Assessing the application of value added tax on Murabaha and Ijarah as Islamic financial instruments in Saudi Arabia

Abstract The integration of Value Added Tax (VAT) into the financial system of Saudi Arabia has brought about significant implications for Islamic financial instruments, particularly Murabaha and Ijarah. These Shariah-compliant contracts, which are fundamental to Islamic finance, operate on unique legal and commercial principles distinct from conventional finance. The application of VAT poses critical challenges regarding compliance, interpretation, and consistency with Islamic legal doctrines. This study explores the practical and legal dimensions of VAT implementation on Murabaha and Ijarah in the Saudi context, identifying key issues of compatibility and economic impact. The objective is to assess the extent to which VAT regulations accommodate the specificities of Islamic finance, evaluate stakeholder responses, and determine whether current tax policies hinder or support the growth of Shariah-compliant products. The results reveal notable inconsistencies and ambiguities in the VAT treatment of these instruments, particularly in how deferred payment structures and lease-based ownership transfers are taxed. This study lies in its contextualized legal-economic analysis of VAT on Islamic financial products within a jurisdiction governed by both Shariah and modern regulatory frameworks. It highlights the tension between fiscal policy and religious compliance, offering a unique perspective on tax harmonization in Islamic economies. The VAT serves national revenue goals; its uniform application may inadvertently burden Islamic financial institutions and compromise Shariah principles. The study recommends tailored VAT guidelines that recognize the distinctive nature of Murabaha and Ijarah, increased consultation with Shariah boards, and capacity-building for tax authorities.