TAX NEWS - 2010

Luxembourg Tax: Guidance issued on Islamic finance for real estate transactions

The Luxembourg indirect tax authorities issued a circular on 17 June 2010 addressing transfer tax issues related to two types of Islamic finance instruments: Murabaha and Ijarah agreements. The circular extends existing transfer tax and VAT incentives to Murabaha and Ijarah transactions.


Substance-over-form approach

The circular provides a definition of the above contract types, taking into consideration the substance of each agreement, so that Murabaha represents a cost-plus-profit agreement and Ijarah represents a leasing agreement. Such Sharia'a-compliant contracts, however, require that an intermediary structure (e.g. a Special Purpose Vehicle (SPV)) be interposed for the acquisition.


Transfer taxes

The circular describes the generally applicable rule under which transfer taxes are not levied on the sale of the shares of a Luxembourg real estate-rich company, but the sale of shares of a partnership or economic interest grouping (EIG) that owns Luxembourg real property will trigger a 6% transfer tax (see Law of 21 December 2001, article 9,1°). If the financial operator (SPV) discloses in the deed that the purpose of the transaction was to purchase the property in order to resell it, the transfer tax rate is increased to 7.2%. However, only a 1.2% tax (paid by the SPV) will be levied on the deed of purchase if that deed and the resale deed are registered simultaneously. The circular confirms that the general rule will apply to Murabaha agreements.

The circular also clarifies the transfer tax treatment applicable to the predetermined mark-up in a Murabaha agreement. This profit margin will be treated as interest and, consequently, will not be subject to transfer tax. The transfer tax levied on the resale transaction will be levied on the acquisition price of the real property by the SPV. However, this treatment will be available only if the following conditions are satisfied:

- The client takes immediate possession of the property after the resale;
- The time between the acquisition of the property by the financial operator and the resale to the client does not exceed 10 days;
- The initial acquisition contract contains a clause specifying that that asset was purchased under the terms of a Murabaha agreement; and
- A copy of the Murabaha agreement is attached to the (authentic) deed.


VAT

The circular confirms that SPVs created under Murabaha or Ijarah agreements are subject to VAT. The circular also confirms, however, that any real estate transaction under such Sharia'a compliant financial instruments may benefit from a VAT exemption under article 44, section 1(f) and (g) of the Luxembourg VAT law, which grants an exemption for certain real estate transactions.


Conclusion

The circular provides clarity and more security for real estate transactions involving Sharia'a compliant financial instruments and confirms the willingness of the Luxembourg government to facilitate the development of Sharia'a compliant products and structures and to position the Grand Duchy as a significant hub for Islamic finance.