The government faces an uphill battle to legislate tax benefits for Islamic bond investors at a parliamentary session starting Friday amid sturdy objections from opposition politicians and churches.

The Finance Ministry is pushing for a bill on Islamic bonds, or sukuk, that would grant tax exemption on profits earned by bondholders in a bid to widen Korea’s access to increasing Middle Eastern oil money.

The bill failed to pass legislation in December 2010 largely due to opposition from church leaders and the main opposition Democratic Party.

The Finance Ministry will push a law revision so that sukuk holders are granted the same tax exemptions on profits as other traditional forms of bonds.

Sukuk is different from other debt in that it provides dividends or returns to its holders, not interests, to comply with Islamic law that prohibits charging or paying of interest.

The government expects sale of sukuk to attract low demand in the local market without tax benefits as investors would shun the tax-carrying securities.

The opposition party, however, raises potential dangers about tapping into the Muslim world of finance.

“The sukuks are required to comply with Shariah law before any national law, which includes potentially dangerous contents regarding national security. It also contains elements of cultural and religious conflicts with that of ours so we should not take the risk,” said Lee Hye-hoon, a member of Democratic Party.

Lee brought up the cases of the U.S., France and Germany, all of which do not give tax benefits to sukuks for the dangers stated above.

“Only the U.K., Singapore, and Ireland grant tax benefits on sukuks and we should not benchmark such developed financial clusters at this stage,” she said.

Church leaders, led by the Council of Presbyterian Churches in Korea, say approving the tax would funnel contributions to terrorist activities from zakat, a tax paid by Muslims with wealth to be distributed to the poor and needy.

Granting tax exemption on sukuk “will be like pouring gasoline over a burning fire. That money can be used for terrorism, or money-laundering in our banks,” said Lee Man-sub, head pastor at the Korean Association of Church Communication.

“It’s unfair to give them a tax advantage and with all that money pouring in, they could take control over our economy.”

According to the Korea Investment & Securities, local companies may raise more than $1 billion from sales of Islamic bonds within a year if the bill passes. The parliamentary approval would follow Thailand, where the regulator on Feb. 10 permitted institutions to sell Shariah-complaint bonds.

Skeptics of sukuk speculate the government’s dealings with the United Arab Emirates.

“The government agreed to finance some nuclear power plant projects Korean companies want to build in the Middle Eastern nation. There I see the need for Seoul to grant tax exemption on sukuk to fund the massive capital needed,” Rep. Jun Byung-hun was quoted as saying in an interview this week.

Korea Electric Power Corp., the nation’s biggest electricity provider, won a $20 billion contract to build nuclear power plant in the UAE in December.

Samsung Engineering in April won a $1.5 billion contract to build utility and offsite facilities for a gas project in Abu Dhabi. The government sees a growing need for companies to issue sukuk and lure Middle Eastern capital as trade increases.

“We expect the changed system would help lure money from the wealthy Middle Eastern countries and diversify the nation’s debt-selling routes and risks, while improving the overall borrowing conditions for local companies,” the Finance Ministry said in a statement.

President Lee Myung-bak in December expressed his will to further push the bill after the parliament had rejected the proposal in December.

Speaking favorably of the bill during his trip to Malaysia, he said Korea “also want to participate with Malaysia in financial sectors like bonds, when a possible opportunity arises,” Lee said in Kuala Lumpur in December.

By Cynthia J. Kim (cynthiak@heraldcorp.com)