Islamic Banking

UK Budget Changes for Islamic-Compliant Finance

John Challoner and Louise Higginbottom Norton Rose 5 April 2005

UK Budget Changes for Islamic-Compliant Finance

The UK's Finance Act 2003 provided relief from stamp duty land tax for certain Sharia’a mortgages. These are financial products which are aimed at (but not restricted to) UK Muslims and involve transactions where, broadly, a bank acquires a house or other building and agrees to sell or lease the property to an individual in a way which avoids the payment of interest. The relief only applies to transactions entered into by individuals, and only applies to transactions known as morabaha and ijara.

Two changes are proposed to this legislation. First, technical changes are being made so that the relief can be applied to ijara leases in Scotland. Scottish property law has the effect that these products cannot be structured to benefit from the reliefs.

Also, the law is being amended to make it clear that a particular form of ijara lease known as “diminishing musharaka”, under which beneficial ownership in the property passes to the customer in tranches, will qualify for the relief. Whilst these changes are welcome, it is unfortunate that the opportunity has not been taken to extend the benefit of the relief beyond individuals. It is not clear why transactions involving companies are excluded. These changes will apply from Royal Assent.

Islamic Banking Products

Increasingly over the last few years, UK financial institutions have been offering sharia’a compliant banking products; indeed, the Islamic Bank of Britain offers only such products. Historically, marketability of these arrangements has been inhibited by the tax treatment. Transactions such as morabaha and mudaraba (a form of partnership arrangement) involve profits being generated which are not interest.

This can result in payments by the financial institution being treated as distributions of profits, and not deductible and has given rise to uncertainty as to the correct tax treatment for customers.

The Finance Act 2005 will contain provisions, effective for transactions entered into on or after 6 April 2005, which aim to put such products on a level playing-field with non-sharia’a-compliant products. It is expected that basic rate income tax will be deductible from payments of profits where this would apply to corresponding payments of interest. Customers will receive a credit in respect of this tax, and their tax affairs will be greatly simplified.

The financial institution will also obtain tax relief for the payments. These changes are very welcome. However, the detailed rules will need to be considered in the context of other finance transactions which are not designed to comply with Islamic law but which generate returns which are equivalent to interest, to ensure that these new provisions do not apply to them.

This article is a general guide only and is not intended to be definitive advice which should be sought as appropriate in relation to a particular matter. If you would like to discuss a particular matter, please contact the authors.

Register for WealthBriefingAsia today

Gain access to regular and exclusive research on the global wealth management sector along with the opportunity to attend industry events such as exclusive invites to Breakfast Briefings and Summits in the major wealth management centres and industry leading awards programmes