Contracting conceptsAccommodation of concepts
Mudarabah – profit sharing partnership separating responsibility for capital investment and management.
The entry into a mudarabah arrangement is acceptable for a UK entity or person as it would be treated as akin to a partnership arrangement wherein the investor (rab-al-mal) contributes the capital and the recipient (mudarib) provides professional or managerial expertise to carry out the venture to earn a profit that is shared between the rab-al-mal and the mudarib under an agreed ratio.
Where a mudarabah is used for deposits with a bank, care must be taken to ensure any deposit complies with the definition of ‘deposit’ in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (as amended) (RAO). While a traditional mudarabah requires that the rab-al-mal bears the risk of any loss on the deposit, the RAO requires that to be classified as a deposit under article 5(2) of the RAO, the depositor must be entitled to the right to repayment, whether on-demand or under terms agreed. The Financial Conduct Authority (FCA)’s solution to this and to ensure that Islamic deposits are categorised as protected deposits under FCA rules (and therefore that customers who deposit funds with IFIs receive equivalent deposit protection to conventional depositors under the Financial Services Compensation Scheme) was that depositors under a mudarabah would be entitled to full payment of the amount deposited (thereby satisfying the RAO requirement). Because this could be construed as a guarantee of the deposit by the mudarib and depart from the principle that the rab-al-mal bears the risk of any loss on the deposit, the rab-al-mal would, however, have the right to opt-out of the deposit protection subsequently on religious grounds and choose to be repaid under the risk-sharing methodology reflecting a traditional mudarabah. In 2017, Dana Gas (an issuer based in the United Arab Emirates) attempted to render its mudarabah sukuk unenforceable on several grounds, one of which was that the sukuk were not shariah-compliant because they featured what appears to be a guarantee from the mudarib of the face amount of the sukuk contrary to the risk-sharing methodology reflecting a traditional mudarabah. While Dana Gas had sought to bring proceedings to adjudicate on this matter in the Sharjah Federal Court of First Instance, several of the sukuk documents were governed by English law, and so Dana Gas had also sought and obtained an interim injunction in the English High Court preventing the sukuk holders from declaring an event of default or dissolution event concerning the sukuk. On 17 November 2017, the English High Court ruled against Dana Gas on all grounds.
Murabahah – cost plus profit agreement.
Murabahah transactions can generally be implemented under English law. As in economic terms, the murabahah is akin to a loan, the transactions would be classified as loans for International Financial Reporting Standards (IFRS) purposes.
Concerning the taxation of a murabahah transaction, before the introduction of section 57 of the Finance Act 2005 (replaced by section 564C of the Income Tax Act 2007 and sections 503 and 511 of the Corporation Tax Act 2009), the profit paid by the customer to the bank would not have been tax-deductible by the customer. However, since the new legislation came into effect, subject to satisfying the applicable preconditions, the profit would now be treated as interest payable during the period of the loan and hence qualify for a tax deduction.
Where the assets acquired by the bank under the murabahah transaction include real property, while SDLT would otherwise have been levied on both the purchase of property by the bank and the subsequent sale to the customer, since the introduction of section 73 of the Finance Act 2003, provided certain conditions are met, no SDLT is payable on the subsequent sale of the property by the bank.
For value added tax purposes, HM Revenue and Customs treats the sale of the asset by the vendor and the onward sale by the bank to the customer under the normal value added tax rules, which will be dependent on the nature and location of the asset.
Musharakah – profit sharing joint venture partnership agreement.
It is permissible for a UK entity or person to enter into a musharakah arrangement because it is akin to a joint venture or partnership arrangement. However, care should be taken to determine whether the musharakah arrangement could fall within the broad definition of ‘collective investment scheme’ in the Financial Services and Markets Act 2000 (FSMA). To the extent the musharakah arrangement is considered a collective investment scheme, the IFI may need to apply for permission under the FSMA.
A musharakah where each partner’s share in the capital remains constant would be treated as a partnership and therefore be transparent for tax purposes, which means that the profits of the partners would be taxed.
In the case of a diminishing musharakah, following the enactment of section 47A of the Finance Act 2005 (replaced by section 564C of the Income Tax Act 2007 and sections 503 and 511 of the Corporation Tax Act 2009), and provided that the specified conditions are met, the return paid to the financier is now treated as if it interested payable on a loan and is tax-deductible.
Ijarah – lease to own agreement.
An ijarah will generally be classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership to the lessee. If all the risks and rewards incidental to ownership are transferred to the lessee, such an ijarah is likely to be categorised like a finance lease. An ijarah munthahiyah bi-tamlik (lease to own) is akin to conventional hire purchase and so would be accounted for in the same way as a finance lease.
Wadiah – safekeeping agreement.
Wadiah agreements are not commonly used in the United Kingdom, but the entry into such an agreement should be possible provided the applicable regulatory requirements are met.
Law stated dateCorrect on
Give the date on which the information above is accurate.
31 July 2020.