Finance and Treasury blog

Foreign investors applying Shariah compliant finance when investing into the United Kingdom

I was recently asked to contribute an article to the Winter 2007 edition of “economic focus” which is the magazine of the Arab British Chamber of Commerce.

In the previous edition, an article had surveyed the recent changes to UK tax law intended to facilitate Islamic finance, explaining that the goal is equal tax treatment for Islamic finance products. Accordingly, I decided to follow on by considering the practical application of Islamic finance to two common cross border investment scenarios, namely the purchase of an investment property and the purchase of a trading company.

The article is reproduced below with the consent of the editor.

Assumed fact pattern

Envisage an individual Arab investor resident in the Middle East, who intends to invest in the UK.  The individual may either have enough funds to make the investment, or he or she may need to borrow part of the total investment from a bank.  Consider two different investments:

(1) an investment property in the UK

(2) the shares of a UK trading company

For simplicity, assume that the individual is resident in a country which has no local income tax, and also has no double tax treaty with the UK.

Purchase of UK investment property – conventional finance

When planning this investment, the individual needs to consider some key UK tax points:

• The UK charges inheritance tax on assets situated in the UK, even if the owner is resident and domiciled overseas.
• UK source rent is taxable at 22% when paid to recipients who are not UK resident.
• The UK charges UK residents capital gains tax on gains made from selling investment property, but does not charge non-resident investors on such capital gains.

Diminishing Shared Ownership for property acquisitions with Islamic finance

I was recently asked to contribute an article on Islamic finance for the January 2007 edition of PwC’s client newsletter “UK Real Estate Insights.” I decided that readers might be interested in learning about the changes to UK tax law that have been enacted to facilitate diminishing musharaka.

A copy of the article is reproduced below:

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Many devout Muslims consider that Islam prohibits the receipt or payment of interest. Historically, this has precluded them from using mortgage finance for property acquisitions. Although Islamic finance has developed alternative acquisition structures that avoid the payment of interest, in a UK context without complex tax planning, such structures typically gave rise to additional tax costs compared with a conventional mortgage, such as double stamp duty or a lack of relief for finance costs; hence the need for legislation.

Over the last few years, tax law has been amended to facilitate property acquisition through shared ownership. The main driver for this has been a desire to make the tax system more inclusive, by creating a level playing field for Islamic housing finance compared with conventional mortgage finance. However everyone needs to be aware of the rules as the legislation is applicable to any transaction falling within its definitions, and can benefit non-Muslims as much as Muslims. In this article, Mohammed Amin considers the current tax treatment of one common structure used for Islamic mortgages, namely “diminishing musharaka”, or “diminishing shared ownership” as it is called in FA 2006. Although the legislation has primarily been aimed at facilitating the finance of housing through a domestic mortgage equivalent, it is applicable more broadly to property finance and may provide an alternative to the “Ijara” arrangements usually implemented for financing real estate investment.