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After many years of ignoring the issue, the Government is consulting on eliminating a tax trap
Posted 22 December 2024
Along with other professionals, for many years I have been asking the UK Government to eliminate the capital gains tax charge when appreciated real estate (apart from an individual's main residence) is refinanced in a Shariah compliant way. The tax charge is unfair, because no such charge arises on a conventional refinancing.
In January the Government announced that it was consulting on the issue. I covered this in my February column for the magazine Islamic Finance News. You can read it below.
In a future website page I will share my response to the consultation. In the October Budget the Government announced that they would indeed be changing the law.
As far as I can recall, I first wrote about the problem of refinancing commercial real estate using Islamic finance in my 1 May 2018 IFN column “Harmonizing the taxation of conventional and Islamic finance requires careful detailed work.” [My page "UK taxation needs to accommodate Shariah compliant real estate refinancing"] Very briefly, if the commercial real estate is worth more when refinanced than when it was originally bought, the Shariah compliant refinancing transaction triggers a taxable capital gain. Conversely no such capital gain arises if the refinancing uses conventional finance.
That column mentioned that with my help the Chartered Institute of Taxation had written to the UK tax authorities to explain why UK tax law needed to change, and to outline how to change it. Eventually in late 2018 the UK tax authority responded that they had no plans to change the law.
I reverted to the subject in my 1 August 2022 IFN column “The UK government needs to tackle Shariah compliant refinancing.” [My page "The tax treatment of Shariah compliant refinancing is unfair"] This mentioned that the scale of the problem was growing, with an increasing number of UK taxpayers finding themselves with an unexpected taxable gain. I also pointed out that the tax authorities were applying the law inconsistently, because in at least one case mentioned in the article the HM Revenue and Customs head office specialist had concluded after reviewing the transaction documentation that no tax charge arose!
Since then, lobbying has continued behind the scenes, in parallel with a steadily growing number of affected taxpayers. Although I have been involved with the lobbying, and many Islamic finance professionals are aware of it, as far as I am aware the lobbying is not in the public domain so I cannot say more about it. Finally, in January there was a positive development.
On 16 January 2024 HM Treasury issued a consultation document “Tax Simplification for Alternative Finance” which can be downloaded from the link. Responses to the consultation must be submitted by 9 April 2024. I will of course be submitting a response, and once I have done so will publish it on my website.
The changes that the Treasury are consulting about would eliminate the taxable capital gain that arises on refinancing appreciated real estate. They would also eliminate another problem that receives much less discussion. If the real estate includes plant and equipment eligible for what the UK calls “capital allowances” (“tax depreciation” in many countries tax language), the refinancing transaction can cause a recapture of previously granted tax depreciation and lead to future tax depreciation being granted to the bank providing the refinancing rather than the beneficial owner who has undertaken the refinancing and who is using or subletting the real estate.
The Treasury consultation document is understandably concerned that any legal changes do not create scope for tax avoidance. Conversely one of my UK Islamic finance contacts reminded me that the current rules contain their own scope for tax avoidance! If the real estate has fallen in value since acquisition, under current law Shariah compliant refinancing will trigger a capital loss for tax purposes, which can be offset against other taxable gains.
Finally, the Treasury consultation ignores existing cases. I believe there is an overwhelming case for retrospectively eliminating the capital gains tax charge on Shariah compliant refinancing, since HM Revenue and Customs have been inconsistent between taxpayers.
Mohammed Amin is an Islamic finance consultant and former tax partner at PwC in the UK.
