COMMENT

October 2006
NewHorizon
With the growing realisation of the importance of interest-free financing, Muslims continue to seek alternatives that adhere to Islamic concepts. But Shariah-compliant products have posed challenges for governments who have been used to working with a conventional taxation structures; which often impact on the transaction cost of Shariah-compliant products, thus hindering their growth. A firm support from authorities, particularly in the West, is required to resolve such issues and UK is a notable case where the government is supportive of the development of Islamic financial serv­ices.

With the emergence of Islamic finance in the international financial arena in the last three decades, and the role of London in the development of various Shariah-compliant structures for both UK and non-UK companies, there is increasing debate about the implica­tion of the tax treatment of these struc­tures. If the taxation of such structures is not levelled with the conventional ones, of course, it will stifle the inno­vation and growth of the Islamic financial sector.

Interest-based home finance products do not comply with Islamic law, but Islamic law can accommodate con­tracts to facilitate house purchases. Initially, the Islamic mortgages were offered in the UK, based on the Murabahah and Ijara instruments. Murabahah products - where an insti­tution buys and re-sells the home to the consumer, accepting payment of the price over a lengthy period; Ijara home financing products - where the institution combines a sale with rent­ing the un-owned share of the proper­ty to the consumer meeting the same purpose as a ‘regular mortgage prod­uct whilst also complying with Islamic principles.

The Murabaha product was first offered in the UK by the Islamic Investment Banking Unit of the United Bank of Kuwait (now Ahli United Bank) in 1997 as the Al Manzil Home Purchase Plans, however with some drawbacks. The Ijara plan fol­lowed in 1999. Prospective Muslim homeowners complained that it was more expensive than conventional mortgages, as under the Murabaha Plan, the bank purchases the property (the original purchase price) from the vendor on behalf of the potential buyer, then sells the property to the potential buyer at a slightly higher price “The Murabaha sale price” (incorporating the bank’s profit on the deal). The UK tax authorities levied stamp duty on the higher Murabaha sale price rather than on the lower original purchase price. This was obviously an extra burden on the Muslim buyer, who was in effect, being penalised by the UK tax author­ities. On the other hand, under the Ijara product, stamp duty was payable twice, once when the bank purchased the property and again under the trans­fer of title which gave ownership to the customer at the end of the transac­tion.

These plans were devised to create ways acceptable from a Shariah point for the Muslim buyer, to finance the purchase of his/her home. With these problems of the added cost, the market was becoming very uncompetitive for Islamic mortgages, the effect of which was that majority of Muslims in the UK were not able to afford the prod­ucts. There are encouraging signs from the UK Government to resolve this taxation issue of Shariah-com­plaint instruments, introducing legis­lation in relation to taxation as well as regulation to ensure a level playing field for Islamic finance products while at the same time enabling the consumer to make informed choices and offering valuable consumer pro­tection. This move was first initiated in the Finance Act 2003 for Ijara home purchasing plans with the abolishing of the double stamp duty. Finance Act 2004, 2005 and 2006 have further extended the support for the balanced tax treatment of various Shariah-com­pliant structures under the ‘alternative finance arrangements’.

As the number of Institutions offering Islamic financial services in the UK increases, more and more innovative Shariah-compliant products will be developed and with it new issues on the tax treatment of these products will arise. With the support already being extended by the UK tax and reg­ulatory authorities in the development of Islamic financial services, these new issues are also likely to be resolved. London will keep playing its leading role in the development of a successful and vibrant Islamic finan­cial services industry, not only in the West but also globally. At the same time, to become part of the main­stream financial system, institutions offering Islamic products and services in the UK would need to ensure that they are fully able to exploit the opportunities offered by this con­ducive environment to meet the needs of the Muslim retail market customers and compete with conventional mar­ket products while maintaining a com­petitive edge in quality banking, and customer service.

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