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IIBI LECTURES NEWHORIZON October–December 2008 Promoting Islamic finance July: UK taxation of Islamic finance – levelling the playing field Mohammed Amin, MA FCA AMCT CTA (Fellow), tax partner at PricewaterhouseCoopers LLP and head of the firm’s Islamic finance practice in the UK, reviewed the tax law changes the UK has made since 2005 to facilitate Islamic finance, and assessed whether the playing field is now level. Amin is a member of the Council of the Chartered Institute of Taxation, of the Policy & Technical Committee of the Association of Corporate Treasurers and of the HM Treasury Islamic Finance Experts Group. He is also chairman of the Muslim Council of Britain’s Business & Economics Committee and member of the IIBI editorial panel of NewHorizon. The lecture began by explaining why UK tax law needed to change to enable Islamic finance transactions to be carried out without excessive tax costs. Amin contrasted two transactions, which from the customer’s perspective have identical economic consequences and identical net cash flow. Diagram 1 below shows the purchase of a machine financed by conventional bank debt, with a loan of £1000 to be repaid after two years with rolled up interest of £100. Diagram 2 below shows the purchase of a machine with Islamic finance, which the bank provides through a murabaha transaction. The customer purchases the machine from the bank for £1100 which is payable in two years time. Although the two transactions result in the customer obtaining a machine immediately and paying £1100 in two years time, under UK tax law prior to modification, the tax consequences of the two transactions were very different. In the case of the conventional transaction, the customer claims capital allowances on a machine costing £1000 and deducts £50 in years one and two as interest expense. Capital allowances are a deduction for the cost of the machine, which in general would be given at 20 per cent per year on a Diagram 1 Conventional purchase Diagram 2 Islamic purchase 30 IIBI www.newhorizon-islamicbanking.com
NEWHORIZON Shawwal–Dhu Al Hijjah 1429 IIBI LECTURES reducing balance basis, so the cost of the machine can only be amortised over a number of years. With the Islamic transaction, the customer claims capital allowances on a machine costing £1100. As the capital allowances are given over an extended period of time, the customer’s tax relief with the Islamic transaction would be deferred further into the future than with a conventional purchase where the finance cost of £100 is deducted over the first two years. Overall, the Islamic transaction would be treated less favourably than the conventional transaction. Having illustrated the problem, Amin then went on to explain how UK tax law has been modified with the goal of equalising the tax treatment. He explained that, strictly speaking, the UK has no tax law for Islamic finance. Instead, the legislation reveals a fundamental principle that the same tax law should apply to all citizens, regardless of religion, and that the tax treatment of a transaction cannot be allowed to depend on whether or not it is Shari’ah-compliant. Instead, UK law now defines certain types of transactions, carefully using language that is completely neutral regarding religion. Amin illustrated this with the text of Finance Act (FA) 2005 s.47, which defines a transaction called ‘purchase and resale’ that happens to correspond to murabaha. The legislation then separates the mark-up in the transaction (£100 in the example above) and treats it in the same way as interest is treated for tax purposes. The table below sets out the UK tax law concepts Amin covered, and the Islamic transactions to which they correspond: Tax law Purchase and resale Deposit Profit share agency Diminishing shared ownership Alternative finance investment bond After covering the tax rules in more detail, especially those for alternative finance investment bonds (sukuk), Amin addressed some of the remaining problem areas. He illustrated one problem with the Diagram 3 below: Diagram 3 Islamic refinancing In this example, a customer already owns a property now worth £100, but which was originally acquired, perhaps some years ago, at a cost of £20. With conventional finance, the customer could simply borrow money secured on the property. However, if the customer wants to raise finance in a Shari’ahcompliant way using the property, he will need to sell the property to the bank, rent it back, and then eventually repurchase it. The stamp duty land tax rules (SDLT) for Islamic finance ensure that no SDLT arises on such an Islamic refinancing, provided it is carried out with a financial institution as defined for tax law. However, there has been no equivalent development of the capital gains tax rules. Accordingly, the sale of the property to the bank for any price above £20 will trigger a taxable capital gain, even Islamic finance Murabaha Mudarabah Wakala Diminishing musharakah Sukuk though the customer will be committed to repurchasing the property in due course. ‘A level playing field for Islamic and conventional finance remains several years away. However, the UK has made good progress,’ concluded Amin. October preview: Surviving the credit crunch – Shari’ah-compliant retail investment opportunities The love affair with bricks and mortar has been especially pronounced within the UK Muslim community, who have historically embraced property as a low-risk ‘Shari’ahcompliant’ alternative to conventional investments. The credit crunch and resulting property market price fall have dramatically underlined the need for investors to hold a diverse range of assets. Bashir Timol, director of 1st Ethical, a UK-based independent financial advisers firm, will analyse what Shari’ah-compliant investments are currently being developed by retail product providers in light of current market conditions and assess which existing conventional investments can be adapted to meet Shari’ah requirements. The lecture will take place on 16th October at 6.30 pm at: British Bankers’ Association Pinners Hall 105–108 Old Broad Street London EC2N 1EX There is no charge to attend the lecture but you must register. To register, please visit: www.islamic-banking.com www.newhorizon-islamicbanking.com IIBI 31
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Page 6 and 7: NEWS NEWHORIZON October-December 20
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