Determining beneficial ownership in Islamic finance transactions

Registers of beneficial ownership are an important tool in combating corruption, since illicit wealth is often hidden by using trusts (as understood in English law) and similar entities which are found in other legal systems.

I was asked about the implications of such anti-corruption measures for Islamic finance, and wrote about it in my September 2020 column in the magazine "Islamic Finance News." I also used the article to set out some principles for determining where beneficial ownership lies in Islamic finance transactions.

Corruption, beneficial ownership registers, and Islamic finance

People with illicit wealth, often called “black money”, whether obtained through major theft, corruption or tax evasion have a practical problem. What do you do with the money?

Buying real estate or company shares is hazardous, since their ownership is registered. As a poor person, how do you explain where you got the money to buy the assets?

Keeping black money hidden in a cave or a safe deposit box is pretty unproductive. Quite often, people buy valuable real estate or shares in companies, not in their own names but in the names of relatives or friends. The practical risk they take is of relative or friend deciding one day to just keep the asset, since they are legally its owner!

You find a highly reputable law firm and create a trust with some of the partners as trustees, handing over your black money to them for investment. The registered owners of any assets that the trust purchases will be the law firm partners. In most jurisdictions (prior to the developments below), trusts were secret and required no public disclosure. While you might be the only real beneficiary of the trust, and therefore the “beneficial owner” of the assets, nobody can discover this without breaking into the law firm and copying its files.

To counter such abuse of trusts, there has been major pressure around the world for public registers which would disclose not just the legal ownership of assets but also their beneficial ownership. Countries whose citizens often hide undisclosed wealth in trusts set up overseas have applied great pressure to locations such as Jersey and the Cayman Islands where trusts are set up to introduce public registers of beneficial ownership.

What is not well known is that some major countries, in particular the USA, have no such transparency requirements. In the USA, a crook still has plenty of scope for hiding their wealth in trusts and similar entities without having to take it out of the USA.

In 2019, the Democrat controlled House of Representatives passed the Corporate Transparency Act of 2019. However, parallel legislation, the “Improving Laundering Laws and Increasing Comprehensive Information Tracking of Criminal Activity in Shell Holdings (ILLICIT CASH) Act” is stuck in the Republican controlled Senate.

I do not expect it to pass at all, and certainly not before the presidential election in November. Since new laws require both the House and the Senate to approve them, that means no change yet. I am also sceptical that President Trump would sign such legislation instead of vetoing it.

I was asked whether such transparency legislation would negatively impact upon Islamic finance in the USA. I see no reason why it should.

When do Islamic finance transactions that involve a change in legal ownership also involve a change in beneficial ownership?

For example, you own a building. To raise finance, you sell the building to a bank, and rent it back under a diminishing musharaka transaction. Are you or the bank the beneficial owner?

In my view, if you are paying rent at market rental rates, and your repurchase of the building, whether in slices or all at once, will be at the open market price on repurchase, then the bank clearly has beneficial ownership.

Conversely, if your rent is fixed (or set by reference to market interest rates) and your repurchase will be at a pre-specified price, then you have retained beneficial ownership.