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1 Islamic Finance New opportunities for France The French Landscape And tax Neutrality Michel Collet – CMS Bureau Francis Lefebvre Avocat, Partner Dubai, December 15th, 2010 2 SUMMARY 1. Background 2. General tax aspects (Guidelines) 3. Specific tax treatments 3 1 BACKGROUND • When “West meets East” • France’s potential to develop Islamic finance • Legal and tax issues raised by Islamic alternative finance arrangements 4 1.1. When “West meets East” Until 2007 : The incidence of Islamic finance products began to increase in western economies in the mid-to-late 1990s but faced a setback after 9/11 The sector is hitting its stride again since the increasing of oil-price No serious political interest to implement Islamic finance in France 2007-2009 : Political willingness to make Paris a financial center for Islamic finance Creation of a “tax committee” in cooperation with PARIS EUROPLACE to create a proper environment for the development of Islamic finance in France The main purpose is to attract this new source of finance 5 1.2. France’s potential to develop Islamic finance France will have to compete with other European countries E.g. over recent years, London has developed into a major centre for Islamic finance For this, France holds many "trump cards” French Muslim population (over 6 million people, 10% of the French population) is the largest in the European Union (vs. 2 million resident Muslims in the UK)* Historical and political links with Muslim countries Islamic contract law is closer to French contract law than to Common law 6 1.3. Issues raised by Islamic Finance in France (1/2) Legal issues Implementation of Shariah’s compliant products in a non Islamic system needs the creation of alternative finance and legal arrangements The new financial products are very different from convential Western products Major issue: how to caracterize Shariah’s compliant arrangements based on French law ? 7 1.3. Issues raised by Islamic Finance in France (2/2) Tax issues How shall Islamic financial arrangements be treated from a tax perspective ? Tax issues largely depend on legal issues. Regulatory issues Make sure that Islamic financial products are subject to Banking law (especially in the scope of Banking monopoly) Make sure there is no discrimination or advantage (so-called fair taxation) of the Islamic alternative arrangements over conventional Western products 8 2 GUIDELINES FOR IMPLEMENTING ISLAMIC FINANCE Approach Qualifying Islamic financial arrangements Simple use of the Guidelines Importance of the Guidelines 9 2.1. Approach No need to amend French law : there is no such provisions prohibiting the mechanisms of Islamic financial arrangements Need to clarify legal and tax aspects, in order to secure and satisfy the interests of investors and financial services This was and can be achieved through Guidelines lined by authorities that cover legal and tax issues 10 2.2. Tax authorities willingness : implementation of the alternative financial instruments (1/2) 25 Feb. 2009 : First Guidelines for Islamic finance Statement of practice 4 FE / 09 defines the legal concepts of Sukuk and Murabaha and the tax treatment applicable. Replaced by Statements of practice dated of 24 Aug. 2010 11 2.2. Tax authorities willingness : implementation of the alternative financial instruments (2/2) 24 Aug. 2010 : New Guidelines Murahaba (Statement of practice 4 FE/S1/10) Sukuk (Statement of practice 4 FE/S2/10) Ijara (Statement of practice 4 FE/S3/10) Istisna (Statement of practice 4 FE/S4/10) Coming soon : Mudaraba, Musharaka, Salam, Wakala 12 2.3. Simple use of the Guidelines The Guidelines are short and self-explanatory Banks, investors and the customers will have reference concepts easily understandable The set framework is large enough to cover all sorts/interpretations of covered products 13 2.4. Importance of the Guidelines Each statement of practice : Transposes an Islamic financial arrangement with the help of French legal / secular concepts Qualifies this operation as a banking operation (=> subject to banking law, in the scope of banking monopoly) Connects this operation to legal provisions already applying to similar conventional Western products Explains the tax treatment applying to the alternative product 14 3 GUIDELINES APPLICATION 3.1. Murabaha : Statement of practice 4 FE/S1/10 - Murabaha with purchase order - Tawarruq - “Reverse Murabaha” 3.2. Ijara : Statement of practice 4 FE/S3/10 3.3. Istisna : Statement of practice 4 FE/S4/10 3.4. Sukuks : Statement of practice 4 FE/S2/10 15 3.1.1. Murabaha with purchase order (1/5) Transfer of asset Transfer of asset Supplier Purchase price Payment of purchase price Financial Institution + profit (deferred) Customer 16 3.1.1. Murabaha with purchase order (2/5) Definition The Customer identifies an asset they are interested in purchasing and needs financing Supplier sells the asset to the Financial Institution, which resells it to the Customer, based on purchase price plus a profit which is payable over an agreed period. The Financial Institution may charge a Fee. Maximum of six months between the two transfers of asset. Price, Margin and Fee are determined or determinable when the contract occurs. 17 3.1.1. Murabaha with purchase order (3/5) Tax treatment Payments of the Customer to the Financial Institution that correspond to the profit margin are treated as an interest. As such, they are not subject to withholding tax if the Financial Institution is located abroad (Exception: location in a “Non Cooperative Country or Territory”)*. For the Customer, Interest is normally deductible for Corporate Income Taxation. * Black list issued on 12 Feb 2010 : Anguilla, Belize, Brunei, Costa Rica, Dominica, Grenada, Guatemala, Cook Islands, Marshall Islands, Liberia, Montserrat, Nauru, Niue, Panama, Philippines, St Kitts and Nevis, St Lucia, St Vincent and the Grenadines. (To be updated on 1 Jan 2011.) 18 3.1.1. Murabaha with purchase order (4/5) Tax treatment The profit margin is exonerated from VAT. The Fee is subject to VAT for its part that is not related to financial intermediation (the invoice shall precise the amount). 19 3.1.1. Murabaha with purchase order (5/5) Tax treatment If real estate, transfer tax. Financial Institution pays 0,715 % of the Purchase Price. Customer pays 5,09% of the Purchase Price. The Purchase Price / Acquisition price does not include the profit margin and the Fee. If Customer resells the asset : Capital gain = Sale price minus Purchase Price (including the Fee except if the latter was deductible from Customer’s income) 20 3.1.2. Tawarruq (1/2) Transfer of asset Transfer of asset Third Parties Payment of Purchase price purchase price + profit Financial Institution (deferred) Customer Definition The Customer purchases an asset from the Financial Institution and resells this asset to a Third Party. The Customer’s purpose is to obtain liquidities by using the time lag between the two operations. The asset must be liquid (securities, raw materials) and cannot be a real estate (or deemed real estate company). 21 3.1.2. Tawarruq (2/2) Tax treatment Same rules as Muharaba with purchase order. (Corporate Income Tax, VAT, Transfer Tax issues…) Financial Institution may sell an asset they owned before entering into the Tawarruq transaction. In such case, the profit margin of the Financial Institution will be calculated by taking into account the market value of the asset at the date of contract (and not the value at the date of acquisition by the Financial Institution). 22 3.1.3. Reverse Murabaha (1/3) 1. The Customer 2. Asset purchase asks the FI to on behalf of the buy an asset Customer through his cash account Seller Financial Institution Customer 3. Transfer of the asset to the Customer 4. Resale of the 5. Sale of the asset asset to the FI to third parties Third Parties Purchase with Cash payment (usually) deferred payment Financial Institution Customer 23 3.1.3. Reverse Murabaha (2/3) Definition Customer buys an asset by paying cash (with liquidities they have in their account). Customer sells back the asset to the Financial Institution. Price = Purchase price plus a profit which is paid over the agreed period. The asset must be liquid (securities, raw materials) and cannot be a real estate (or deemed real estate company). 24 3.1.3. Reverse Murabaha (3/3) Tax treatment The profit margin of the Customer is treated like the profit margin of the Financial Institution ; it is ruled by the provisions applying to “Murabaha with purchase order”. 25 3.2. Ijara Rental stream (purchase price + profit) Transfer of asset Supplier Purchase price Customer Financial Institution Lease of asset (+ transfer of asset at end of lease) Definition The Financial Institution purchases an asset and leases it to the Customer. The Customer has a purchase option to become owner of the asset during or at the end of the leasing period. The rental agreement and the purchase option have to be concluded at the same time (but might appear in two distinct contracts). The Customer can be the original owner of the asset (sale and lease back). 26 3.2. Ijara Tax treatment applying to Leasing Ijara is treated as a financial lease For the Customer (Lessee) Rental payments are deductible from corporate income tax. When Customer becomes owner, the asset must be included in the balance sheet for a value equal to the Purchase Price (consequently, depreciation at the Customer’s level). For the Financial Institution (Lessor) Rental payments are subject to corporate income tax. Depreciation must be calculated according to estimated useful life of the asset (under certain conditions, possibility to depreciate according to the longevity of the contract). 27 3.3. Istisna Manufacturing contract Manufacturer Purchase price (advance, split or deferred payment) Customer Definition The Customer purchases a work (construction, product) to a Manufacturer. Types of payments : advance, split with a schedule or deferred . The contract provides that the Customer becomes owner of the asset once the work is completed. 28 3.3. “Parallel Istisna” (Combination of two arrangements) Manufacturing Manufacturing contract contract Manufacturer Purchase price Payment schedule (advance, split or deferred payment) Financial Customer Institution Legal definition The two Istisna arrangements concern the work involved. At completion of the work : Ownership is transferred from Manufacturer to Financial Institution Simultaneously, ownership is transferred form Financial institution to Customer (6 months at the latest) The Financial Institution receives : An “Income” (= Profit Margin) An Intermediary Fee 29 3.3. “Parallel Istisna” Tax treatment The profit margin is treated as an interest. No withholding tax if Financial Institution is located abroad (except NCCT). Other elements (Intermediation fees, capital gains) are taxable according to common rules applicable to each party. The profit margin is exonerated from VAT. The Fee is subject to VAT for its part that is not related to financial intermediation (invoices shall precisely detail the amount). 30 3.4. Sukuks Definition Sukuks are hybrid instruments, representing an ownership share in the underlying asset or business held by the issuer. 31 3.4. Sukuks Tax treatment The taxation of Sukuks may be complex. Sukuks may grant to the holders (successively) : A form of ownership (equity, equity funds, property rights…) A form of bond (bonds, bond funds, tracking securities…) French tax law clearly distinguishes between the treatment of financial instruments corresponding to a form with ownership and the treatment applying to bonds. 32 3.4. Sukuks If the conditions are met and as long as they are not converted into ownership, Sukuks characterize conventional bonds (§14 Statement of practice). Returns on the sukuk are treated like interest charge/income. Application of the accrued interest rule on the expected profit return Legal issue Fiducie does not provide beneficial ownership to beneficiaries; so: Combination of Fiducie (assets ownership) and Fond commun de tritrisation (rentals) Tracking Securities and contractual arrangements. 33 Contact details Michel Collet CMS Bureau Francis Lefebvre 1-3 Villa Emile Bergerat 92522 Neuilly-sur-Seine France T +33 1 47 38 55 21 F +33 1 47 45 86 75 E email@example.com
"Islamic Finance New opportunities for France Paris Europlace"