(MENAFN - Arab News) FOLLOWING the recent circular from the Luxembourg tax authorities describing the major principles and contracts of Islamic finance and their respective tax treatment, most financial market players have welcomed the measures.
However, one advisory firm, Dananeer for Islamic Finance Consulting and Training Services, has called for further clarification, especially relating to the qualifying conditions attached to Murabaha transactions.
In a statement last week, Dananeer stressed that the conditions may have implications from a Shariah perspective.
The Luxembourg minister of finance led the praise for the director of contributions for introducing the Islamic finance circular, and market players stress that it shall lift one of the hurdles which have, until now, prevented Luxembourg from being the leader in Islamic finance in Europe.
Luxembourg financial market specialists such as Marc Theisen, partner at the prominent law firm, Theisen Schiltz, and Claude Zimmer of Luxembourg Global Trust, one of the leading tax advisers in the Duchy, told Arab News that by issuing the circular, the Luxemburg tax authorities confirmed the most liberal approach to Islamic financial transactions - the taxation over the period of the deferred payment for Murabaha contracts and the tax neutrality for the issuance of sukuk through special purpose vehicles (SPVs) established in Luxemburg.
The proposed tax treatment, they added, "is perfectly in line with the continued efforts of the Luxemburg government to sustain the Duchy as the best or one of the best leaders in international financial engineering centers. It is a very pragmatic and open-minded position taken by the tax authorities. This innovation and pragmatism is not new and has happened many times in the past. The fund industry in Luxemburg was the first mover with many structures including UCITs, with its success we all know. Luxembourg is number one in Europe and No. 2 in the world for cross-border distribution. It also has the most favored trademark tax regime at approximately 6 percent. The circular on Islamic finance is just the latest manifestation of this pragmatism and innovation, especially in this new field, which is showing rapid growth worldwide. We have to commend the Luxembourg government and financial regulatory authorities for this far-sighted policy."
However, they did acknowledge that the Luxembourg authorities do need the technical assistance and intellectual engagement from Islamic finance experts and Shariah scholars from abroad, including professional bodies such as the Kuala Lumpur-based Islamic Financial Services Board (IFSB), so as to leverage its policies and measures on Islamic finance.
Indeed, in November 2009 the IFSB Council admitted Banque centrale du Luxembourg, the central bank, as an associate member, thus making Luxembourg the first European Union country to become a member of the IFSB, whose mandate is to set prudential and regulatory standards for the global Islamic financial sector. Perhaps equally importantly, the Banque centrale du Luxembourg will also second staff to the IFSB so that they can become familiar with Islamic finance concepts and study the various issues, notably liquidity and risk management.
The circular covers a whole range of Islamic finance products including Murabaha, Musharaka, Mudarabah, Istisna, Ijarah, Ijraha wa Ikitina and Sukuk (Islamic bonds). According to the preamble of the circular, "Islamic finance involves financial instruments used by investors who wish to manage their investments observing the values of Islam. The objective of Islamic finance is to share profits and losses between those who provide the capital and those who use it." The director of contributions identifies two Shariah principles that merit particular attention: "third party" capital providers (such as banks for instance) cannot in principle play a passive role, but must in contrast act as true "partners"; and the prohibition on lending money (with interest) to third parties.
But last week, Dananeer for Islamic Finance Consulting and Training Services, a company recently established in the Benelux countries, while welcoming the Circular called on the director of contributions to clarify and reconsider some of the conditions relating to the tax treatment of Murabaha transactions from a Shariah point of view. Some of the senior people involved in Dananeer include Mohamed Boulif, formerly with the Dar Al-Maal Al-Islami (DMI) Group in Geneva, Sufian Bataineh, S. Quraishi and H. Bouchella.
Indeed, the current tax law provisions when applied to Islamic finance transactions lead to a double taxation of Murabaha transactions.
The circular aims, by defining specific requirements, to establish a level-playing field between conventional and certain Islamic finance transactions, namely Murabaha and sukuk.
Murabaha is the sale of a commodity for a deferred price which includes an agreed profit added to the cost. The circular indeed treats Murabaha as a sale agreement. Consequently, in principle, the profit realized on that sale is acquired by the financier from the signature of the agreement and the entire proceeds of the sale are taxable immediately, including the financier's margin, otherwise called its profit.
Nevertheless, to the extent that, on an economic level, the financier's profit constitutes the remuneration for a deferred payment during that period, that profit may benefit from a spread of taxation on the proceeds for continuous or discontinuous services at successive maturities, remunerated in particular by rents. In other words, the profits are taxed on a linear basis over the term of the payment deferment, whatever the reimbursement.
The above benefits, however, are subject to certain conditions, including: a) the agreement between the parties must clearly highlight the fact that the financier acquired the property in order to resell it, concomitantly or within a period which may not exceed six months, to its client; b) the agreement must separately indicate the specific remuneration of the financier for its involvement, with the financier's profit constituting the compensation for a payment deferment, the client's acquisition price and the price for acquisition of the property by the financier; c) the financier's profits must be clearly stated, known and accepted by the two parties to the agreement; d) the financier's profits must be expressly indicated as being compensation for the service provided by the financier to the client which results from the effective deferment of payment granted to the investor.
There may for example be a clause presenting the profits as "compensation for the payment deferment granted to the purchaser by the vendor, the purchaser undertaking to pay the vendor the profit until the date of final reimbursement"; and with regard to accounts and fiscal aspects, the profits must be spread by the financier on a linear basis over the period of the payment deferment, whatever the reimbursement. — M.P.
From a Shariah perspective, stressed Dananeer in a statement, the above conditions are not a problem except for the first one (a).
The practical implementation of the first condition, explained Dananeer, is likely to trigger questions. Murabaha, the statement added, has originally never been considered as a financing instrument. "It is a newly-developed product that has been derived in order to avoid the accruement of interest (the prohibited Riba) in loan transactions which is a pillar of the modern financial system. Shariah scholars have allowed Murabaha as a method of financing provided, however, that certain strict conditions are complied with. One of the main conditions is that the commodity must be in the ownership and physical possession of the seller at the time of sale.
"Therefore, when a potential purchaser of a commodity approaches a financing party to finance such a commodity, the financing party cannot enter into a sale contract simply because he is not yet the owner of that commodity. As a result, one of the issues raised by the first condition from a Shariah perspective is: How the parties can state in the sale contract that the seller acquires the commodity in order to resell it to the purchaser?" it continued.
By Mushtak Parker