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Islamic Finance New opportunities for France Paris Europlace

VIEWS: 2 PAGES: 33

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     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 michel.collet@cms-bfl.com

								
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