New French tax rules on Islamic finance

• Text size
•  
•  

- Tax treatment on murhaba transaction

(ii) Tax regime applicable

Such differed payment is treated with regard to most French taxes as interest and not as a capital gain. Therefore the taxation of the profit margin generated by the financier is spread out over the term of the differed payment (on straight line basis) provided that the agreement is properly drafted and specific accounting requirements are met. However, the portion of the profit margin remunerating intermediary services rendered by the financier is directly subject to tax.

In the case of profit margin paid by the French investor company to the financier located outside France, such payment is exempted from French withholding tax according to domestic tax rules provided that the conditions indicated above are met.

The tax administrative regulations have also confirmed the cases where capital gain taxes on the real estate purchase/resale transaction, registration duties, business license tax and VAT can be mitigated.

Tax treatment on sukuk and similar indexed financial transactions

Main characteristics of Sukuk transaction for French tax purpose A sukuk transaction is one whereby investors finance the purchase of an asset by means of profit-sharing financing. In a common type of sukuk transaction, a French group set up an SPV in order to purchase an asset, that purchase being financed through the issuance of sukuk bonds subscribed by investors and the SPV's parent company. The SPV then rents the asset to third party and benefits from put option granted by the parent company on this asset. The SPV transfers the asset to a fiduciary for management purpose. The fiduciary will remunerate the sukuk bonds holders, and might repay to the SPV the management fees paid the SPV (such as statutory audit fees for example). Sukuk bonds are repaid either in the course of the transaction on the basis of predetermined term or at their maturity. Therefore, on this type of transaction the return on the sukuk bonds is directly correlated to the return on the underlying asset leased, and there is a combination between the issuance of bonds and trust mechanism as the sukuk bonds holders are also the beneficiaries of the rights attached to the trust.

(ii) Similar indexed financial transactions for French tax purpose Such transactions correspond to debts securities and participating loans giving right to remuneration indexed on the return generated by one or many underlying assets held with the issuer or the borrower. In case of debts securities and participating loans used for the financing of one or many assets, the refund of the principal is indexed on the value of such assets.

(iii) Tax regime applicable

French tax authorities point out the criteria upon which the sukuk or similar indexed transactions must fulfill to qualify as debt instruments for French tax purpose. Some of them are the following:

- Sukuk bonds or indexed debts securities holders should be repaid in priority to the shareholders of the issuing company; they should not receive any voting rights or any rights on the profit deriving from the liquidation of the issuer or the borrower;

- the remuneration of the sukuk bonds or indexed debts securities holders should be variable and linked to the return of an underlying asset or the profit generated by the issuer or the borrower. In addition, such remuneration should not exceed a ceiling defined by reference to market rate (e.g. Euribor or Libor) increased by a margin;

- partial repayment of the principal is allowed, and such repayment should be made either progressively or entirely at their maturity date.

Sukuk bonds or indexed debts securities complying with the criteria set forth by French tax administrative regulations qualify as debt instruments, and the remuneration paid to holders qualifies as interest from French tax standpoint. Such interests are tax deductible for the French paying company pursuant to the limitations applicable under domestic tax law. In the case of interest payments made by French company to foreign recipient, the withholding tax exemption stated under the domestic tax law applies even if the sukuk bonds or indexed debts securities are issued according to French or foreign law, provided that they qualify as debt instruments for French tax purpose.

The business license tax impact is analyzed at the level of the activity performed by the fiduciary, which can be in France either a bank or a Law firm. For banks, interest paid to sukuk bonds or indexed debt securities holders qualify as operating expenses and then will reduce such impact.

VAT exemption could be achieved on the transfer of goods, rights and warranties from the SPV to the fiduciary provided that the transaction is structured appropriately.

According to various statistics available there are 5 million Muslims in France and 55% of such population is interested by banking offer complying with sharia principles. The French finance place is targeting approximately € 100 billion stake on the whole Islamic finance market, notably from savings from gulf and Asian countries. The new tax provisions will undeniably contribute to facilitate the performance of Islamic financial transactions in France efficiently, safely and at low cost.

-Ends-

Serge Bakoa, PhD
Attorney-At-Law
Tax Law Specialist with Paris Bar Association
78 rue de Rennes
75006 Paris
T: 33 (0)1 45 44 92 95
F: 33 (0)1 45 48 72 23
sbakoa@hstb-avocats.com

© Press Release 2009