My change of mind regarding Shariah compliant refinancing transactions

Alongside many other people, I campaigned for many years, eventually successfully, to have UK tax law changed to ensure that Shariah compliant refinancing of real estate did not trigger a taxable capital gain.

During that time, it was always my view that, in the absence of a law change, the refinancing did trigger a taxable capital gain if the property had appreciated in value since acquisition.

Obviously this was not an issue if the property was the disposing individual's principal private residence, and therefore exempt from capital gains tax. However many refinancings involve real estate outside that limited exemption.

The law was changed prospectively from 30 October 2024, but with no relief for prior refinancing transactions. A month or so afterwards, I was asked about such a prior refinancing. This led me to analyse the tax treatment afresh, and I changed my mind about the tax treatment.

I explained it in my January 2025 column for the magazine "Islamic Finance News." I have never been embarrassed about changing my mind, whether about politics, religion, taxation, or anything else!

Another development in UK Shariah compliant refinancing

For many years the UK tax authority, HM Revenue & Customs (“HMRC”), has sought to tax individuals and companies who used Shariah compliant refinancing for real estate that had increased in value, unless it was a principal private residence exempt from capital gains tax.

HMRC’s view was that nothing in the UK tax legislation governing “diminishing shared ownership” (which is the part of the law used in Shariah compliant refinancing) precluded a capital gains tax charge on the initial sale from the owner to the financial institution. That was also my view of the law.

That is why, when I learned that in the refinancing case mentioned in my 3 August 2022 column an HMRC official had concluded that the initial sale was not taxable, I considered that the official had reached the wrong legal conclusion. That case did not stop HMRC seeking to tax many other people who had undertaken refinancing transactions.

I was recently approached for advice by another individual facing a very large capital gains tax charge on a refinancing transaction. Despite my view that strictly tax is due, I decided to help, pro bono, and composed the written argument I would put forward if I were acting for him. No matter how bleak a case may be, an experienced adviser can always find some argument to put forward!

The act of writing down the argument caused me to change my mind. I now think that the better interpretation of the capital gains tax law is that the initial sale in the refinancing transaction does not give rise to a taxable capital gain. (The law change announced in October is still welcome, since it puts the matter beyond doubt going forward.)

I had never thought about the issue as carefully as I did when composing the written argument on behalf of the individual. It shows the importance of writing down your detailed analysis of any issue, rather than just leaping to the end conclusion.

The key point is that the initial sale from the original owner to the bank is not a free-standing contract. It is integrally linked with the subsequent contractual provisions covering the lease back of the property, and the original owner’s contractual right and obligation to repurchase the property.

Taxing the initial sale from the original owner to the bank without also taking into account the effect of the inseparably linked contracts is to ignore both the legal reality and the commercial reality. As Lord Wilberforce said in 1978 in the tax case Aberdeen Construction Group Ltd v CIR [While the link is to the Australian Tax Office, it gives the full text of the UK House of Lords judgment] “capital gains tax is a tax upon gains: it is not a tax upon arithmetical differences.”

Of course, the past six years of lobbying for a law change were needed because HMRC considered that tax was due under the law as it stood.

With great delight, the individual has told me that HMRC has now agreed to stop trying to tax him. I cannot claim any credit, since HMRC abandoned their previous position before the individual’s advisers had a chance to put forward my arguments!

Mohammed Amin is an Islamic finance consultant and former tax partner at PwC in the UK.

Appendix — Extract from my email to an individual who HMRC were seeking to tax

My personal view is that the position HMRC have taken on your case is the correct interpretation of the law.

Namely that a Shariah compliant refinancing of real estate constitutes a disposal for capital gains tax purposes, triggering a CGT liability if the real estate has appreciated since its original acquisition and is not otherwise exempt from CGT, for example a principal private residence.

However, while you should not have got yourself into that situation, once you are in it then it is appropriate to put forward the best possible arguments why CGT should not apply. If I were your tax advisor, I would proceed along the following lines.

Firstly, I would avoid any mention of fairness in any of my correspondence. There is an old saying “there is no equity in taxation”, where equity is being used as an old term for fairness, although in law the word equity has another more precise meaning.

Secondly, I consider that attempting to base an argument on TCGA 1992 s.26 is invalid. What you have is a sale plus arrangements to buy back, not a transaction falling within section 26.

The initial sale from you to the bank is not a free-standing contract. It is integrally linked with the subsequent contractual provisions covering the leasing back to you for the property, and your contractual entitlements (and I assume requirements) to repurchase the property.

Your tax advisor should read all the original documents to ensure that this is the case.

Accordingly, it is simply invalid to attempt to tax the initial sale from you to the bank without also taking into account the effect of the inseparably related contracts. Trying to do so is to ignore both the legal reality and the commercial reality.

Indeed, if the initial sale to the bank had led to your capital gains tax calculation producing a loss rather than a gain, HMRC would by their own practice be seeking to deny you that as an allowable loss.

HMRC have a targeted anti-avoidance rule that relief for capital losses should only be available where a group or company has suffered a genuine commercial loss and made a real commercial disposal. See the link below.

Taking all of your contractual arrangements with the bank together, you have not made a gain.

Diminishing shared ownership was designed by Parliament to have the same economic consequences as a secured mortgage loan.

You never achieve any distancing between yourself and the market value of the real estate.

If it goes up while legally in the ownership of the bank, that increase will eventually accrue to you since you have the right to reacquire at a fixed price, and if it goes down while legally in the ownership of the bank, the decrease will eventually be suffered by you due to your obligations to reacquire at a fixed price.

Accordingly, it is simply incorrect in law for HMRC to contend that you have a taxable capital gain. To do so is to propose “accepting results which are paradoxical and contrary to business sense” to quote Lord Wilberforce.

This is the type of argument I would put forward, if the contractual documents say what I expect them to say.