A General Review of Modarba Companies:
The Government of Pakistan has been constantly pursuing one of its major economic objectives i.e. the Islamization of all financial transactions in the country. As a major step, the concept of Modaraba was institutionalised in 1980 through the formulation of Modaraba Companies and Modarabas (floatation and control) Ordinance, 1980. Thereafter, the entire ambit of domestic banking and financial activities was brought in line with the tenets of Sharia with effect from January 1, 1985 and the State Bank of Pakistan issued detailed rules and guidelines relating to Islamic mode of finance. One thing which emerged as part of this restructuring was the concept of Ijara (Lease) and thus leasing was granted official recognition as an acceptable Islamic mode of financing.
The overwhelming importance of Modarabas and their significant contribution to the national economy in the areas of leasing, stock market investments, short and long-term financing, trading and manufacturing cannot be ignored. Modarabas account for over 36% of the paid up capital of all listed financial institutions in the country including banks. Nearly 37% of the listed financial institutions in Pakistan are Modarabas. Now let us examine in detail the activities of Modarabas, Leasing Companies and investment Banks in Pakistan.
Modarabas:
Modaraba, an approved mode of Islamic financing is assuming importance in our financial system and has shown a considerable growth over the last few years. Modaraba is a partnership between capital on one side and personal effort on the other. In this system of business proportionate share in the profit is determined by mutual agreement. But the losses are to be borne by the investor of the capital. In Pakistan, the sponsor of a modaraba has to be a company which must be registered under the Modaraba Companies and Modaraba (Floatation and Control Ordinance 1980).
To ensure that only sound Modaraba are floated and their management is proper, the government has restricted the registration of general purposes Modarabas with banks, financial institutions and investment companies only. The capital of modarabas is only subscribed through public floatation. The certificates issued by the companies are listed in the stock exchanges of the country.
The new rules disallow second modaraba unless the performance of the first one has been satisfactory for three years. The operation of modarabas in Pakistan is strictly scrutinised and monitored by the Corporate Law Authority (CLA) as well as the State Bank of Pakistan (SBP).
These companies are periodically audited by statutory auditors who are approved by CLA. In addition, CLA picks five modarabas each year at random to conduct special audit by a different group of auditors than the statutory one.
State Bank of Pakistan is also arranging a special audit primarily to check the health of the assets and internal controls scope of business activity.
The Modaraba due to its legal structure and operative framework can theoretically undertake any business activity prescribed by Shariah and highlighted by dynamic competitiveness and acumen of its fund managers. Modaraba being a mode of transaction and business is not without influence of the general business practices in Pakistan. However, Modaraba cannot carry on any business which is repugnant to the Islamic injunctions. The business as generally understood, is an activity for profit and therefore it has to be governed and managed accordingly. Great deal of inconsistency prevails because fabric of laws, social practices and the values are not entirely in conformity with Islamic sharia.
Modaraba Industry in Pakistan, serving as an impetus for its rapid acceptance and development as an effective and prospective alternative to riba, free financing. This is the reason that within a decade notwithstanding the challenges of already deeply entrenched interest-based financing system, fiscal restraints and geopolitical constraints the number modaraba companies have mushroomed over 50 in the country.
Floatation:
For floating a Modaraba, first of all, there must be a Modaraba Management Company, known as Manager of the Modaraba or "Modaraba Company". The company may be registered under Companies Ordinance 1984. After incorporation as Joint Stock Company, it is to be registered as Modaraba Company with the Registrar of Modarabas, Islamabad. Once registered as a Modaraba Company by the Registrar of Modarabas, it can float any number of Modarabas subject to the recent requirement of three years satisfactory performance. For creating and managing Modaraba, inter alia, the Modaraba Company has to prepare a business plan and prospectus containing various information as required in 4th schedule of the Modaraba ordinance, which is to be cleared by the Religious Board appointed for the purpose.
In case of Modaraba companies applying for listing on stock exchange 50% of the total paid up capital shall be subscribed by the sponsors or their associate or friends, relatives and associated undertakings and balance of 50% shall be offered to the general public including NIT. Modaraba cannot be floated with a paid-up capital of less than 2.5 million. Laws in Pakistan permit banks to register themselves as a modaraba company for the floatation of their own modarabas. With some initiative, this offers a unique opportunity to banks in Pakistan to diversify into new areas of business play an active and innovative role in the economic development of the country.
Future of Modaraba:
The government policy of privatization and deregulation of economy and easing of fiscal and banking regulations have opened new avenues of investment and diversification for the financial sector.
In this context the modarabas along with the investment finance bank will play a pivotal role in strengthening and developing the capital market activities and to establish the confidence of investors.
The Modaraba, undoubtedly is an important and useful element of our financial structure and the investors are keen to put their money in modaraba primarily because of the fact that their business is in conformity with the injunctions of Islam.
Leasing:
Leasing is an age old mode of financing as its traces are available even in the period dating back to 5000 B.C. but this technique evolved gradually in various parts of the world. In 1950s' the United States of America pioneered this concept in the modern mode of capital formation, followed by Europe in 1960s'. Japan adopted the technique of lease financing in 1970s' which speeded to Southeast Asian countries and Latin America. In the recent past, we have seen a remarkable interest in development finance shifting from credit to other type of finance providing equity or equity related services, which includes leasing, especially in developing countries.
Now a days Leasing is an extremely versatile mode of financing and is recognized as a major source of funding in many developed countries of Europe, USA and Japan, and as well as in many developing countries of the world including Pakistan. According to World Leasing Year Book 1990, leasing contributes more than US$275 billion to world wide annual capital formation.
Issues Related to Modarba:
The government took a step towards Islamization of the economy (free from Riba) by passing an Ordinance in 1980 and Rules in 1981 for formation of Modaraba companies and floatation of Modarabas. The Modaraba companies act as "Modarib" and are registered under the Companies Ordinance and thereafter, registered with the Registrar of Modarabas as a Modaraba company, subject to satisfaction of the Registrar that applicants are eligible for Registration and that the directors are of sound and reputable background. The Registrar has to satisfy about the business to be undertaken and the investment to be made through floatation of Modaraba. The Federal Government has constituted a Religious Board which is headed by a sitting judge of Lahore High Court, Mr. Justice Khalilur Rehman and consists of Justice Maulana Taqi Usmani and Mr. Mohammad Mahmood Ghazi, a Director of Dawa Academy at Islamabad which examines that the business to be undertaken is not opposed to the injunction of Islam and the Registrar does not permit the floatation of a Modaraba unless the Religious Board has certified in writing that Modaraba business is in accordance with the Sharia. The Modarabas are of two types:-
a) Multipurpose Modarabas i.e. a Modaraba having more than one specific purpose or objective and;
b) Specific Purpose Modarabas i.e. a Modaraba having one specific purpose or objective.
The first Modaraba was formed in 1981 for a specific purpose of disposing of the Twin Towers. This was for a fixed period and was wound-up after the disposal of said Towers. The first multipurpose Modarabas for an indefinite period were floated in 1985 in the name of BRR Modaraba and First Habib Modaraba. In 1987, First Grindlays Modaraba and Modaraba Al-Mali were floated. The success of the Modarabas attracted others in the business and gradually up to 1990, 14 Modarabas were floated. The public were happy that the Modarabas were giving good profit and were also managed within the injunctions of Islam. In addition, section 37 of the Modarabas Ordinance, 1980 held an assurance to investors of distribution of not less than 90 per cent of profits as dividend. Section 37 reads as follows: "Exemption from tax: The income of a Modaraba shall be exempt from tax under the Income Tax Ordinance, 1979 (XXXI of 1979), if not less than ninety per cent of its profits were distributed to the holders of Modaraba Certificates:.
owever, when the Corporate Law Authority and Registrar of Modarabas started giving permission to new Modarabas in quick succession and 19 new Modarabas were floated in 1991, the total number of Modarabas today stands at 46, it created anxiety amongst the public about the future of Modaraba Industry. The multiplication of Modarabas, followed by imposition of 25 per cent tax on the income of the Modarabas after first 3 years of tax exemption, announced in the budget of 1992, took away the glitter of good dividend in future. The levy of tax of 25 per cent on the Modarabas which were assumed to permanently tax free, removed the obligation of payment of 90 per cent dividend to Modaraba Certificate holders.
The tax regime not only applied tax on income but all the other taxes like Turn Over Tax of half per cent and With-holding Tax of 2.5 per cent were also applicable to the Modaraba transactions. It was after great efforts by the Modaraba Associations. It was after great efforts by the Modaraba Assocation of Pakistan and the understanding of the Ministry of Finance that Turn Over Tax was withdrawn from Modaraba Sector. With-holding Tax of 2.5 per cent on Modaraba transactions of the Modarabas was reduced to 1 per cent. Further concession was allowed in the budget of 1993 with two years lower taxation of 12.5 per cent, after three years exemption, and thereafter 25 per cent tax.
The tax problems of the Modaraba are not totally solved so far. The application of Capital Value Tax on purchase of commodities by Modarabas which were tax exempt and were therefore, unable to show an assessment of tax for the Assessment Year 1993 has badly hurt the Modarabas doing Leasing business. They have to pay 5 per cent Capital Value Tax on purchase of any vehicle or machinery for leasing and therefore, Modarabas are losing business to Leasing Companies, which are already under tax net. The With-holding tax of 2 per cent on imports of goods and 2.5 per cent on sale is also adversely affecting the trading of the Modarabas. Representations have been made by the Association to the Finance Ministry and Central Board of Revenue and we still hope that Ministry of Finance will take notice of problems of the Modarabas and help solve these grievances of the Modaraba sector
The Government of Pakistan has been constantly pursuing one of its major economic objectives i.e. the Islamization of all financial transactions in the country. As a major step, the concept of Modaraba was institutionalised in 1980 through the formulation of Modaraba Companies and Modarabas (floatation and control) Ordinance, 1980. Thereafter, the entire ambit of domestic banking and financial activities was brought in line with the tenets of Sharia with effect from January 1, 1985 and the State Bank of Pakistan issued detailed rules and guidelines relating to Islamic mode of finance. One thing which emerged as part of this restructuring was the concept of Ijara (Lease) and thus leasing was granted official recognition as an acceptable Islamic mode of financing.
The overwhelming importance of Modarabas and their significant contribution to the national economy in the areas of leasing, stock market investments, short and long-term financing, trading and manufacturing cannot be ignored. Modarabas account for over 36% of the paid up capital of all listed financial institutions in the country including banks. Nearly 37% of the listed financial institutions in Pakistan are Modarabas. Now let us examine in detail the activities of Modarabas, Leasing Companies and investment Banks in Pakistan.
Modarabas:
Modaraba, an approved mode of Islamic financing is assuming importance in our financial system and has shown a considerable growth over the last few years. Modaraba is a partnership between capital on one side and personal effort on the other. In this system of business proportionate share in the profit is determined by mutual agreement. But the losses are to be borne by the investor of the capital. In Pakistan, the sponsor of a modaraba has to be a company which must be registered under the Modaraba Companies and Modaraba (Floatation and Control Ordinance 1980).
To ensure that only sound Modaraba are floated and their management is proper, the government has restricted the registration of general purposes Modarabas with banks, financial institutions and investment companies only. The capital of modarabas is only subscribed through public floatation. The certificates issued by the companies are listed in the stock exchanges of the country.
The new rules disallow second modaraba unless the performance of the first one has been satisfactory for three years. The operation of modarabas in Pakistan is strictly scrutinised and monitored by the Corporate Law Authority (CLA) as well as the State Bank of Pakistan (SBP).
These companies are periodically audited by statutory auditors who are approved by CLA. In addition, CLA picks five modarabas each year at random to conduct special audit by a different group of auditors than the statutory one.
State Bank of Pakistan is also arranging a special audit primarily to check the health of the assets and internal controls scope of business activity.
The Modaraba due to its legal structure and operative framework can theoretically undertake any business activity prescribed by Shariah and highlighted by dynamic competitiveness and acumen of its fund managers. Modaraba being a mode of transaction and business is not without influence of the general business practices in Pakistan. However, Modaraba cannot carry on any business which is repugnant to the Islamic injunctions. The business as generally understood, is an activity for profit and therefore it has to be governed and managed accordingly. Great deal of inconsistency prevails because fabric of laws, social practices and the values are not entirely in conformity with Islamic sharia.
Modaraba Industry in Pakistan, serving as an impetus for its rapid acceptance and development as an effective and prospective alternative to riba, free financing. This is the reason that within a decade notwithstanding the challenges of already deeply entrenched interest-based financing system, fiscal restraints and geopolitical constraints the number modaraba companies have mushroomed over 50 in the country.
Floatation:
For floating a Modaraba, first of all, there must be a Modaraba Management Company, known as Manager of the Modaraba or "Modaraba Company". The company may be registered under Companies Ordinance 1984. After incorporation as Joint Stock Company, it is to be registered as Modaraba Company with the Registrar of Modarabas, Islamabad. Once registered as a Modaraba Company by the Registrar of Modarabas, it can float any number of Modarabas subject to the recent requirement of three years satisfactory performance. For creating and managing Modaraba, inter alia, the Modaraba Company has to prepare a business plan and prospectus containing various information as required in 4th schedule of the Modaraba ordinance, which is to be cleared by the Religious Board appointed for the purpose.
In case of Modaraba companies applying for listing on stock exchange 50% of the total paid up capital shall be subscribed by the sponsors or their associate or friends, relatives and associated undertakings and balance of 50% shall be offered to the general public including NIT. Modaraba cannot be floated with a paid-up capital of less than 2.5 million. Laws in Pakistan permit banks to register themselves as a modaraba company for the floatation of their own modarabas. With some initiative, this offers a unique opportunity to banks in Pakistan to diversify into new areas of business play an active and innovative role in the economic development of the country.
Future of Modaraba:
The government policy of privatization and deregulation of economy and easing of fiscal and banking regulations have opened new avenues of investment and diversification for the financial sector.
In this context the modarabas along with the investment finance bank will play a pivotal role in strengthening and developing the capital market activities and to establish the confidence of investors.
The Modaraba, undoubtedly is an important and useful element of our financial structure and the investors are keen to put their money in modaraba primarily because of the fact that their business is in conformity with the injunctions of Islam.
Leasing:
Leasing is an age old mode of financing as its traces are available even in the period dating back to 5000 B.C. but this technique evolved gradually in various parts of the world. In 1950s' the United States of America pioneered this concept in the modern mode of capital formation, followed by Europe in 1960s'. Japan adopted the technique of lease financing in 1970s' which speeded to Southeast Asian countries and Latin America. In the recent past, we have seen a remarkable interest in development finance shifting from credit to other type of finance providing equity or equity related services, which includes leasing, especially in developing countries.
Now a days Leasing is an extremely versatile mode of financing and is recognized as a major source of funding in many developed countries of Europe, USA and Japan, and as well as in many developing countries of the world including Pakistan. According to World Leasing Year Book 1990, leasing contributes more than US$275 billion to world wide annual capital formation.
Issues Related to Modarba:
The government took a step towards Islamization of the economy (free from Riba) by passing an Ordinance in 1980 and Rules in 1981 for formation of Modaraba companies and floatation of Modarabas. The Modaraba companies act as "Modarib" and are registered under the Companies Ordinance and thereafter, registered with the Registrar of Modarabas as a Modaraba company, subject to satisfaction of the Registrar that applicants are eligible for Registration and that the directors are of sound and reputable background. The Registrar has to satisfy about the business to be undertaken and the investment to be made through floatation of Modaraba. The Federal Government has constituted a Religious Board which is headed by a sitting judge of Lahore High Court, Mr. Justice Khalilur Rehman and consists of Justice Maulana Taqi Usmani and Mr. Mohammad Mahmood Ghazi, a Director of Dawa Academy at Islamabad which examines that the business to be undertaken is not opposed to the injunction of Islam and the Registrar does not permit the floatation of a Modaraba unless the Religious Board has certified in writing that Modaraba business is in accordance with the Sharia. The Modarabas are of two types:-
a) Multipurpose Modarabas i.e. a Modaraba having more than one specific purpose or objective and;
b) Specific Purpose Modarabas i.e. a Modaraba having one specific purpose or objective.
The first Modaraba was formed in 1981 for a specific purpose of disposing of the Twin Towers. This was for a fixed period and was wound-up after the disposal of said Towers. The first multipurpose Modarabas for an indefinite period were floated in 1985 in the name of BRR Modaraba and First Habib Modaraba. In 1987, First Grindlays Modaraba and Modaraba Al-Mali were floated. The success of the Modarabas attracted others in the business and gradually up to 1990, 14 Modarabas were floated. The public were happy that the Modarabas were giving good profit and were also managed within the injunctions of Islam. In addition, section 37 of the Modarabas Ordinance, 1980 held an assurance to investors of distribution of not less than 90 per cent of profits as dividend. Section 37 reads as follows: "Exemption from tax: The income of a Modaraba shall be exempt from tax under the Income Tax Ordinance, 1979 (XXXI of 1979), if not less than ninety per cent of its profits were distributed to the holders of Modaraba Certificates:.
owever, when the Corporate Law Authority and Registrar of Modarabas started giving permission to new Modarabas in quick succession and 19 new Modarabas were floated in 1991, the total number of Modarabas today stands at 46, it created anxiety amongst the public about the future of Modaraba Industry. The multiplication of Modarabas, followed by imposition of 25 per cent tax on the income of the Modarabas after first 3 years of tax exemption, announced in the budget of 1992, took away the glitter of good dividend in future. The levy of tax of 25 per cent on the Modarabas which were assumed to permanently tax free, removed the obligation of payment of 90 per cent dividend to Modaraba Certificate holders.
The tax regime not only applied tax on income but all the other taxes like Turn Over Tax of half per cent and With-holding Tax of 2.5 per cent were also applicable to the Modaraba transactions. It was after great efforts by the Modaraba Associations. It was after great efforts by the Modaraba Assocation of Pakistan and the understanding of the Ministry of Finance that Turn Over Tax was withdrawn from Modaraba Sector. With-holding Tax of 2.5 per cent on Modaraba transactions of the Modarabas was reduced to 1 per cent. Further concession was allowed in the budget of 1993 with two years lower taxation of 12.5 per cent, after three years exemption, and thereafter 25 per cent tax.
The tax problems of the Modaraba are not totally solved so far. The application of Capital Value Tax on purchase of commodities by Modarabas which were tax exempt and were therefore, unable to show an assessment of tax for the Assessment Year 1993 has badly hurt the Modarabas doing Leasing business. They have to pay 5 per cent Capital Value Tax on purchase of any vehicle or machinery for leasing and therefore, Modarabas are losing business to Leasing Companies, which are already under tax net. The With-holding tax of 2 per cent on imports of goods and 2.5 per cent on sale is also adversely affecting the trading of the Modarabas. Representations have been made by the Association to the Finance Ministry and Central Board of Revenue and we still hope that Ministry of Finance will take notice of problems of the Modarabas and help solve these grievances of the Modaraba sector
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