Although the Grand Duchy of Luxembourg is a very small country in
terms of area and population (2,586 km2 and 502,000 inhabitants), it is
one of the most important financial centers all over Europe. Nowadays,
Luxembourg is considered to be the first European financial centre and
globally the second after the United States of America in terms of fund
industry. Furthermore, Luxembourg is recognized as one of the leading
Islamic financial centers through its history in the field of Islamic
finance and its continuous efforts to develop this sector. (source)
The eminence record of Luxembourg in that respect is full of
achievements. Luxembourg was the first of the European countries to host
an operating Shari'ah-compliant financial institution in the 1970s.
Further, the first Takaful Company in Europe was established in
Luxembourg in the1980s. In 2002, Luxembourg listed the first Sukuk in
the European stock markets and in 2009 the Luxembourg central bank
became the first European central bank to become a member in the Islamic
Financial Services Board (IFSB), leading to Luxembourg being the first
non-Muslim country to host the annual IFSB meeting in May 2011.
Despite having more than 40 regulated Shari'ah-compliant investment
fund, and further having complications in determining the number of
unregulated Shari'ah-compliant funds, it is clear that Luxembourg could
play a much more important role in this sector, especially for the
Middle Eastern investors.
This eminence record is the result of the continuous efforts done by
the Luxembourg Government to modify the tax laws and regulations to
accommodate different types of Shari'ah-compliant vehicles and products.
The Luxembourg tax authorities have issued 2 tax circulars to clarify
the tax treatment of various Islamic financing arrangements and issues.
Direct tax circular
The first circular essentially deals with the direct tax treatment of
murabaha and Sukuk, however also describes various other
Shari'ahcompliant instruments, such as musharaka, mudaraba, ijara,
ijarawa- lqtina and istisna.
Murabaha
Murabaha refers to a sale transaction in which assets are sold under
deferred terms at cost plus a profit mark-up. The cost price and mark-up
are known by both the buyer and the seller. Both Islamic and
conventional financial institutions can act as buyers/sellers in
murabaha financing arrangements. The predetermined markup represents the
remuneration for the financial institution.
Sukuk
The circular, however, adopts a substance over form approach and
provides that the taxation of the income can be deferred over the term
of the transaction (as would be the case in a conventional financing
arrangement).
Sukuk are the second type of Islamic financial transaction analyzed
in the circular. Luxembourg-based Soparfi and securitization vehicles,
among others, are flexible vehicles that can be used to issue Sukuk, as
illustrated in the example below.
According to the circular, for Luxembourg tax purposes, Sukuk would
be treated like conventional bonds and the yield on sukuk would be
treated as interest payments on conventional debt instruments. This tax
treatment would apply even though the yield on the instruments is
directly contingent on the income earned on the underlying asset. Hence,
the yield will be taxdeductible at the level of the Sukuk issuer in the
same way as interest on a conventional debt obligation.
No withholding tax applies on such a yield under Luxembourg domestic
law (implications of the EU Savings Directive should be fairly limited
given the nature of the instruments and the residency of the investors).
Indirect tax circular
The second circular, which was issued in June 2010, deals mainly with
indirect tax. The circular covers various VAT and transfer tax issues
related to murabaha and ijara agreements.
The circular clarifies the tax treatment applicable to the
predetermined mark-up concluded in a Shari'ah agreement. Such profit
margin will be assimilated as interest and consequently not subject to
tax. The transfer tax levied on the resale transaction will be
consequently levied on the acquisition price of the real estate by the
SPV. However, such treatment will be only granted if the below
conditions are met:
- The client must immediately take possession of the property after the resale
- The delay between the acquisition of the property by the financial operator and the resale to the client must not exceed ten days
- The initial acquisition contract of the asset must contain a clause specifying that that asset was bought under the terms of murabaha agreement
- A copy of the murabaha agreement must be attached to the authentic deed
Further, the circular confirms that SPVs created under murabaha or
ijara contracts are subject to VAT. Any real estate transaction under
such Shari'ah-compliant financial instruments may however benefit from
certain VAT exemptions. This circular will provide clarity and more
security in the real estate transactions involving Shari'ahcompliant
financial instruments.
Regulatory circular
On 26 January 2011, the Luxembourg regulatory authority (CSSF)
clarified the rules applicable to Sukuk issuance as to the prospectus
which facilitates the listing process of Sukuk in the Luxembourg Stock
Exchange market. Sukuk may be treated as asset backed securities or as
guaranteed debt securities.
The minimum information disclosure required for guaranteed securities concerns:
1 Nature of the guarantee. It includes a description of any
arrangements, including commitments to ensure obligations to repay debt
securities and/or the payment of the yield. Such description shall set
out how the arrangement is intended to ensure that the guaranteed
payments will be duly serviced
2 Terms and conditions of the guarantee. It must also include all
details about conditionality on the application of the guarantee,
guarantors power of veto to changes security holders rights
3 Information to be disclosed about the guarantor. It must disclose
information about itself as if it were the issuer of that same type of
security that is the subject of the guarantee
4 Indication of the places where the public may have access to the
material contracts and other documents relating to the insurance has
also to be included
All these efforts confirm the willingness of the Luxembourg
Government to facilitate the development of Shari'ah-compliant products
and structures, and to position the Grand Duchy as a significant hub for
Islamic finance.
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