Islamic finance - alternative finance investment bonds - Sukuk
The measure
In Finance Act 2007, the UK Government introduced the Alternative Finance Investment Bond rules which were an important first step in facilitating sukuk issuance in the UK. However, tax barriers still remained from the issuer's perspective. (Sukuk are tradable financial certificates complying with Shariah law which equate in substance to conventional debt.)
Finance Bill 2009 will introduce relieving measures for stamp duty land tax, capital gains and capital allowances rules for land transactions involved in connection with the issuance of sukuk. The changes are intended to remove the previous tax barriers that essentially prevented the issuance of real estate backed sukuk by UK corporates - thus enabling sukuk to be held, issued and traded without incurring stamp duty land tax and corporate tax costs over and above that which would be incurred in connection with similar dealings in traditional corporate bonds.
Under draft legislation published for consultation in the run-up to the Budget, the reliefs will broadly apply where land is transferred by one person to a bond-issuer ("the first transaction") to be held by the latter for the purpose of the issuance of an alternative finance investment bond until the termination of the bond (no later than 10 years) at which time ownership of the land reverts back ("the second transaction"), and, for the purpose of generating income or gains for the bond, the bond-issuer and the original owner enter into a leaseback agreement. The first and second transactions are to be relieved from stamp duty land tax and tax on chargeable gains - subject to satisfying six conditions. A pre-existing stamp duty land tax relief for sale and leaseback arrangements is intended to provide a complete exemption for the acquisition of the leaseback. The originator will also retain the right to claim capital allowances. In effect, the transfer will be ignored and for tax purposes the originator will continue to be treated as holding the assets.
Who will be affected?
The changes will affect UK corporates wishing to raise real estate backed funding in a Shariah- compliant manner in order to access a wider investor population.
When?
The relief from stamp duty land tax and from tax on capital gains will be available in respect of land transactions whose effective date for stamp duty land tax purposes is on or after the date that Finance Bill 2009 receives Royal Assent.
The UK Government continues to take steps towards creating a level playing field between Islamic and conventional finance and promoting the UK as a centre for Islamic Finance. These changes should generally be welcomed by UK corporates (not just those Shariah-compliant organisations) in facilitating fund raising from Islamic investors.
However, there remain some practical points regarding the application of the draft legislation as currently published which could give rise to a claw-back of the above tax reliefs in certain benign yet commercial situations. In our view, it would be fairer for no claw-back of tax relief to arise or for carve-outs to be included to deal with circumstances where the relevant conditions for the tax relief are not met for reason of events outside the bond-issuer's control.
In addition, we note that the principle of relieving the first transaction may arguably place sukuk transactions at an economic advantage compared to issuances of normal asset-based securities which can attract stamp duty land tax on the sale element of the transaction, which, subject to satisfying conditions, shall be relieved under sukuk.
The Islamic banking sector will be disappointed that there have been no further announcements from the Government regarding the likelihood of issuing sovereign sukuk since the Government's pronouncement in December 2008 that this would "not offer value for money at the present time". Given the borrowing requirements outlined by Mr Darling today this position may need to be revisited.
