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Sharia financing for UK property transactions

Are you considering a Sharia compliant structure to purchase a property portfolio in the UK? The UK property market has historically been seen as a stable and lucrative investment for overseas buyers, many of which have originated from the Middle East.

Last updated: 1 September 2020

The desire to own a property in London either to escape the hot summer months in the Middle East, or to provide a safe haven, hasn’t diminished despite tax changes in recent years. There’s been a lot to contend with following the introduction of the Annual Tax on Enveloped Dwellings (ATED), Non-Resident Capital Gains Tax (NRCGT), and the changes to the Inheritance Tax (IHT) treatment of property held through companies.

 

About the author

Rakesh Dabasia

+44 (0)20 7710 3135
DabasiaR@buzzacott.co.uk
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Last updated: 1 September 2020

The desire to own a property in London either to escape the hot summer months in the Middle East, or to provide a safe haven, hasn’t diminished despite tax changes in recent years. There’s been a lot to contend with following the introduction of the Annual Tax on Enveloped Dwellings (ATED), Non-Resident Capital Gains Tax (NRCGT), and the changes to the Inheritance Tax (IHT) treatment of property held through companies.

 

What is Sharia law?

What is Sharia law?

Within the Islamic faith, the payment or receipt of interest is forbidden under Sharia law. This means the purchase of a home for personal occupation or an investment property becomes more difficult where loans or mortgages are required. Loans and mortgages are also often used to finance the property purchase to reduce the exposure to UK IHT. 

How are financial institutions working within Sharia law?

How are financial institutions working within Sharia law?

As a result, some financial institutions have developed financial arrangements to facilitate the purchase of property in a way that’s compliant with Sharia law. While increasing in popularity, there’re still relatively few financial institutions willing and able to offer a viable option.

A common structure used by financial institutions is known as diminishing shared ownership. This is where you, as the purchaser, put down a deposit of generally at least 20% of the total purchase price, and the financial institution purchases the remaining share in the property. You then pay rent to the financial institution for the share of the property you don’t own.

As the purchaser, you can make payments to the financial institution to purchase further shares in the property in much the same way as capital repayments are made on a conventional mortgage. This in turn would reduce the amount of rent to be paid.

The amount of rent charged can be fixed at the outset with a payment plan to reflect any capital payments to be made to eventually own the property outright. The rent is determined by a combination of market interest rates and the financial institution’s margin. Most financial institutions review the rent amount on a quarterly basis.

Once the entire property is acquired by the purchaser, full title of the property will be transferred to them and no further rent is payable.

There are specific provisions in tax law for a Sharia compliant structure, such that there is no Stamp Duty Land Tax (SDLT) on the transfer from the financial institution to the purchaser. The rent is also treated under the interest exemption for financial institutions.

One thing to look out for

One thing to look out for

However, there is one area that still hasn’t been addressed adequately, despite representations to HMRC on the matter. For instances where the purchaser has completed the entire purchase of the property and wishes to use that property as collateral for the purchase of a further property, or to extract funds for personal use, the property would need to be sold to the financial institution to release funds. If this was not a Sharia compliant structure, then the refinancing of the property wouldn’t be treated as a disposal for capital gains tax purposes, as the purchaser would still legally own the property with a lien to the financial institution. 

The refinancing under a Sharia compliant structure does crystallise a taxable capital gain, which in the past may have not been taxable if the purchaser was non-UK resident. If the property is the main residence of the purchaser, then Private Residence Relief (PRR) would be available to alleviate the position. But often the property is a second home or an investment property, which will crystallise a taxable capital gain.

If you’re considering a Sharia compliant structure to purchase a property portfolio in the UK, it's important to take UK tax advice to ensure the structure does not realise UK capital gains which could be mitigated.

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