This is reminiscent of a microcosm of Malaysia’s strong inclusion of the role of Islamic finance, especially sukuk issuance, in the country’s economic transformation program (ETP), and its latest Five-Year Development Plan, which was announced by Prime Minister Mohd Najib Tun Abdul Razak during his budget 2011 speech and at the launch of the ETP in November 2010. Malaysian Government-Linked Companies (GLCs) under the program are required to increase their investments through Islamic finance structures and to venture cross-border with the aim of developing a diversified and enhanced returns strategy.

Islamic finance facilitation, albeit a niche objective, fits in with Japan’s new growth strategy in other ways as well. A key role of the financial strategy, according to Japan’s Financial Services Agency (FSA), the banking regulator, “is to support the real economy. Amidst the low birth rate, the increasingly aging society, and the economy’s low growth rate, the financial sector is expected to provide more solid support to the real economy and enterprises by providing suitable investment opportunities to the household sector and diverse fundraising methods to enterprises.”

Because of the proscription on riba (interest), maisir (financial speculation — gambling) and gharar (full disclosure in financial transactions), Islamic finance is considered to impact on the real economy in a much more productive way. Also, Islamic finance transactions have to be backed by real and tangible assets.

A further fit with Islamic finance is in the additional mandate of the FSA through the financial strategy which concentrates on three pillars including developing supply and sources of funds to Japanese companies; requiring the financial sector to serve as a bridge between Asian and Japanese economies; and the provision of asset management capabilities “to utilize Japanese national assets safely and effectively.”

Equally important under the new financial strategy is the “vitalization of the corporate bond market” in Japan to strengthen the financial and capital markets through dispersion and diversification of financing methods of private companies as well as expansion of investment opportunities.

The FSA in a statement confirmed that it “will actively support initiatives by market participants to stimulate the corporate bond market, focused on the review of underwriting examinations by securities companies; granting of covenants and information disclosure; corporate bond management and the development of infrastructure for disseminating corporate bond price information.”

To facilitate "changes of the tax system for cross-border transactions" Japan’s FY2011 tax system reforms incorporates “tax reforms necessary for Islamic finance, and tax reforms necessary for securities lending.” These, says the FSA, aims to encourage foreign investors to participate in Japan’s financial and securities markets.

In August 2010, the FSA published its “FY2011 request items for tax revisions,” and submitted it to the Japanese Ministry of Finance and Ministry of Internal Affairs and Communications for approval and adoption. This document is based on the “new growth strategy — blueprint for revitalizing Japan” and requested tax measures to be adopted with the aim of achieving a “new financial market-based nation.”

The main specific request Items includes tax reforms necessary for Islamic finance and for securities lending. The FSA under the new growth strategy will also promote the “development of the environment for Islamic bond issuance in Japan.” Regarding tax principles for non-residents and foreign corporations, the FSA is studying specific actions with tax authorities, in the direction of revisions from the “entire income principle” to the “attributable income principle.”

Other related items in the document include the introduction of necessary changes in the tax treatment of quasi-bond beneficiary rights usable as Islamic bonds, including, for example: i) eliminate withholding income tax on dividends of quasi-bond beneficiary rights, received by overseas investors; ii) and eliminating registration license tax and real estate acquisition tax related to buyback of trust property by the fundraiser, for issuance schemes of quasi-bond beneficiary rights.

The measures are expected to be adopted by the Japanese Cabinet earlier than later in 2011. Japanese bankers stress that there is definitely a need for tax reform relating to Islamic finance products to create a level playing field as for the treatment of equivalent conventional products. The status quo, according to one Japanese banker, is that Islamic investors can invest only in equity type of Islamic bonds, since they are prohibited from receiving interest for the religious reason. In major countries, dividends of Islamic bonds (equity type) received by foreign investors are not subject to tax, while they are subject to tax in Japan.

Japanese financial institutions active in the Islamic finance such as Nomura, Daiwa, Japan Bank for International Cooperation, Mitsui, Mitsubishi, Sumitomo and others, would like to see the Financial Services Agency making dividends of quasi-bond beneficial interests (“QBIs”) of special purpose trusts received by foreign investors tax-exempt. “Quasi-bond beneficial interests,” according to one Japanese banker, means a type of beneficial interest to receive a certain predetermined amount. In a legal context, they correspond to an equity in which Islamic investors can invest. Currently, interest of bonds received by foreign investors is not subject to tax.

They stress that the FSA’s proposal contains three important aspects. It would be the first measure on Islamic finance products in the Japanese legal system; it would be the first measure on taxation of Islamic financial transaction in the Japanese legal system; and the proposal is targeted to make sukuk issuance possible although it can be used for conventional transactions as well.