It may also have something to do with the ambition of the country to develop Cape Town into an international financial hub, an ambition which was confirmed by Alan Winde, the finance minister of the provincial government of the Western Cape; and South Africa’s aim of attracting inward foreign direct investment (FDI) from the Middle Eastern countries and others such as Malaysia and Brunei.

A clear-cut statement of intent came from the South African National Treasury at the time of the announcement of the intention to introduce the tax neutrality measures: “The development of Islamic finance in South Africa is critical to the expansion of National Treasury's strategy to position South Africa as a gateway into Africa. The treasury envisages South Africa being a central hub for Islamic product development and ensuring the rollout of such products into African markets.”

Given that Islamic finance has been around in South Africa since 1989 when Albaraka Bank South Africa, now a joint venture between the Saudi-owned Albaraka Banking Group and UK-based DCD London & Mutual PLC, was licensed, Islamic finance was a mere niche curiosity, which the South African authorities tolerated more for political reasons and the white-controlled media treated with cynicism and suspicion.

In fact the South African Reserve Bank (SARB) had licensed another bank called Islamic Bank Limited following the collapse of Apartheid in the early 1990s and which was managed by a Muslim member of the ruling South African government party, the African National Congress (ANC). The license was a controversial one given that the promoters had very little experience of banking per se let alone Islamic banking. Not surprisingly, the bank collapsed after only a few of years of operations with serious allegations of mismanagement and fraud which left Muslim investors livid and cynical about Islamic finance, from which the South African market is only now recovering after two decades. In fact, the liquidation of Islamic Bank Limited is still not completed after all this time.

Nevertheless, South Africa like Malaysia, Egypt and Britain has also been a laboratory for the contemporary Islamic finance movement, albeit in the form of Jame Limited, a small Shariah-compliant cooperative and credit union, which was established in the 1980s well before the likes of Albaraka and Islamic Bank Limited. South African firms such as Columbus Steel were some of the first in the world to access Islamic corporate finance then arranged by Kleinwort Benson in London in the 1980s.

But with the spectacular growth of Islamic finance globally over the last decade or so with total assets currently under management estimated between $900 billion to $1.2 trillion and the presence of a 3 million and relatively affluent Muslim minority, the South African government has been forced to take more notice of this development. Similarly, the International Monetary Fund (IMF), the World Bank, the IFC (International Finance Corporation), the Asian Development Bank and even the African Development Bank are all promoting Islamic finance as an option in their dealings with Muslim countries which has resulted in them launching sukuk (Islamic certificates) and funds to finance their activities in these countries.

The fact that Mauritius is also promoting itself as an offshore banking centre including for Islamic capital market products has also stirred Cape Town into action. Moreover, the success of new entrants such as the Oasis Group, a fast-growing asset management company which now has a stable of over 40 Shariah-compliant funds under its Crescent label, and the Islamic banking windows of the banking majors such as ABSA, FNB, Standard Bank and Nedbank, has been another major factor in the new financial inclusion policy of the National Treasury with respect to Islamic finance.

South African Finance Minister Pravin Gordhan, introducing the Taxation Laws Amendment Bills 2010 in the National Assembly in Cape Town on Aug. 24, 2010, gave some insight into the government’s rationale for the tax changes relating to Islamic financial products.

“South Africa is an ideal location for multi-nationals to base their regional operation for investments into sub-Saharan Africa. South Africa offers world-class financial services, strong and clear financial regulatory architecture and world-class infrastructure … Certain domestic tax anomalies, the exchange control regime and fierce competition from certain low tax countries, remain stumbling blocks to South Africa taking full advantage of the opportunities that are available.

“To remedy this situation, the proposed amendments remove various tax hurdles that a multinational company would face if it based its regional headquarter in South Africa. Another important area of innovation relates to the growing use of Islamic financing, which contains certain prohibitions in respect of finance, including prohibitions against interest, immoral substances and the lack of transparency in respect of investments. At issue is the tax system’s lack of recognition of Islamic finance, as it mainly focuses on traditional forms of finance. The proposed amendments will level the playing field in respect of certain Islamic financial products when undertaking savings and investments and when attempting to bank finance,” explained Gordhan.

The tax system does not currently cater for Islamic financing, thereby hindering the growth of South African financial service activities in this regard. The proposed amendments seek to place Mudaraba, Murabaha and Diminishing Musharaka on an equal tax footing with conventional finance products. One benefit of the proposal, says the National Treasury, “is to provide Islamic savings products with the R22,300/R32,000 exemption for interest available to traditional savings products.”

There are also further proposed amendments relating to Diminishing Musharaka, which is commonly used in Islamic home financing or mortgage products. The amendments propose the abolition of the double stamp duty (property transfer tax) which is implicit in the Islamic contract because it involves the transfer of title at the front and back end of the scheme. In the UK, for instance, HM Treasury has done away with the double tax stamp duty on the basis that the net economic effect of the Diminishing Musharaka is similar to that of a conventional mortgage, albeit that the Islamic scheme involves two transfer contracts, and as such it would be unfair to punish the Islamic contract with a double tax.

Local Islamic bankers stress that the new measures when adopted would result in greater product innovation and choice; and in lowering the development costs and cost of capital for Islamic financial products. South African Muslims have long been complaining that Islamic financial products in their local market were not as competitive as their conventional counterparts, especially in a country that already boasts the highest banking charges in the developed world.