Isfin Islamic Finance In Western Countries(Regulatory & Legal) Arendt
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How to implement Islamic finance principles within the Western existing regulatory and legal framework:Luxembourg focus
May 12, 2011
Contents
I. Introduction to Islamic finance in Luxembourg 3
II. Legal tax framework
A) Tax in Luxembourg 5
B) Tax and Islamic finance 6
III. Existing opportunities in Luxembourg
A) Regulated structures
1. Overview 7
2. UCITS as an illustration 8
B) Non-regulated structures 9
C) Sukuk and structure products 15
IV. Conclusion 21
Private EquityI. Introduction to Islamic finance in Luxembourg
3
I. Introduction to Islamic finance in Luxembourg
1978 First Islamic finance institution established in a Western country (Islamic Banking System, later Islamic Finance House Universal Holdings S.A.)
1983 First Shariah compliant insurance company in a Weste rn country (Solidarity Takafol S.A.)
1990 Other renowned Islamic finance institutions set up Luxembourg establishments: Faisal Finance and FWU Group
4
establishments: Faisal Finance and FWU Group
2002 First Western stock exchange to enter the Sukuk mark et (Malaysia Global Sukuk)
2010 Luxembourg Central Bank first EU Central Bank to become a member of the Islamic Financial Services Board (IFSB)
2011 Luxembourg banks requested to join the Islamic Liquidity Management Corporation
2011 First Annual IFSB meeting in a Western country (May 2011)
� 37 Shariah compliant funds and sub-funds created under Luxembourg law as of March 2011
� Luxembourg is the largest European domicile for shariah compliant investment funds
I. Introduction to Islamic finance in Luxembourg (2 )
5
� 16 Sukuk listed on the Luxembourg stock exchange since 2002
� Large number of non-regulated structures
� Specialised teams and dedicated services for Shariah compliant structures and funds offered by Luxembourg service providers
II. Legal tax framework
A) Tax in Luxembourg
� Flexible and secure tax environment
� Advantageous domestic tax system
II. Legal tax framework
� Advantageous domestic tax system
� Well-developed tax treaty network
B) Tax and Islamic finance
� No need for specific legislation for Shariah compliant transactions as thetax system is based on:
� an economic approach; and� a substance over form principle
� Tax Circular on Islamic finance:
� The Luxembourg tax authorities published an administrative Circular related toshariah compliant finance instruments (Circular L.G.-A n°55 dated 12 January2010)
� In particular, the Circular clarifies the Luxembourg direct tax treatment of murabahaand sukuk:
� economic approach confirmed� Luxembourg UCIs investing in Islamic finance instruments are excluded from
the scope of the Circular
III. Existing opportunities in Luxembourg
A) Regulated structures
III. Existing opportunities in Luxembourg
A) Regulated structures
1. Overview
� Broad range of investment vehicles available
� Worldwide distribution capacities to retail and institutional investors
� Integration of Shariah special features:
10
� Integration of Shariah special features:
� Shariah board
� Ban of haram activities
� Exclusion of riba (specific limits)
� Purification of haram income
UCITS
Strong SupervisoryFramework
Retail and institutionalInvestors
2. UCITS as illustration
�Luxembourg law perfectly allows the integration of such specific features inconventional regulated vehicles
UCITS
High Risk Diversification
TS, MMI, UCI, Cash, Derivatives,
No short selling
PassportEU
EEA, Asia, Middle East, Americas
B) Non-regulated structures – Case studies
12
Real Estate Acquisition in Europe
Luxembourg
Shareholder
UAEUAE
LuxCo LuxCo
GCC
PPL and IFL IFL
Equity (1%) Convertible loan (99%)
Shareholder Shareholder Loan
Target Jurisdiction
ItalyCo FrenchCo
Shareholder Loan
Project Company(Jersey)
LuxCoCaymanCo
Private Placement
Memorandum
JVCO(Cayman)
Joint Venture Agreement
Real Estate: UK Mixed-Used Development
Conventional Funding Shariah Compliant Funding
(Cayman)
Finance Company
(Luxembourg)
Occupational Tenants
Private Equity: Shariah compliant transaction GCC-Turkey
Investment Bank & Investors
Offshore SPV
Murabaha & Mudaraba
LuxCo 1
Luxco 2
Real Estate Private Equity Company
Equity, Murabaha
ShareholdersShareholders
Shareholders
Private Placement of Shares
Luxembourg Holding Company S.A.
Holding Structure for a foreign Islamic Bank
Real Estate Education Other
BanksTakaful Re-Takaful
Holding Company Other
Islamic Bank
Tax treatment of Murabaha transaction
� Analysed as a sale, the gain i.e. the difference between acquisition andsales price realised by the financing entity under the murabahatransaction – the “Gain” – being as a rule taxable upon signature of theagreement
� However, the Gain being the remuneration of a deferral of payment(comparable to an interest), in such case possibility of a deferred taxationi.e. taxation on a straight-line basis during the period of the deferral ofpayment
Tax treatment of Murabaha transaction (2)
� The Gain qualifies as interest if:
�pursuant to the murabaha agreement, it is clear that the financing entity acquiringthe asset sells it back simultaneously or in a period not exceeding 6 months
�the murabaha agreement distinguishes between (i) the remuneration of thefinancing entity for its intermediation (ii) the acquisition price paid by thefinancing entity and (iii) the acquisition price paid by the investorfinancing entity and (iii) the acquisition price paid by the investor
�the Gain of the financing entity must be clearly stated, known and accepted byboth parties
�the Gain must be expressly qualified as being the counterpart of the servicerendered to the client and resulting from the deferral of payment granted to theclient and
�from an accounting and tax perspective, the Gain is accounted for on a straight-line basis by the financing entity, irrespective of the actual payments made
C) Sukuk and structured products
Sukuk al Mudaraba/Musharaka structure
Partners(Mudarib/Musharik)
Sharia’h-compliant Sharia’h-compliant
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Sukuk
Issuing sukuk
Risks (Returns or possible losses)
Sharia’h-compliantAgreement
(Mudaraba/Musharaka)
Sharia’h-compliantProject
Luxembourg SPV Investors(Sukuk Holders)
Investors(Sukuk Holders)
Luxembourg SPV
Project Company
Sukuk Payments
Sukuk al ljara Lease (ljara)
Rent
Sukuk al Ijara structure
OccupationalTenants
Sukuk PaymentsRent
RentOccupationalTenant Lease
Sukuk Issuance Platforms in Luxembourg
� Deutsche Bank: Al Miyar S.A.
22
� Dar Al Istithmar: Al Waseelah Capital S.A.
Sukuk Issuance Platform
23
Tax treatment of Sukuk
� Analysed as debt instrument from a Luxembourg tax perspective
� Thus, the remuneration paid to the sukuk holder = interest payment
� remuneration is tax deductible at the level of the sukuk issuer
� not subject to a WHT in Luxembourg
� Remuneration = income from transferable securities
� Luxembourg tax provisions related to typical silent partners andprofit-linked obligations are not applicable
IV. Conclusion
� Luxembourg is a primary hub for the development of Islamic finance
� first European stock market to launch and list Sukuk
� availability of regulated and non-regulated structures compliant with Shariah principles
� first European Member State to be admitted to the Council of the Islamic finance Services Board
⟹⟹⟹⟹ Luxembourg legal framework largely compatible with Islamic finance and suitable for issuance of Shariah compliant products but operational challenges need of industry standards based on IFSB guidelines
Thank you
Florence Stainier, PartnerThierry Lesage, PartnerBishr Shiblaq, Head of Dubai Representative Office
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