Islamic Finance Legislation – Selected UK Experience Puzant Merdinian, SJ Berwin LLP April 2009 CP2: St East and Central Africa Conference on Islamic Banking

Agenda Government objectives Areas needing legislative change Brief legislative history Q&A 1 St East and Central Africa Conference on Islamic Banking

The UK Government Objectives To enhance the UK's competitiveness in financial services by establishing the UK as a gateway for international Islamic Finance To ensure that everybody, irrespective of their religious beliefs, has access to competitively priced financial products The government has been careful to use language that is completely neutral regarding religion 1 St East and Central Africa Conference on Islamic Banking

Select Areas Needing Legislative Change Stamp Duty Land Tax Direct Tax Capital Gains Tax Withholding Tax Value Added Tax Regulatory treatment of Alternative Finance Investment Bonds (“AFIBs”) 1 St East and Central Africa Conference on Islamic Banking

Early Attempts Finance Act 2003 amended the SDLT treatment "SDLT Shariah loophole" was closed down in 2008 SDLT solutions for purchase and resale transactions 1 St East and Central Africa Conference on Islamic Banking

Wholesale Changes to Legislation Finance Acts 2004, 2005, 2006, 2007 Income Tax Act 2007 (supplemented previous tax legislation contained in ICTA 1988) Finance Act 2008 (created new powers for HMRC to enact secondary legislation) Corporation Tax Act 2009 (contains standalone chapter 6 on Alternative Finance Arrangements and grants amendment powers to HMRC) Taxation of Chargeable Gains Act St East and Central Africa Conference on Islamic Banking

Alternative Finance Returns The legislation is designed to apply to: –purchase and resale transactions; –diminishing share ownership transactions; –alternative finance investment bonds; –profit share arrangements; and –profit share agency "Premium" to financial institutions viewed as interest for taxation purposes Requirement for a financial institution (s. 46 Finance Act 2005, replaced for corporation tax purposes by s. 502 Corporation Tax Act 2009) Loan relationship or classification as interest/expense 1 St East and Central Africa Conference on Islamic Banking

Taxation of AFIBs Finance Act 2007 (replaced in part by the Corporation Tax Act 2009) If certain conditions are met: –the amounts payable by the sukuk issuer to sukuk holders will be deductible for the issuer under the loan relationship regime –the amounts payable for sukuk will be taxed at the hands of the sukuk holders as interest or under loan relationship rules –the bondholder is not treated as having an interest in the sukuk assets 1 St East and Central Africa Conference on Islamic Banking

Taxation of AFIBs cont’d Conditions: –The arrangements must provide for a person (the bond holder) to pay a sum of money (capital) to another (the bond issuer); –The arrangements must identify assets that the bond issuer will acquire (the bond assets) to generate income or gains (direct or indirect); –The arrangements must have a specified life (the bond term); –The bond issuer must undertake to: (i) dispose of any bond assets at the end of the bond term; (ii) make a repayment of the capital (redemption payment) at the end of the bond term; and (iii) pay other amounts (additional payments) to the bond holder on one or more occasions before the end of the bond term 1 St East and Central Africa Conference on Islamic Banking

Taxation of AFIBs cont’d –The additional payments must not exceed a reasonable commercial return on the loan of the capital; –The bond issuer must arrange for the bond assets to be managed with a view to generating income sufficient to pay the redemption payment and the additional payments; –The bond holder must be able to transfer his rights under the arrangements to another person; –The arrangements must be listed on a recognised stock exchange; and –The arrangements must be treated under International Accounting Standards ("IAS") wholly or partly as a financial liability of the bond holder (whether or not the bond-holder actually uses IAS) 1 St East and Central Africa Conference on Islamic Banking

Stamp Duty Land Tax for AFIBs June 2008 UK Government consultation paper February 2009 response document proposes the following requirements to achieve an exemption from SDLT: –The asset must be defined and returned to the originator within the same period as the sukuk issuance (10 years maximum); –there must be a legal charge over the asset in favour of HMRC; –asset substitution allowed, but with constraints; –the asset must be returned to originator to avoid SDLT charge; –the issuer must issue bonds up to 60 per cent of asset value; and –wide ownership required (no bondholder control) 1 St East and Central Africa Conference on Islamic Banking

Value Added Tax December 2006 – HM Revenue & Customs VAT Information Sheet applies to: -purchase and resale transactions -diminishing share ownership transactions -profit agency and profit share arrangements -Islamic current accounts 1 St East and Central Africa Conference on Islamic Banking

Regulatory Treatment of AFIBs The current status and issues FSA and HM Treasury consultation paper proposals: –FSMA 2000 (Regulated Activities) Order 2001 to be amended to include AFIBs as a specified investment on the same basis as instruments creating or acknowledging indebtedness –AFIBs would be excluded from the CIS definition by amending FSMA 2000 (Collective Investment Schemes) Order 2001 –A unique definition of AFIBs to be created consistent with the tax definition in the Corporation Tax Act 2009 –AFIBs to be subject to mandatory listing requirements 1 St East and Central Africa Conference on Islamic Banking

1 St East and Central Africa Conference on Islamic Banking