As the government pledges to relax the rules governing Islamic finance, city lawyers are busy dealing with increased overseas interest in this field, reports Lucy Trevelyan

Two years after abolishing the requirement on those buying a property in Britain via an Islamic law-compliant mortgage to pay double stamp duty, Chancellor Gordon Brown has again used the Budget to cater for the needs of the UK’s 1.8 million Muslims.

March brought the announcement of more legislative changes relating to Islamic finance products – including profit earned on deposit accounts – which will effectively put the taxation of some compliant products on a par with equivalent non-Islamic financial products.


Shari’ah law governs how Muslims invest, and under its strict regulations the payment or receipt of interest is prohibited, meaning conventional mortgages and savings accounts are unsuitable.


Neil Miller, a partner at City firm Norton Rose, explains: ‘The prohibition against paying or receiving interest is found in the words and statements of the Prophet Mohammed and is really wider than a restriction against interest but is more concerned with fair dealing and not acting in a usurious way to your fellow man.’


Also prohibited under Shari’ah law, he says, are gambling and speculative behaviour, as well as deals involving products such as pork and alcohol.


‘Islamic economic theory requires a person who has capital, which includes cash, to deploy that capital in a risk-sharing enterprise rather than “lend” it, at no “risk”, in the certainty of a return. In simple terms, equity is good, debt less so – so a large part of Islamic finance is about finding ways of creating Islamically acceptable debt,’ he adds.


Islamic deposit accounts are based on a profit-sharing arrangement and involve banks generating a profit from customer funds, which is then shared between bank and customers. The law changes mean lower-rate tax on ‘profits’ can be deducted at source, as with conventional savings accounts, so some customers, who may currently have to complete tax returns, will not have to, and the process will be simplified for others.


Tim Plews, a partner at City giant Clifford Chance, who helped negotiate with the Financial Services Authority to allow the Islamic Bank of Britain to operate under Shari’ah principles before its launch in 2004, says the concessions show a change in the government’s attitude.


‘The government has an agenda of being socially inclusive – especially since 9/11 – and says it wants to make the world of finance more accessible to British Muslims.’


Robert Newman, a property partner at City firm Stephenson Harwood, says there has been a growing demand for Islamic finance in real estate work, and the establishment of Islamic funds and other forms of asset finance, such as of ships and aircraft.


‘This results from a growing interest in UK investment from the Middle East, a growing desire as Islamic finance products become more sophisticated to take advantage of these as an ethical alternative which was not previously available, and changes in UK law and the provision of UK domestic financing in a Shari’ah-compliant fashion which has opened up a new market in the UK.’


Mr Plews says the Islamic finance market is ‘vibrant’ at present, and both he and Nick Edmondes, joint head of Trowers & Hamlins’ Islamic finance team, agree that there is a huge amount of money in the Middle East looking for a suitable home for investment purposes.


Mr Edmondes says: ‘Middle Eastern companies are looking to invest where they can. Most of them have an understanding of how the process works in the UK so that’s where they first started to invest, but now they are looking further afield in places such as eastern Europe and the Far East.’


Mr Newman says the most commonly used contracts when financing real estate under Shari’ah law are: the Murabaha, whereby the financier purchases the asset and sells it to the customer with an agreed mark-up, accepting payment by instalments and thus effectively offering credit without interest; and the Ijara, a lease arrangement whereby the financier purchases the asset and leases it to the customer for a rent, usually offering an option for the customer to eventually acquire the asset.


He says: ‘Murabaha transactions are currently being used in UK both for residential property and commercial property, while Ijara lease structures are found both in home finance and as a part of structured financing transactions whereby a bank may lend money on a conventional basis to an entity which then enters into an Ijara lease with the Islamic customer.’


Other Islamic finance structures, he says, include the Istisna’a contract used for financing construction and the Mudharaba contract in which one party puts in capital and the other the actual work, in effect a sleeping partnership, with profits being shared. The Musharaka partnership structure, which may be on a diminishing basis involving a gradual transfer of ownership, is also of interest in real estate transactions.


The Finance Act 2003, Mr Newman explains, introduced provisions relating to alternative property finance intended to create a level playing field for the Murabaha and the Ijara structures, whereby only one of the two transactions involved in making the deal Shari’ah compliant would be subject to stamp duty.


He continues: ‘The 2005 Finance Bill proposes certain modifications to these provisions to extend the relief to the diminishing Musharaka structure and also to relieve what would otherwise be onerous reporting requirements to submit land transaction returns on each partial transfer.’


He says matters such as the right-to-buy legislation and the capital adequacy requirements for banks contained in the Basel capital accord are also being addressed where they might disadvantage customers of Shari’ah-compliant products.


However, Mr Newman adds that the present and proposed tax changes do not fully address the various types of Islamic finance product which might be used, ‘particularly in the case of commercial investment by Muslim investors using corporate entities, for which the alternative property finance reliefs would need to be extended to corporate as well as individual purchasers’.


Mr Edmondes says there is also an issue with the insurance industry. ‘At the moment there is no organisation that offers an Islamic-compliant insurance product – a Takaful, which is basically a mutual form of insurance.


‘Muslims should not use non-compliant insurance products but in the UK they are legally obliged to have some insurance, such as motor insurance. It would be good if the regulators could find a way of allowing an Islamic product which sits side by side with conventional products in the same way as with Islamic banking.’


He says that setting up banking or insurance operations such as this may be ‘academically interesting’ but it is neither his department’s core activity nor that profitable. Like the other lawyers questioned, much of his work involves advising Islamic banks with their activities which can be both challenging, if, at times, frustrating.


‘When you’re structuring something you have to make sure that it works legally, is tax efficient and Shari’ah compliant. It’s interesting work for lawyers,’ he says.


Mr Miller says that to win instructions on a consistent basis from the ‘important clients’, it is crucial to have a Middle East presence. Mr Edmondes agrees and says it is also critical for Islamic finance lawyers to know their clients, given that the committee of Shari’ah scholars – which each Islamic finance client has to ensure that its structures and products are Shari’ah compliant – could take a different view on the same product.


‘The frustration can be when for no reason you can understand one committee will say something is compliant and one will say it’s not.


‘However, that’s also part of the reason why this sort of work is good business for lawyer: no one structure can be duplicated again and again. It’s also good for investors – they can choose to invest with a more liberal go-ahead bank or one which is more conservative.’


Mr Plews adds: ‘Ultimately, I suspect, if a bank was unhappy with a Shari’ah scholar’s attitude, they would find another one.’




Lucy Trevelyan is a freelance journalist