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The tax treatment of Shariah compliant refinancing is unfair

The Government is aware that Shariah compliant refinancing receives much worse tax treatment than conventional refinancing, but cannot be bothered to fix the problem.

Posted 10 October 2022

A recent email from a reader reminded me that the need to change UK tax law so that Shariah compliant refinancing receives the same tax treatment as conventional refinancing is not just "nice to have." It is essential.

At present Muslims who have refinanced property (other than their principal private residence) in a Shariah compliant way are regularly facing unexpected tax bills. Theoretically they should have known how the tax law worked as there is a legal fiction that all citizens know all of the law. In practice, unless they receive expert tax advice, taxpayers will continue to stumble into this trap.

For a full explanation of the problem, see my page "The tax trap with Shariah compliant refinancing."

As the Government long ago stated that it wanted Islamic finance to be on a "level playing field" with conventional finance, its failure to fix this problem is simply unfair.

I made this the subject of my August 2022 column in the magazine "Islamic Finance News." You can read it below.

The UK Government needs to tackle Shariah compliant refinancing

In my column of 1 May 2018 I explained how a tax charge can arise if a UK taxpayer refinances a building that has appreciated in value, using a Shariah compliant structure such as diminishing musharaka.

Very briefly, unless the asset is exempt from capital gains tax (in most cases your principal private residence is exempt) you can end up triggering a taxable capital gain, even though your economic interest in the property has not changed.

I illustrated this by assuming that you had bought a building for $100,000, that it was now worth $1,000,000, and you were raising $750,000 by selling the building to an Islamic bank for $750,000 and buying it back using diminishing musharaka.

Obviously, if you were using conventional finance, you would simply have taken out a $750,000 loan secured on the appreciated property, with no tax consequences. The diminishing musharaka transaction triggers a taxable gain of $650,000.

That article mentioned that, with my help, the UK’s Chartered Institute of Taxation had raised the problem with HM Revenue & Customs (HMRC), proposing a change in tax law to ensure equal treatment for Shariah compliant refinancing and conventional refinancing. HMRC eventually agreed that there was a problem, agreed that the tax treatment was unequal, but declined to ask the government to change the law. Effectively, they considered other priorities were more important – my words not theirs!

It is a growing problem.

I was recently contacted by a tax advisor who has several clients in this situation. He asked me if HMRC had announced any form of concessional treatment to avoid the tax charge arising. I was not aware of any published concession, and a search of the government website while writing this article has failed to find anything. I will be pleased rather than embarrassed if any reader does find a published concession and sends it on to me!

Oddly enough, I am aware of one specific case to the contrary as a result of private correspondence. After seeing all the details of the refinancing, an HMRC head office specialist decided that no tax charge arose in the case of that specific taxpayer because the Shariah compliant refinancing was equivalent to a conventional refinancing.

However, as mentioned above, this view in that one case has not led to a published concession that I can find. Furthermore, while the head office specialist’s decision is clearly fair and sensible, in the absence of a formal decision by HMRC to consciously not apply existing tax law, I consider that his decision was unique as a simple matter of legal interpretation of the transactions undertaken in a diminishing musharaka refinancing, and therefore open to further scrutiny and testing.

As there are more such transactions with every year that goes by, the UK needs a proper solution, preferably in the form of legislation, or otherwise in the form of a published HMRC concession that all taxpayers can rely upon.

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


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