Islamic Finance in Luxembourg
Luxembourg has taken an important step to become the European platform for Islamic Finance. Luxembourg was already the 1st European stock market to list sukuk bonds and was recently admitted as the first European Member State to the Council of the Islamic Financial Services Board. Luxembourg tax authorities have now confirmed the tax treatment of Islamic finance techniques by a tax circular.
This step was taken on January 12th, 2010 with a circular which describes the major principles of Islamic finance, several shariah-compliant agreements, and their tax treatment under Luxembourg tax law.
The main features of the Tax Circular are highlighted below:
General points:
The main principles of Islamic finance are the following:
- Prohibition of RIBA (“interest/usury”). Therefore a conventional loan, for instance, is forbidden as it includes interest.
- Prohibition of activities with elements of GHARAR (“uncertainty”) and/or MAYSIR (“speculation”). Therefore excessive speculation such as derivative instruments, gambling is forbidden. The notion of risk is not forbidden but it must be shared among all parties involved.
- Prohibition to invest in HARAM (“unlawful”) business/products such as e.g.:
- Alcoholic beverages, drugs and tobacco products
- Weapons and defense
- Adult entertainment such as pornographic and gambling related products
- Pork related industry
- Conventional financial services (banks, insurance companies,…)
- Transactions should be backed by tangible and identifiable assets.
A few shariah-compliant agreements defined in the tax circular
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MUDARABA |
Mudaraba can be defined as a profit sharing investment partnership whereby only one of the partners (the Rab ul Mal) provides capital while the other acts as an entrepreneur (the Mudarib) to undertake the business/investment activity. As an example, the mudaraba principle usually applies to shariah-compliant bank deposits. While profits are shared on a pre-agreed ratio, loss of investment is borne by the investor only. In such case, the Mudarib (“entrepreneur”) only loses its part of the previously expected future income. |
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MUCHARAKA |
Mucharaka can be defined as a profit and loss sharing partnership according to which, on the one hand, profits are shared as per a pre-agreed ratio, while on the other hand, losses are limited to the capital contributed by each partner. All Mucharaka partners usually contribute funds and have the right, but not the obligation, to exercise executive powers in the project. |
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IJARA |
Ijara can be defined as a shariah-compliant lease agreement, according to which the lessor can earn profits by charging rentals on the asset leased to the lessee, instead of lending money and earning interest, which is of course not shariah-compliant. |
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IJARA-wa-Iqtina |
Ijarah-wa-iqtina is very similar to the concept of Ijara but differs in the way that the lessee has the possibility to acquire the asset at the end of the contract. |
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Istinah |
Istinah can be defined as a sales contract applicable to assets that are identified by specifications or order, where the price is fixed in advance, but the assets are manufactured/built and delivered at a later date. In most cases, the price is paid progressively in accordance with the progress of the job. |
