior Monetary Board approval, Islamic banks may issue investment participation certificates, sukuk, and other Shari'ah-compliant funding instruments for use in their operations or capital needs. They may also carry out financing and joint investment operations through mudarabah partnership, musharakah joint venture, murabahah cost-plus financing, ijara leasing, istisna'a construction and manufacture arrangements, and other Shari'ah-compliant contracts.

How sukuk gains and coupons are taxed

Section 14 of R.A. 11439 provides for tax neutrality: the Government shall endeavor to achieve neutral tax treatment between Islamic banking transactions and equivalent conventional banking transactions within the provisions of the National Internal Revenue Code of 1997. Revenue Regulations No. 17-2020 implements this by requiring that Islamic banking transactions be taxed no more heavily and no more lightly than conventional banking transactions, with references to interest construed as references to profits and losses.

Under the tax neutrality framework, gains or profits realized by sukuk holders from sukuk with a maturity of less than five years are subject to a 20% final withholding tax, while those with a maturity of five years or more are excluded from gross income and exempt from income tax. For pre-termination, the entire gain is subject to final withholding tax at rates based on remaining maturity: 5% for four years to less than five years, 12% for three years to less than four years, and 20% for less than three years. Gains of non-resident aliens not engaged in trade or business in the Philippines and non-resident foreign corporations are subject to 25% final withholding tax.

The sukuk issuer withholds the tax at every payment of gains or profits and for purchases of assets, whether directly from a supplier or through an agent. Gains realized by the originator or obligor, arranger, manager, and underwriter are subject to regular income tax and value-added tax or percentage tax, whichever applies. Gains of the special purpose vehicle are subject to regular income tax but exempt from VAT.

Any disposal or lease of the underlying asset, and execution of any additional instrument required in a sukuk transaction for Shari'ah compliance but not required in a conventional bond transaction, is deemed excluded for taxation purposes. A documentary stamp tax is imposed on sukuk instruments under the documentary stamp tax provisions of the National Internal Revenue Code of 1997, as amended.

Frequently asked questions

Do I need a separate license to put up an Islamic bank in the Philippines? Yes. The Monetary Board must authorize the establishment of an Islamic bank, and under Section 10 the bank is licensed and regulated in the same manner as a universal bank, with capitalization equal to that required of a universal bank.

How much tax is withheld on sukuk profits? Gains on sukuk maturing in less than five years are subject to 20% final withholding tax; those maturing in five years or more are exempt from income tax. Pre-terminated sukuk are taxed at 5%, 12%, or 20% depending on remaining maturity.

Can a conventional bank offer Islamic banking products? Yes. Under Section 3, a conventional bank may engage in Islamic banking through a designated Islamic banking unit, provided it segregates the unit's transactions from its conventional banking business.

Practical takeaways

• The Monetary Board authorizes Islamic banks, Islamic banking units, and foreign Islamic banks entering under R.A. 7721.
• Licensing and capitalization follow the universal bank standard, plus a Shari'ah advisory council is mandatory.
• Sukuk issuance requires prior Monetary Board approval; gains are taxed at 20% below five years and exempt at five years or more.
• Sukuk instruments are subject to documentary stamp tax under the Tax Code.
• Acquiring more than 10% of an Islamic bank's voting stock needs prior Monetary Board approval to have legal effect.

Primary sources

The rules discussed above are drawn from the following primary sources. Where the firm's library holds the document as a PDF it is embedded here in full; the rest are cited by title.

RMC No. 81-2024 — Tax Treatment of Sukuk (Islamic Bond) as Islamic Banking Arrangement Pursuant to the Tax Neutrality Provision of Republic Act No. 11439 (An Act Providing for the Regulation and Organization of Islamic Banks) as Implemented by Revenue Regulations No. 17-2020Open in Law LibraryDownload PDF

• REPUBLIC ACT NO. 11439 - AN ACT PROVIDING FOR THE REGULATION AND ORGANIZATION OF ISLAMIC BANKS (REPUBLIC ACT No. 11439)

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.