TAX LAWS AFFECTING THE WAQF IN MALAYSIA: A COMPARISON

WITH THE UNITED STATES AND TURKEY

Tunku Alina Alias, PhD

1
Advocate & Solicitor, High Court of Malaya

ABSTRACT

This article discusses the effect of current tax laws on awqaf in Malaysia, and
explores the extent current taxation policies support, balance, regulate and oversee the
waqf institution. A comparison is made to the tax policies of the United States vis-à-
vis their foundations and of Turkey in respect of vakiflar, from which some
suggestions are proposed for tax policy and legal changes to be made in Malaysia in
order to encourage the endowment of property as waqf. An argument will be made
that the encouragement of awqaf endowment and activities will lead to economic
growth.

Keywords: Waqf, Malaysia, tax, economy, economic growth.

INTRODUCTION

In the distant past, the institution of waqf2 was the sole provider of public services and
municipal needs (by way of operating or providing funding for mosques, suraus, soup
kitchens, bathhouses, water fountains, madrassas, centres of education, irrigation, rest
houses, hospitals and orphanages) in Muslim territories. Cash awqaf also provided
funding or financing to individuals and merchants during the Ottoman era. Today,
1
Address: 21-6, Block B, The Boulevard, MidValley City, Lingkaran Syed Putra,59200 Kuala
Lumpur, Email: tunkualina@gmail.com.
2
References in this paper to the term “waqf” (pl. awqaf) means the endowment of property in
accordance with Islamic principles. The word ‘waqf’ literally means “to detain” and “to prevent”. In
Islamic literature and in the Sharia’ (Islamic law) it means the endowment of privately owned property
in perpetuity whose usufruct would be allocated towards charitable purposes, without depleting the
original endowment. Traditionally, Islamic view on what is included within charitable purposes include
a spectrum of deeds ranging from simple alms, charity, philanthropy, righteous works, good works as
well as taking care of one’s family. See Murat Cizakca, A History of Philanthropic Foundations: The
Islamic World from the Seventh Century to the Present, 1st ed., 1 vols. (Istanbul: Bogazici University
Press, 2000); Magda Ismail Abdel Mohsin, Cash Waqf: A New Financial Product, 1st ed. (Kuala
Lumpur: Prentice Hall, 2009).
government, nonprofit organizations and financial institutions have supplanted these
functions that were previously supplied or carried out by awqaf. This however does
not render the waqf either obsolete or redundant, if the institution can be utilized for
some other public need or public servic function. The primary decision that must be
made by Malaysian policy makers is whether to recognize the waqf as a valid and
legitimate vehicle for provision of public needs and goods. If so, it is essential to
provide the framework so as to enable it to take its place amongst the other nonprofit
organisations as part of a vibrant and economically productive nonprofit sector. This
article deals with taxation as part of that framework.

In section 1 of this article, the writer will discuss the overall landscape of
philanthropy and the role of the nonprofit sector within the economy of a country, as
found in the the literature reviewed. The section also focuses on the role of taxation as
one of the crucial aspects of the framework that would support the nonprofit sector in
general, and the waqf in particular. In section 2, the writer identifies the current
Malaysian tax provisions affecting the waqf. Section 3 discusses the position of
taxation pertaining to the foundation in the United States and the vakif in Turkey. The
United States is chosen as being one of the countries with the most vibrant nonprofit
sectors in the world, and Turkey as the Muslim country with the most progressive
vakif sector. Both the foundation and the vakif are in essence similar to the waqf and
therefore afford a good comparison. In Section 4, some proposals to reform
Malaysian tax provisions are put forward, on the assumption that policy makers are
interested in bringing forward the institution of waqf as an economic contributor.

SECTION 1: PHILANTHROPY, THE NONPROFIT SECTOR AND

THE EFFECT OF TAXATION POLICIES

CHARITY AND PHILANTHROPY

Charity and philanthropy are differentiated from one another. Charity is identified
with alms giving, arbitrarily given on a personal basis to the needy or the poor to
address or ameliorate immediate needs. Philanthropy tends to be institutionalized,
strategic and scientific in that it addresses root causes and discriminates its
beneficiaries. There are many motivations for why people give in charity or in
philanthropy. These can be due to religious reasons, desire for prestige, altruism,
wealth management or tax shelter reasons. We focus on two: religious motivation
from the Islamic perspective and economic reasons.

In the Quran, prayer and charitable behaviour are often enjoined simultaneously.
“Wa-aqama al-salaa ta wa-ata al-zakaa ta”3 is a constant refrain in the Quran4. There
is also a host of the Prophet’s hadiths encouraging charitable giving. In Islam, the idea
of sharing surplus wealth is closely related to the concept of spending (infaq). Afzal-
ur-Rahman5 emphasizes that expenditure towards good works and charitable giving
is not discharged merely through payment of zakat6 but there is a true claim upon
such excess or surplus wealth. The principle that belies such expenditure is referred to
by ur-Rahman as Anfaq al-Afw and outlined in the Quran: “They ask how much they
are to spend; say: “What is beyond your needs.”7. Those who comply with this
exhortation are one of the righteous people8.

As the objective of all Muslims is to achieve falah (or favour of Allah) in the now and
the hereafter, the primary strategy is to accumulate birr (or blessings) through
righteous deeds during one’s lifetime. However, Abu Hurairah reported Allah’s
messenger as saying: “when a man dies, all his acts come to an end, but three:
recurring charity, or knowledge (by which people benefit), or a pious offspring, who
prays for him.” 9 The waqf structure provides an avenue whereby a person motivated
to obtain the favour of Allah can fulfill these three aspirations simultaneously and
continue to obtain blessings after death.

There are also economic justifications for giving, such as for tax shelter reasons.
Observations from the United States are useful to study this motivation. Four

3
“And be steadfast in prayer and regular in charity”.
4
al-Quran Verse al-Baqarah 2:110 and 2:277; also Verse al-Muzzammil 73:20
5
Afzal-Ur-Rahman, Doktrin Ekonomi Islam, trans., Zaharah Salleh, 1 ed., 4 vols., vol. 2 (Kuala
Lumpur: Dewan Bahasa dan Pustaka, 1991; reprint, 3rd).
6
Zakat is compulsory tithes of 2.5% of surplus wealth over and above a threshold value (nisab) which
is held during the preceding lunar year. Surplus wealth is defined as chargeable wealth after deducting
living expenses and debts. The nisab is 3ozs of gold or 21 ozs of silver or equivalent value.
7
al-Quran Verse al-Baqarah 2:219
8
al-Quran Verse az-Zariyat 51: 16-19 and Verse al-Maarij 70: 15-25
9
Muslim 1992: bab3, hadith 14
demographic factors determine giving and they are income, wealth, religious
participation and family structure10 . Americans tend to give because of the low cost
and ease of giving. It is cheap for Americans to contribute when tax deductions for
contributions are given during a time when applicable tax rates are high.

THE NONPROFIT SECTOR AND SOME OF ITS INSTITUTIONS:

THE WAQF, THE FOUNDATION AND THE VAKIF

OVERVIEW

Today the waqf does not exist in a vacuum, but it operates within an environment
consisting of many other nonprofit and charitable organizations referred to as the
nonprofit sector11. ‘Nonprofit’ does not mean that such institutions do not or are not
capable of making a profit in the generally accepted sense12 but they do not distribute
profits or benefits to founders, trustees or members. Only beneficiaries as identified
by the founding documents of the organization will benefit, through the programs
affected by the institutions. The Handbook on Non-Profit Institutions in the System of
National Accounts13 also provides a definition of nonprofit institutions that share a
set of five characteristics: organizations, do not exist primarily to generate profits and
are non-profit distributing where they do make a profit, institutionally separate from
government, self-governing, and non-compulsory. Under the classical fiqh format, the
public benefit waqf would fit into this definition of a nonprofit.

Nonprofit Sector Institutions: The waqf, the foundation, the vakif.

In Malaysia, there are many different organizations and bodies that carry out
nonprofit activities intended for public or social benefit. They can be categorized as

10
see Arthur C. Brooks, Social Entrepreneurship: A Modern Approach to Social Value Creation
(Prentice-Hall, 2009).
11
Also sometimes referred to as the charitable sector or the voluntary sector.
12
Australian Bureau of Statistics, Non-Profit Institutions Satellite Account 1999-2000 (Belconnen,
2002).
13
United Nations, "Handbook on Non-Profit Institutions in the System of National Accounts," in
Department of Economic and Social Affairs Statistics Division, (United Nations, New York: United
Nations Publication, 2003).
government initiated nonprofit organizations 14 , nonprofit organizations that serve
businesses15 and nonprofit organizations that serve households.16. Depending on type,
the constitutional basis of a nonprofit organization in Malaysia can take one of eight
legal forms: an unincorporated trust (offshore 17 and onshore Malaysia), an
incorporated trust (offshore and onshore Malaysia), an incorporated foundation
(offshore), a society, a charitable public company, a statutory trust or agency, a
statutory charity or a religious endowment such as the waqf. In Malaysia, all awqaf
are vested in the State Islamic Religious Councils (SIRCs), which are statutory
bodies. The SIRCs are sole trustee to the awqaf, automatically by operation of law.
The waqf, ipso facto, does not have legitimacy as a legal entity in the eyes of
Malaysian law and does not fully qualify as a nonprofit organization.

Under US federal legislation there is no definition of the term ‘nonprofit’. Nonprofit

status is a state-law concept, in which approved entities may be eligible for exemption
from sales, property and state income taxes. Bruce Hopkins and Jody Blazek 18
explain that there are three legal forms under US state law that can be adopted by
nonprofit organizations in order to exist, being unincorporated association, nonprofit
corporation19 or charitable trust20. The nonprofit corporation is the most common
legal form adopted by foundations. The term “foundation” is best described as a “non-
governmental, nonprofit organization, having a principal fund of its own, managed by
its own trustees or directors and established to maintain or aid social, educational,
charitable, religious or other activities serving the common welfare.”.

14
Government initiated nonprofit organizations are government agencies such as the Social Welfare
Department or statutory trusts or trust funds such as the Employees Provident Fund and the Pilgrim
Fund.
15
Nonprofit organizations serving businesses are those professional organizations such as the Bar
Council, Malaysian Medical Associations, the different Chambers of Commerce, the Federation of
Malaysian Manufacturers and other organizations that serve the business community.
16
Foundations, religious, political, youth or sporting organizations, charities, mutual benefit
associations and trade unions fall under the category of nonprofit organizations serving households.
17
Offshore structures refer to those established within the Federal Territory of Labuan. These are not
allowed to hold Malaysian assets or property.
18
Bruce R. Hopkins and Jody Blazek, The Legal Answer Book for Private Foundations (New York:
John Wiley & Sons Inc, 2002).
19
Many states have adopted the American Bar Association 1987 Revised Model Nonprofit Corporation
Act. The Indiana Nonprofit Corporations Act was based on this model.
20
Trusts are formed pursuant to state laws some of which have adopted the Uniform Trust Code, 2000
Turkish nonprofit organizations take one of two legal forms: association and vakif21.
In 2005, there were more than 71,000 associations and 4,300 active vakiflar 22
operating in Turkey23. The two legal forms are differentiated in their focus in that
associations are member-based whereas vakif are asset-based. It appears that the
association seems to be the more popular form of civil society organization in the
nonprofit sector.

Economic contributions of the Nonprofit Sector

In 2004, Malaysians gave in kind and monetary terms a total of RM15 billion24 of
which RM14.9 billion was contributed by businesses. The Gross Domestic Product
(GDP) of Malaysia in the same year was RM 474 billion25 thus translating overall
giving as 3.16% of GDP from which household monetary contributions account for
0.02% of GDP. Government expenditure on social security and welfare services,
housing and community amenities and other community and social affairs accounted
for 0.5% of GDP in both 2004 and 200526.

In contrast, if the United States Nonprofit Sector were a country, it would have the
seventh largest economy in the world according to GDP data compiled by the World
Bank for 200727. In 2008 Americans gave a total of $307.65 billion to charitable and
philanthropic causes28 . 75% of this giving was from living individuals and 7% was
from bequests. Foundations (independent and community foundations) granted up to
13% of the total giving whilst corporations (including corporate foundations)

21
Turkish term for waqf. (pl. vakiflar).
22
To be distinguished from the 5859 legacy Ottoman vakiflar managed by the General Directorate of
Vakiflar.
23
Filiz Bikmen, The Landscape of Philanthropy and Civil Society in Turkey (Istanbul: Third Sector
Foundation of Turkey, 2006).
24
Department of Statistics, Malaysia: Report on Distribution and Use of Income Accounts and Capital
Accounts 2004
25
Department of Statistics, Malaysia: Annual National Accounts (Gross Domestic Product) 2000-2008
26
Department of Statistics Malaysia, Annual National Accounts (Gross Domestic Product) 2000-
20082009.
27
National Council of Nonprofits, http://www.councilofnonprofits.org/?q=economy/npstatistics
(accessed March 26th 2009).
28
Center on Philanthropy at Indiana University, Giving USA 2009. The Annual Report on Philanthropy
for the Year 2008 (Indianapolis: Giving USA Foundation, 2009).
contributed 5% of this total. Between  1968  and  2008,  total  giving  in  America  was  
estimated  to  be  1.7%  to  2.2%  of  the  GDP.  

Ali Carkoglu29 concluded that there is a very low amount of individual giving in
Turkey (equivalent to USD 1.9 billion in 2004), totalling to not more than 1% of
household income and 0.5% of the GDP of Turkey. Corporate giving by 500 of the
largest companies in Turkey in 2007 amounted only to USD160 million. The reason
for this is because the public perceived that intermediate channels were unavailable to
direct aid to recipients (in other words, it is difficult to give) which leads to a high
dependence on state intervention30 .

Comparing the three countries, it is observed that the GDP of the United States in
200431 was USD 11,679 billion, whereas Malaysia’s was only USD118 billion and
Turkey’s was almost triple of Malaysia at USD 302 billion32 . Notwithstanding, the
Gross National Income per capita of Malaysia was higher at USD3, 311 compared to
Turkey’s USD2, 397 whilst that of the United States was 10 to 15 times larger at
USD33, 07033 . In 2004, individual giving by citizens in the United States was 1.5%
of GDP, compared to 0.02% of GDP for Malaysia. The individual Turk, despite
having a lower GNI per capita than Malaysia, contributed 0.6% of GDP to public
benefit and charity.

What is interesting is that according to the World Economic Outlook for 2004,
Malaysia had a resource balance (aggregate savings in excess of aggregate
investment) of 12.7% of its Gross National Product, compared to -0.5% of an
advanced nation (such as the US) and 1.6% of developing countries (such as Turkey
which was categorized under Central and Eastern Europe). This suggests a capacity
for Malaysia to increase aggregate consumption through more philanthropic and
awqaf endowments and activities to create an expansionary effect to the economy.

29
Bikmen; Ali Carkoglu, "Trends in Individual Giving and Foundations Practices in Turkey," in
Philanthropy in Turkey: Citizens, Foundations and the Pursuit of Social Justice, ed. Filiz Bikmen and
Rana Zincir(Istanbul: TUSEV Publications, 2006).
30
Carkoglu.
31
For purposes of true comparison, the year 2004 is the most recent data year for which a common
basis can be obtained for the three countries.
32
World Bank, The Little Green Data Book 2006 (Washington DC: The World Bank, 2006).
33
Ibid.
There is insufficient giving by individual Malaysians, a situation which can certainly
be improved.

TAX POLICIES

Are people’s motivations for giving related to tax policies? For the purposes of this
article, the writer makes the assumption that there is a connection between giving and
tax policies. Otherwise, if donations are given regardless of tax incentives, then the
tax subsidies are wasted on donations that would have been made in any event34 . The
claim that tax reasons have a bearing on the rate of founding awqaf must be the
subject of another paper. Many areas should be addressed in a nonprofit tax policy,
and in this article we address treatment of donations and tax preference policies.

When a country affects a progressive income tax system35, any allowable deductions
for charitable purposes are efficient only for higher-income taxpayers 36 . Tax
deductions are designed as incentives particularly in high tax rate jurisdictions. The
incentive effect however varies with any given taxpayer’s marginal tax bracket37. In
other words, in a progressive tax system as tax rates rises, the “price” of giving goes
down – it is “cheaper” for those in the higher tax bracket to give. Thus, there is some
question on the fairness of the charitable-contribution deductions.

Tax credit of some percent of the gift may be more equitable, as it allows the same tax
benefit for each dollar contributed38. A tax credit may be directly set-off against the
amount of taxes payable, and reduce the amount payable.

34
Evelyn Brody, "Tax Deduction and Philanthropy," in Philanthropy in America. A Comprehensive
Historical Encyclopedia, ed. Dwight Burlingame(Santa Barbara: ABC Clio, 2004).
35
A progressive tax system imposes taxes to income above a base amount, starting with low rates and
progressing to higher rates as income increases. The opposite is regressive tax which is not a actually a
system, but an effect where the tax is considered regressive such as a fixed poll tax on per head basis,
as the effect of the tax is felt more by those that earn less. In between is proportional tax, whereby
every citizen is taxed the same proportion. Examples are consumption taxes such as sales and services
taxes whereby everyone pays the same proportion based on the amount consumed.
36
Brody.
37
Ibid.
38
Ibid.
From a tax perspective, nonprofit organizations can be categorized into three broad
classes39: public benefit, mutual benefit and government agencies. Tax laws tend to
give preference (such as deductibility of donations, tax credits or rebates) for the
public benefit category of nonprofits. The basic strategy according to the sample
Basic World Tax Code (BWTC) drafted by Hussey and Lubick40 is to exempt income
related to the purpose of the NGO and to tax unrelated commercial business income.
Some countries allow commercial activities by their nonprofit sector but apply a
“destination of income” approach that does not tax profits if used for exempt
purposes41 .

TAXATION IN MUSLIM STATES IN THE PAST

 

Other than zakat (on certain quantities of gold, silver, articles of trade, livestock and
produce of land), tax in Muslim states in the past include kharaj (land tax on non-
Muslim owned lands within Muslim territories), ‘ushr (tax on Muslim owned lands,
which is a lower rate that kharaj), jizyah (a poll tax on non-Muslims) and some
customs duties and tolls42 . Awqaf lands were taxed with ‘ushr43 . Between 1530 to
1540 AD, 17% of the tax revenue collected in Western Anatolia were from real estate
awqaf and in other provinces, taxes from real estate awqaf varied between 5 to 16%
of the total tax revenue44 . By the mid 18th century, revenues from awqaf lands

39
Milton Cerny, "Taxation and Transition: Nonprofit Organizations in a Market Economy," Tax Notes
International, (1999).
40
Ward M. Hussey and Donald C. Lubick, Basic World Tax Code and Commentary (Harvard
University, 1996).
41
Cerny.
42
S.A. Siddiqi, Public Finance in Islam (New Delhi: Adam Publishers & Distributors, 2005).
43
Haydar Can Taygun, "The Legal Confrontation between Tradition and Modernity: Awqaf of the
Ottoman State in the Nineteenth Century," (2009). http;//www.hctaygun.com/awqaf_taygun.pdf
(accessed 14th January 2011).
44
Omer L. Barkan and E.H Ayverdi, "Istanbul Vakiflari Tahrir Defteri, 1970," Istanbul.(as quoted by
Murat Cizakca, "Economic Dimensions of Foundations in the Ottoman Era," in Philanthropy in
Turkey: Citizens, Foundations and the Pursuit of Social Justice, ed. Filiz Bikmen and Rana
Zincir(Istanbul: TUSEV Publications, 2006).
represented up to 30% of the Imperial Ottoman budget45 . No taxes were levied on
cash awqaf 46.

In classical Islamic nomenclature, taxes were imposed on wealth and taxes on earned
income, profit, capital gains, enterprise and consumption were non-existent.
Similarly, there were no taxes on estate47, gifts or inheritance.

SECTION 2: TAX AND WAQF IN MALAYSIA

Malaysia has a progressive income tax system. Currently, no tax is imposed on estate,
gift or inheritance and therefore considerations to avoid such taxes are irrelevant for
Malaysians.

TAX DEDUCTION FOR DONORS

Section 44(1) (c) of the Income Tax Act permits a donor to deduct from his
chargeable income any gift of money to the Federal Government, a State
Government, a local authority or an approved institution or organization up to the
extent of 7% of the donor’s aggregate income in the year (or up to 10% if the donor is
a company). Tax credits are allowed only for zakat payments.

 
TAX EXEMPTION FOR CHARITABLE INSTITUTIONS OR ORGANIZATIONS

The “charitable” label given to any institution or organization is related to its tax-
approved status for the purposes of section 44(6) of the Income Tax Act, 1967 (ITA).
According to the latest information posted on the website of the Income Tax

45
Cizakca, A History of Philanthropic Foundations: The Islamic World from the Seventh Century to
the Present.
46
Barkan and Ayverdi. (as quoted by Cizakca, "Economic Dimensions of Foundations in the Ottoman
Era.")
47
Under fara’id laws, there is a remainder to be paid to the bait ul-mal.
Department 48 there are approximately 980 organizations that have been granted
approved s. 44(6) status.

There are several benefits to obtaining approved status for the purposes of section
44(6) from the Income Tax Department. The approved institution or organization is
exempted from tax on all income (other than dividend income)49. The tax laws will
permit an organization to use not more than 25% of its year-beginning accumulated
funds to participate in a business on the condition that all profits derived from that
business would be used by the organization towards the organization’s stated
purposes. However, if the business is actually operating the primary purposes of the
institution or if the beneficiaries of the organization are operating the business (for
example the Malaysian Institute of the Blind’s Therapy Centre in Brickfields, Kuala
Lumpur is operated by the blind masseurs), then the organization will be permitted to
invest more than 25% of its year-beginning accumulated funds.

It is to be remembered that in Malaysia, the waqf is not recognized as a legal entity

and is subsumed within the construct of the respective State Islamic Religious
Council (SIRC). The SIRC is not an institution or organization as defined by section
44(6) ITA, but is approved as tax exempt on a separate criteria ie by virtue of its
position as a State government agency. Awqaf properties that are vested in the SIRCs
are treated as assets of the SIRC, and accordingly income to these assets such as
rental income are exempt from tax. Notwithstanding, in practice cash endowments are
not automatically tax deductible, and each SIRC must apply to the Inland Revenue for
a tax-exempt status in respect of any cash awqaf scheme that it wishes to launch.
Other types of endowments (eg land, appreciated stock) are not entitled to tax
deductions.

STATE AND MUNICIPAL TAXES

All waqf lands are subject to quit rent (land tax) and municipal assessment rates,
except where it is marked for use as a cemetery, or where the property has been

48
www.hasilnet.gov.my accessed on 10th August 2010
49
Paragraph 13 Schedule 6 Part 1. Religious institutions or organizations not operated or conducted
primarily for profit and established in Malaysia primarily for religious worship or advancement of
religion is also exempt from paying income tax (other than dividends).
transferred to the SIRC thus classifying them as state or government property. Clearly
the financial cost of maintaining waqf lands becomes a drain on the SIRC or the
Baitul-Mal of the state concerned, especially where awqaf land is uneconomical and
not producing any income50.

It is this writer’s view that the waqf is invisible to tax preference treatments.
Consequently, in Malaysia there is no tax incentive to found a waqf except where
donations are made to certain cash waqf schemes approved by the IRD. Current tax
policies therefore do not support, regulate, balance or oversee the waqf institution in
Malaysia.

SECTION 3: COMPARISON WITH THE UNITED STATES AND

TURKEY

UNITED STATES
 

The US Government has as a policy encouraged the formation of nonprofit

organizations in order to deliver public services to the diverse citizenry and encourage
civic movement through communal responsibility. In doing so, the Federal
Government has provided many tax incentives for giving by Americans, granted tax-
exempt status to qualifying organizations and made direct grants to foundations for
re-granting. In providing these incentives and tax-exemptions, the Government
forgoes a large portion of tax revenues.

Under US tax provisions, nonprofits may be categorized as charitable and

noncharitable 51 . Most nonprofits that have applied 52 for and obtained tax-exempt

50
Only 10% of waqf lands (other than for mosques, suraus, cemeteries and religious schools) were
considered economical Syed Othman al-Habshi, "Waqf Management in Malaysia," in The Islamic
Voluntary Sector in Southeast Asia: Islam and the Economic Development of Southeast Asia, ed.
Mohamed Ariff(Singapore: institute of Southeast Asian Studies, 1991)..
51
A third (special) category of its own are churches.
52
Any nonprofit organization having any of the exempt purposes set out section 501(c) (3) of the
Inland Revenue Code of 1969 may apply for tax-exempt status.
status are of the “public benefit” type. The noncharitable nonprofits are mostly
“mutual benefit” types. As at September 2006, there were an estimated 1.8 million
organizations recognized as federal tax-exempt organizations53 .

Taxation policy in the US governing nonprofits take on 4 functions: support, equity,

regulatory and border patrol54 . In the support function, the taxation policy seeks to
incentivize giving and support the nonprofits role in society. In the equity function, it
seeks to ensure that redistribution is carried out in that donations and gifts from the
wealthy are redistributed for public benefit. In the regulatory function, the taxation
authorities act to oversee that nonprofits fulfill their fiduciary duties. In the border
patrol function, the tax authorities ensure that the nonprofits do not stray into areas
such as government and politics, and do not take advantage of tax-exempt status to
benefit from the market.

In the following sections, we will narrow down the tax framework applicable to
foundations.

SUPPORT AND REGULATION OF FOUNDATIONS

One of the most important characteristics of the American foundation is that most are
legally incorporated. Due to their narrow base restricted to private and corporate
donors, private foundations are placed under stringent regulations and scrutiny by the
IRS and the State AG to assure that they will fulfill the public benefit purpose for
their existence, and thus justify their tax-exempt and nonprofit status.

Tax Deductions for Donors55

Progressive income tax was introduced into the United States through the Tax Laws
of 1913 and 1917, however donors to foundations are given many tax benefits.

53
"Non Profit Sector -Increasing Numbers and Key Role in Delivering Federal Services ", in
Subcommittee on Oversight, Committee on Ways and Means, ed. United States Government
Accountability Office, House of Representatives (2007).
54
John Simon, Harvey P Dale, and Laura Chisolm, "The Federal Tax Treatment of Charitable
Organizations," in The Non-Profit Sector. A Research Handbook, ed. Walter P. Powell and Richard
Steinberg(New Haven & London: Yale University Press, 2006).
55
Section 170 IRC.
According to Waldemar Nielsen56, in 1964 Federal legislation allowed donors to
deduct contributions (of cash and fair market value of property 57 to ‘publicly
supported organizations’ of up to 30% of their adjusted gross income and
contributions to other types of tax exempt organizations (including private
foundations) of up to 20% of their adjusted gross income58. These rates are exclusive
to one another, so that it would appear that an individual can obtain up to 50%
deductions from their adjusted gross income if they gave to both publicly-supported
as well as other tax exempt organizations. They can also carry-over these deductions
to subsequent years if they could not fully use the deduction upon founding the
foundation although unused deductions vanish after 5 years.

Donors of long-term appreciated stock are not subject to capital gains taxation on
such stock. The value of deduction for the endowed stock is taken at market value for
up to 10% of the value of the corporation’s outstanding stock. Anything above the
10% cap is valued at cost to the donor.

The US Federal Government has imposed a progressive estate tax ranging between
10% and 55% of value of the estate on intergenerational transfers of wealth occurring
upon death59. In addition to this there is also a gift tax imposed on any gifts made
prior to death. Both the estate and the gift taxes are imposed by virtue of the Unified
Gift and Estate Tax System. Many states also impose their own estate and inheritance
taxes, which sometimes is imposed in addition to federal estate taxes. The inheritance
tax is imposed on beneficiaries and based on the amount inherited from the estate.

56
Waldemar A Nielsen, Golden Donors. A New Anatomy of the Great Foundations (New Bunswick
(USA) and London (UK): Transaction Publishers, 2001).
57
Brody.
58
There is also a floor to the extent that itemized deductions may be claimed if they exceed 3% fo the
amount by which adjusted gross income exceeds a certain amount (which is indexed for inflation and
in 2002 was $137,300). However, the rules prevent a taxpayer from losing more than 80% of the
deductions (Brody, 2004).
59
Estate tax was abolished for the year 2010, but by virtue of section 301 of the Tax Relief,
Unemployment Insurance Reauthorization, and Job Creation Act of 2010 for those estates of those that
die after 31st December 2010 (subject to an exclusion amount of USD 5 million, and for married
couples USD 10 million), the rates applicable in the year 2001 shall be reinstated with a top rate of
35% for years 2011 and 2012.
However, since the Tax Laws of 1935, stock and shares, which are endowed to
foundations or gifted to public charities, are removed from the donor’s estate, and no
federal gift tax is imposed on such charitable contributions60.

Tax exemption for Foundations

In terms of Federal tax treatment and disclosure requirements, there are two
categories of foundations – private and public. The primary difference between them
is that private foundations are funded or endowed by private means, whereas public
foundations or public charities are required to satisfy the “public support test” which
states that in any given four year period, at least a third of the public charity’s income
is derived from public sources. Community foundations are public foundations or
charities. There is also a separate category of foundations called “operating
foundations” which operate facilities such as museums and research institutes. They
are subject to a separate tax requirements, including that they must expend 85% of
their income towards program purposes.

a. Private Foundations

There is no definition of a private foundation found anywhere although the Inland

Revenue Code has determined that organizations which are “organized and operated
exclusively for religious, charitable, scientific, testing for public safety, literary, or
educational purposes…” pursuant to section 501(c) (3) of the Inland Revenue Code,
and those which do not fall within the exceptions set out in section 509 (a) are
deemed to be private foundations. There are two categories: independent foundations
(founded by individuals or groups of individuals) and corporate foundations.

b. Public Foundations

Community foundations are public foundations and considered as charities. This type
of foundation provides a unified management for a number of charitable trusts.
Donors who leave their endowments to the community foundation would agree that
their charitable directives would be honoured so long as they were not obsolete or

60
Section 2516 IRC.
harmful and that they could be altered by the foundation’s directors as changing
circumstances demand without resorting to the courts.

Today, US government regulation over foundations appear in the form of the

administration of tax laws and federal oversight with the Tax Exempt and
Government Entities Division of the IRS, active oversight by State Attorney Generals
and periodic congressional hearings on the state of philanthropic affairs.

The US Tax Reform Act, 1969 therefore provided that in order to qualify for tax
exempt status the private foundation must have a bona fide charitable purpose, it
cannot have excessively close links to a particular business firm (a maximum of 5%
in the company’s total stockholding), the foundation must meet a minimum payout
requirement of 6% of assets annually61, and it must be fully accountable to the
government and communicative with the public.

Private foundations are exempt from federal taxation, except for excise taxes on
certain activities and a 2% (some 1%, if certain conditions are met) excise tax on net
investment income. The rules (collectively referred to a private foundation rules)
prescribing these excise taxes are complicated and are referred to as rules on self-
dealing 62, payout rules63 , rules on excess business holdings 64, rules on jeopardy
investments65 and rules regarding taxable expenditures66 . Additionally, all private
foundations are required to file an annual disclosure and report in IRS Form 990-PF67
(although since 200868 foundations with less than USD25,000 in assets are only
required to fill in an e-postcard format IRS Form 990-N). Public charities (and
61
This pay-out rate has since been reduced to 5%
62
Self Dealing: private foundations may not deal with disqualified persons (IRC section 4946(a))
meaning anyone who owns more than 20% of a donor or contributor (IRC section 4941).
63
Distribution/ Payout: a private foundation must distribute a minimum of 5% of it fair market value of
assets annually (IRC section 4942). This 5% figure is an average over a period of 5 years. Operating
foundations need to payout either 85% of net income from investments or 4.25% of total assets,
whichever less.
64
Excess Business Holdings: a private foundation may not own more than 20% (in some cases, 35%)
in the stock of a business (IRC section 4943). Taxes at 5% on excess holdings imposed, and must the
excess holdings must be disposed off within 5 years, failing which a 200% tax is imposed. The
exceptions to this is (a) functionally related business eg tuition received by a university and (b) passive
holding company deriving 95% of its income in interest, dividends, royalties or capital gains.
65
Jeopardy Investments: (IRC section 4944).
66
Taxable Expenditures: (IRC sections 4945 and 4945(h)).
67
Form 990PF: (IRC section 6033). Section 4947(a)(1) non-exempt charitable trusts, which are treated
as a private foundation, are also required to file this form.
68
Due to the extension of the Pensions Protection Act 2006.
therefore community foundations) are only required to file Form 990, which is less
onerous than Form 990-PF as public charities are already subject of public scrutiny
due to their publicly-supported status.

Tax-exempt organizations must also certify to the IRS that no part of their income
will benefit private shareholders or individuals and that they will not, as a substantial
part of their activities, attempt to influence legislation or participate in political
campaigns for or against any candidate for public office69 .

In addition to obtaining tax-exempt status from the federal government, the

foundation is also likely to apply for state and local tax exemptions as well as a
reduction in postal charges. These qualify the foundation for exemption from sales tax
as well as property tax (if it owns property), and a non-profit bulk-mailing permit
from the postal authorities.

TURKEY

TAX DEDUCTION FOR DONORS

In 1967, a revision to the Turkish Civil Code No 743 by Law No 903 of 13th July
1967 (“the 1967 Law”) had injected new life into the vakif and enabled the
modernization of the institution in Turkey. By the 1967 Law, the government gave tax
incentives to encourage donations. Endowments by founders may be tax exempt
provided 80% of vakif revenues are to be reserved for public purposes70. Additionally,
companies may obtain a tax-deduction for donations to tax-exempt vakiflar up to 5%
of their profit71.

Under the 2008 Vakiflar Kannunu, new tax incentives have been introduced whereby
donations to all vakiflar, whether with or without public benefit status, will be exempt
from gift and inheritance taxes and all donations made for maintenance, reparation,

69
Foundation Center, "Foundation Growth and Giving Estimates. Current Outlook," (New York City:
2010).
70
Cizakca, A History of Philanthropic Foundations: The Islamic World from the Seventh Century to
the Present.
71
Corporation Tax Law No 1999 quoted by Cizakca (2000).
restoration and landscaping of cultural properties belonging to vakiflar (regardless of
public-benefit status) will be fully deductible from income or corporate taxes72 .

TAX EXEMPTION FOR VAKIF

Tax exemption is applied for by each vakif and granted on a case-by-case basis by the
Council of Ministers. A vakif that does not receive a tax-exempt status is considered
as a for-profit business and taxed as such on its profits. A tax-exempt vakif may own
a business if they are units internal to the vakif: they are exempt even though they are
profitable 73 . However, subsidiary companies established by vakiflar are not tax
exempt 74 and their accounts are to be kept separate from their vakif shareholders. Net
profit after tax may be distributed to the shareholder vakif.

SECTION 4: PROPOSALS FOR TAX REFORM FOR THE WAQF

IN MALAYSIA

Today, in an environment whereby demands upon government can no longer be met

or sustained through public revenues, it has become more important for civic
participation to be encouraged. The waqf, as an instrument of private philanthropy
should be incentivized to supplement state efforts and at the same time this will
relieve the burden placed on government so that it can focus on the provision of truly
public goods such as defence, infrastructure, basic healthcare and education. In
designing the tax policies for the waqf, several choices are available 75 to the
draftsman, amongst them a regulatory system and its connection with the tax system,
tax treatment of endowments, donations and business income, accountability and
transparency.

72
Basak Ersen, "Turkey's New Foundation Law," Effect2008.
73
See the example of the internal business units of the Turkiye Diyanet Vakfi .
74
Ministry of Finance Official Gazette dated 28 July 1994.
75
Caplin & Drysdale, "Taxation and Transition: Nonprofit Organizations in a Market Economy"
http://www.capdale.com/taxation-and-transition-nonprofit-organizations-in-a-market-economy (2012).
PREREQUISITE FRAMEWORK FOR A VIBRANT AWQAF SECTOR

Founders and awqaf managers can be incentivized through economic measures, the
first order of the day being a review of taxation policies followed by a liberalization
of rules on investments and income sources for the waqf. However, this must be done
in tandem with certain other strategies to provide a holistic framework. These include
the introduction of an incorporated form of waqf76 and an expansion of its role
beyond dishing out alms and charity. It also provides the waqf and its stakeholders
with legal rights, which had been provided by the Sharia’ from the outset but were
eroded over time. These legal rights include the reinstatement of the family waqf (as a
wealth management tool), the return of the independence and autonomy of the waqf
to private management and the release from restriction of 1/3rd asset rule for
endowments made during the life of a waqif. Additionally, it is necessary to
reintroduce a system of checks and balance by reexamining the dual role of the Mufti
as a member of the SIRC governing the awqaf in the state and as the final arbiter of
Islamic law in the State.

In this connection, it is also important to manage the historical legacy to show that
there is no harm and only benefit if changes are allowed to occur. These benefits
include an easing of the financial and operational burden on the State Religious
Councils, introduction of professionalism and clear value basis for governance such
as transparency, accountability and measurable results.

Similarly important is that the worldview of stakeholders including the State, the
public, the beneficiaries, the trustee and the founder must be revamped so that the
waqf can meet the needs of the people. Finally, a waqf governance framework must
be put into place is to provide a structure by which potential agency issues and moral
hazard can be checked.

76
Cizakca, A History of Philanthropic Foundations: The Islamic World from the Seventh Century to
the Present; Tunku Alina Alias, “Unleashing the Potential of the Waqf as an Economic Institution in
Malaysia: Policy, Legal and Economic Reforms ” (International Centre for Education In Islamic
Finance (INCEIF), 2011).
TAXATION POLICIES TO INCENTIVIZE THE FOUNDING OF AWQAF

The primary economic incentive (or disincentive) for awqaf is taxation policies.
When designing a tax system for the waqf, the policy maker must decide what
purpose is to be achieved. In this situation, we go to the roles such as supporting,
balancing, regulating or overseeing the institution that the tax system can take. At this
stage, this author proposes that the Malaysian tax system might support and balance
the economic functions of the waqf, leaving the regulating and overseeing function to
another oversight body and statute.

In this article, it is proposed that the following strategies may be implemented if the
institution is to be incentivized:-

a. granting of tax-approved status to incorporated public-benefit waqf under

section 44 (6) of the Income Tax Act 1967 . In this regard, any waqf that
is able to prove that its constitutional documents provide that a certain
minimum percentage of its annual income (such as the current
requirements of the IRD of 50%) should be used towards public purposes,
this being defined as purposes involving education, health, religion,
community development, economic advancement, poor relief, human
assistance and any other purposes as may be considered “public benefit”;

b. In consideration for this support, the waqf must meet a certain pay-out rate
(in the United States, it is an annual 5% of the value of foundation assets
each year) to its stated public purposes perhaps allowing for a minimum
number of years of operations to accumulate capital before the payout
requirements must be met. In considering this, the state policy towards
accumulation of assets and/or cash by the waqf to be balanced against the
redistributive expectations for the waqf will have to be studied carefully;

c. Full deductibility from taxable income for the donations or endowments

made to all public-benefit awqaf. Alternatively, the more expensive (to the
state) but equitable tax credit for the value donated, may be considered.
 The maximum ceiling of allowable deductions may be raised from the
current 7-10% to 20-30% of aggregate income to encourage giving;

d. The form of donations allowed should be expanded to land, traded

company shares and any other form of valuable assets and a formula for
valuing these contributions should be decided upon (perhaps valued at cost
to the donor). In this connection, the issue of whether tax on real property
or capital gains should be imposed also arises, and this author suggests
such endowments and donations be exempt;

e. All business income earned and investment income of tax approved awqaf
operating facilities such as hospitals and clinics, universities, research
institutes, museums, zoos, schools and such like, provided a minimum of
85% of its income are used towards its stated purposes ie operating the
facilities, should be completely tax exempt;

f. Business income not related to the purposes for which the waqf was
established should be subjected to normal corporate taxes, and business
income of subsidiaries wholly owned by the waqf which are substantially
connected to the purposes of the waqf should be completely exempt ;

g. In the case of cash awqaf, where the primary form of income in most
instances would be investment income, the draftsman should reduce the
tax rate to perhaps 15% instead of the current 26%, or even abolish it
altogether for the public-benefit cash awqaf (in particular a public-benefit
waqf operating facilities);

h. Certain rules on expenditure, prohibition against self dealing and private

inurement, payout and restricting certain activities involving advocacy in
favour of certain legislation or political parties should be established;

i. Government service taxes and sales taxes on goods and services produced
by awqaf as well as State and municipal laws imposing quit rent on land
and assessment rates on buildings owned by waqf should be reviewed.
Once tax incentives can be given, the problems of scale of endowment and obtaining
further support from the public is mitigated.

CONCLUSION

Taxation policies are one of the methods by which Malaysia can incentivize the
formation of future waqf and to modernize its governance and management. This will
enable the waqf institution to take its place as an economic agent.

The true contribution of the waqf to economic growth is through the development of
human capital and harnessing any surplus wealth by connecting donors with the needs
of their community. With movement from a closed controlled economy where
government treats public services as a department, to a freer market economy with a
large number of taxpayers, government can no longer fund the demands of all its
people for an increased quality of life. Recently, there has been a rise in civil society
and the nonprofit sector must grow to respond to this. The opportunity lost for not
doing so is lack of economic growth, a stunted societal development, loss of social
stability, the overburdening of the government structure and worst of all, a
dependency mentality of the people.

***

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