Abstract:
The operation of Interest free banking (IFB), the banking industry known for its important
role in facilitating financial inclusion, is highly affected by tax laws challenges in the legal
system where it is new. It was introduced in Ethiopia before a decade and many of Ethiopian
tax laws were not formulated in the context suitable for its governance. This paper analyse
taxation of IFB services under different taxation approaches and the tax systems of United
kingdom, Malaysia and Kenya with the aim to draw lesson for Ethiopian Income tax law,
Stamp duty Law and Value Added Tax law. In doing so, by analysing the experience of these
jurisdictions with existing Ethiopian income tax law, Stamp duty law and VAT law, this
doctrinal research has investigated legal gabs under income tax, stamp duty and VAT laws of
Ethiopia on taxation treatment of IFB services. The study shows that Ethiopian income tax
law is not clear on whether the return from diminishing musharaka, Istisna and salam
services is treated as interest for income tax purpose. The paper also identified as imputed
income is assessable income under ITP it poses challenge to the customer using diminishing
musharaka service. In addition, this study pinpointed Ethiopian stamp duty law as the law
placing challenge on IFB services by imposing double taxation on the transactions under
services such as murabaha, diminishing musharaka, ijara, Istisna and salam. Further, it
explores that the presence of more transactions in diminishing musharaka, Ijara, istisna and
salam services give rise to more VAT payment as VAT is to be assessed at every stage of
transaction. The prevailing Ethiopian VAT law taxes the financial cost deserved exemption
under Ijara thumma-al-Bay when compared with conventional counterpart. Thus, the paper
suggests that income tax law, stamp duty law and VAT should be reconsidered to remove
unclarity, double taxation and extra VAT payment in identified IFB services. Finally, it
provides conclusions and recommendations.
