When Islamic finance started to develop from a niche market to a main stream alternative market, especially in the last decade with the liquidity power of the petrodollar, the main financial centres started to take action to try to attract this special type of investments.
Luxembourg followed the same trend, which resulted in the setting-up of a special task force by the Luxembourg Minister of Finance in April 2008, aimed at identifying how Luxembourg could better take advantage of the business opportunities offered by the Islamic finance market stream. The ambition of this task force was to identify and then take measures to remove any legal and/or tax obstacles possibly hindering the developments of such activities in Luxembourg.
The members of this task force quickly realised that Luxembourg already offered the necessary legal and tax environment, plus the necessary business infrastructure and service platform for Islamic financial activities to develop, in other words that there were no substantial obstacles and therefore no reform required at the level of the general legal framework. As an evidence of this fact, it is worth noting that the first Islamic institution in Europe was set-up in Luxembourg in 1978, and then the first Shariah-compliant insurance company in Europe was established in 1983 in Luxembourg (Solidarity Takafol SA). Furthermore, the Luxembourg Stock Exchange was the first to list Islamic bonds (Sukuk) in continental Europe in 2002.
The fact that Islamic finance transactions can easily fit into the existing legal and tax framework in Luxembourg, and more generally in all conventional jurisdictions, can easily be explained. Those transactions are, generally speaking, based on the same economic rationale as their conventional counterparts, the only difference lying in the fact that, in their structuring, they must comply with certain additional Shariah-compliance requirements, mainly the prohibition of interest (Riba); prohibition of excessive uncertainty or speculation (Gharar); and prohibition of illegal (non-Halal). It also means that any conventional financial transaction could also be flagged as Shariah-compliant if, although in an involuntary manner, it complies with such restrictions.
The assessment made by the Luxembourg task force nonetheless made it clear that, in addition to strengthened marketing efforts, further minor legal and tax steps needed to be taken in order for Luxembourg to keep the lead in this industry in Europe, in a position to compete with London and Paris that has, at the time, already make some tax reforms to avoid a double taxation in the context of Murabaha transactions.
Recent Legal Clarifications in the Islamic Finance Field
While Islamic finance transactions had, until then, been dealt with within the scope of the existing legal framework, the Luxembourg authorities have adopted, in the last two years, a number of texts, specific to Islamic finance activities, in order to clarify a number of dedicated issued.
The first text specifically referring to Islamic finance activities to be issued by the Luxembourg direct tax authorities on 12 January 2010 was a tax circular, namely the tax circular No° LG-A n° 55 (hereinafter the ‘Circular’). This Circular analyses briefly the main principles of Islamic finance and describes the main Islamic finance products (ie, Murabaha, Musharaka, Mudaraba, Ijara, Ijara-wa-Iqtina, and Istisna). In a second part, the Circular sets out the criteria that needs to be complied with, form the perspective of the Luxembourg tax authorities, in order for Murabaha and Sukuk transactions to benefit from the same tax treatment as conventional financing products.
However, this Circular was not a real novelty and only came in fact to formalise existing administrative practices. It thus confirmed that, in Murabaha transactions, there is no double taxation on the second sale transaction between the financier and the end-user. For Sukuk, it confirmed that the treatment of Sukuk is identical to the treatment of a loan in conventional finance and Sukuk payments are treated the same way as interest payments for a bond issuer in conventional finance.
Another tax circular n° 749 was issued in 17 June 2010 by the indirect tax authorities (hereinafter the ‘Second Circular’) in order to clarify the tax treatment of Shariah real estate transactions. This Second Circular actually extended to Murabaha and Ijara operations (ie, the main Shariah instruments for real estate transactions) certain existing tax incentives in the field of transfer taxes and VAT.
By reference to the principles found in a circular n° 54 of 22 July 1937, applicable to conventional sale and resale arrangements, the Second Circular confirms that a purchase and resale of immovable property is liable to registration duties based on the acquisition costs and not on the resale price if certain specific criteria are complied with (in particular, the purchaser has to disclose in the purchase deed that that the purchase is realised under a Murabaha contract and a copy of this statement must be attached to the notary deed). It shall be noted, however, that in such a case the initial transfer tax is increased from six per cent to 7.2 per cent. In addition, the Second Circular also clarifies that:
· the difference between the acquisition price and the resale price will be considered as interest and therefore not be subject to registration duties; and
· the sale of shares of a company with substantial immovable property assets is not subject to registration duties.
From another perspective, the Second Circular states that special purpose vehicles (SPVs) created under Murabaha or Ijara contracts are taxable persons for VAT purposes.
On 26 January 2011 the Luxembourg regulator of the financial sector (hereinafter the ‘CSSF’) issued a communication to clarify the treatment of Sukuk according to the Prospectus Regulation. The CSSF wanted to facilitate Sukuk issuance in Luxembourg by evidencing that, with respect to prospectus requirements, Sukuk may be treated as asset backed securities or as guaranteed debt securities. Therefore, the CSSF made it clear that Sukuk are subject to the same disclosure requirements as conventional bonds (in other words, there is no additional requirements in consideration of the fact that they are based on underlying contracts).
Notwithstanding the above recent developments, one can nonetheless hope that the Luxembourg authorities will continue in their efforts to clarify how Islamic finance transactions can fit in the Luxembourg legal environment as it would be helpful for the actors within the financial sector that certain other minor aspects be clarified.
As evidenced, Luxembourg already offers a favourable, stable and secure environment for Islamic finance transactions and, more particularly, the recent clarifications made by the Luxembourg authorities clearly show that tax efficiency is also ensured for such transactions (in the same manner as for their conventional counterparts). Equality of treatment between Islamic finance and conventional transactions is thus, as a matter of principle, ensured.