Taxation of Islamic finance products: Luxembourg Tax Director answers some FAQs
In January 2010, the Tax Director published a Circular the object of which was to clarify the tax treatment of certain shariah compliant structures. The Circular was well received by the market. Nevertheless, questions have inevitably arisen concerning its application to specific projects. Luxembourg for Finance interviewed Guy Heintz, Tax Director, in order to clarify some points.
LFF : What led the Luxembourg authorities to look at the question of the tax status of Islamic finance projects ?
GH : We had received a great many questions from consultants and product promoters concerning the tax treatment of products they were planning to develop. So we were responding to demand. By issuing Circular L.G.-A n° 55 of 12 January 2010 (the Circular), the Tax office clarified the method of taxation that would be applied to certain Islamic finance instruments. The Circular principally covers tax aspects ofmurabaha and sukuk.
LFF : Can we speak of a level playing field between Islamic finance products and conventional products in Luxembourg?
GH : Yes I think so, given that in economic terms the profit of the financing party, in the framework of Islamic finance, is remuneration for a deferred payment. This profit, providing it meets certain conditions, is comparable to interest income in conventional finance.
LFF : The Circular of 12 January 2010 speaks of murabaha and sukuk. Are other products – such as mudaraba, musharaka, ijara and istisna’a covered by the Circular?
GH: The tax treatment of other products is not analysed in detail in the Circular.Mudaraba and mushararka are considered as equity capital, whereas ijara and istina’aare considered as borrowed capital.
LFF : Some questions have been raised concerning the Circular.
For instance, here is a question concerning murabaha:
In order to meet the conditions required to benefit from tax treatment equivalent to conventional products, the Circular stipulates that «the contract between the two parties must specify that the financier buys the good in order to resell it … to the client»; however, shariah law stipulates that a seller must already be in possession of a good at the moment of its sale. How can both requirements be satisfied? One solution proposed by banks is to break down the transaction into two separate stages. First, the client signs an agreement to buy the good when it has been purchased by the financier. Then, when the financier has bought the good, a sales contract is entered into with the client. If other conditions in the Circular are met, would such an arrangement be recognised by the Tax Office?
GH : The initial unilateral promise is sufficient to satisfy all the conditions.
LFF: I have another question concerning murabaha:
If the client decides not to fulfill his promise to buy the good, can the financier resell the good to another client (perhaps under different financial conditions) and still benefit from the same tax treatment ?
GH: In this case, the same tax treatment is applicable.
LFF: Do you intend to publish another circular on this subject?
GH: Clarification of these points will be made in a circular at the appropriate time.