ijara, tax, Court of Appeal and Qatari deal

Project Blue Limited (formerly Project Blue (Guernsey) Limited) v The Commissioners for Her Majesty’s Revenue and Customs [2016] EWCA Civ 485

In a decision dated 26 May 2016 three judges sitting on the Court of Appeal unanimously ruled against the HMRC regarding stamp duty land tax (SDLT), which is a tax payable on transfers of interests in land. The Court found that the party seeking financing for a purchase of land was not liable for SDLT after the initial purchase, whilst the bank providing the financing under an ijara arrangement was liable.

The significance of this judgment from the standpoint of the Islamic finance industry is that this Court (the highest authority yet in this jurisdiction) recognised that the bank offering ijara financing must own the property, during the period of leaseback to the customer. This aligns with the Islamic legal viewpoint. The judges of course are not purporting to interpret or apply shari’a as such but following existing UK government guidelines and applying English contract law to the transaction documents in this case. This affirmation strengthens defences of the controversial re-purchase undertaking in sukuk al-ijara as well. It is in these respects a ruling that should be welcomed by the Islamic finance community.[1]

Project Blue Ltd (PBL), controlled by Qatar’s sovereign wealth fund (and ultimately by the Qatari royal family, and the current ruler of Qatar Hamad bin Khalifa bin Muhammad al-Thāni), purchased Chelsea Barracks in London (‘the property’) from the Ministry of Defence by means of an ijara (actually an ijara wa iqtina’) agreement. Under the terms of the agreement PBL sold the property on to a Qatari bank, Masraf al-Rayan (‘MAR’) and MAR leased the property to Project Blue Development Limited (PBDL), a company in the PBL group.

PBL paid the SDLT on the initial purchase of the property. In the Upper Tax Tribunal it was decided PBL must pay SDLT on the sale to PBDL. PBL submitted unsuccessfully that MAR was liable for the SDLT, and that at any event HMRC’s claim against PBDL was time-barred. This was on appeal from the First Tier Tribunal Tax Chamber case.

At para 8 the Court stated its understanding of ‘the Ijara transaction’ as ‘the lease and the option agreement.’ As the Court observed ‘this arrangement does not involve a loan by the financial institution to the lessee or the acquisition by the financial institution of only a limited interest in the relevant property. Instead the acquisition of this property which is to be financed takes the form of an outright purchase of the relevant interest from its then owner who may or may not be the person seeking the finance.’ It follows from this analysis that since MAR acquired the property it was the legal owner and therefore liable for SDLT.

At paras 18 and 22 the judgment considers the alternative finance arrangements [s 72 Finance Act (FA) 2003; s 71A FA 2005; ss 72(2) and 73(2) FA 2006]. It was not in dispute that the alternative finance arrangement apply to ijara based financing. The dispute between the parties related to the transaction under which MAR purchased the property. The judgment’s analysis as set out by Patten LJ affirmed (para 35) that the alternative finance arrangements left MAR (not PBL) liable for SDLT.

Lewison LJ speaking for the Court added additional detail regarding Shari’a compliant transactions, referring the HM Treasury’s Regulatory Impact Assessment for Alternative Finance Products at para 47. As he correctly indicates (para 48) ordinary understandings about secured loans at interest must be put aside as ‘quite different. ’ At para 47 he said: ‘Under an Ijara arrangement a bank or other financial institution buys the asset that the customer wishes to acquire and then leases that asset to him. The rent is calculated in such a way that the bank will be the real owner of the asset for the term of the lease, and the customer will not.‘ Since the bank, MAR in this case, is the owner it followed that MAR not PBL is liable for the SDLT.

Lewison LJ then distinguished ijara from musharaka, considering the instance where a customer has some money to put towards a purchase (which could result in an undercharge for SDLT payment). He stated that musharaka ‘is a form of partnership under which the partners jointly acquire an asset. The asset will be held by them as beneficial tenants in common in the proportions in which they contributed to the purchase price. Under that kind of arrangement both the bank and the customer will be liable for the SDLT.’ This is an accurate statement as far as it goes. However it should be remembered that the subject matter of a musharaka agreement is not limited to property or tangible assets and may include unrealised business enterprises or projects. This relationship is not reducible to that of tenants in common — which would imply the existence of real property alone.

Lewison LJ goes on to distinguish ‘diminishing Musharaka ‘ (i.e. musharaka mutanaqisha) ‘under which the customer makes periodic payments under a lease to the bank in return for proportionate increases in his own share in the asset. Under both types of arrangement the customer will have the ultimate right to acquire the asset in question.’

In conclusion, this judgment in addition to the rather negative consequences for the perception of the HMRC (and loss to the British treasury of £50 m), and the gains (or rather foregone losses) for PBL and ultimately the Qatari sovereign wealth fund heightened the profile of several contracts, trite in Islamic law, but seldom (actually never before) rehearsed with such clarity and precision in an English legal judgment.

The HMRC stated after the case that the Court agreed with it that SDLT is payable but that they are ‘disappointed that the decision makes that tax much harder to collect so we are considering an appeal.’

 

IDRAK will be waiting and watching….

 

 

 

[1] even as it may increase the cost of financing by means of ijara due to the clarity it affords in relation to the liabilities incurred by an Islamic bank offering such financing in the United Kingdom.

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