How to implement Islamic finance principles within the Western existing regulatory and legal framework:Luxembourg focus

May 12, 2011

Contents

I. Introduction to Islamic finance in Luxembourg 3

II. Legal tax framework

A) Tax in Luxembourg 5

B) Tax and Islamic finance 6

III. Existing opportunities in Luxembourg

A) Regulated structures

1. Overview 7

2. UCITS as an illustration 8

B) Non-regulated structures 9

C) Sukuk and structure products 15

IV. Conclusion 21

Private EquityI. Introduction to Islamic finance in Luxembourg

3

I. Introduction to Islamic finance in Luxembourg

1978 First Islamic finance institution established in a Western country (Islamic Banking System, later Islamic Finance House Universal Holdings S.A.)

1983 First Shariah compliant insurance company in a Weste rn country (Solidarity Takafol S.A.)

1990 Other renowned Islamic finance institutions set up Luxembourg establishments: Faisal Finance and FWU Group

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establishments: Faisal Finance and FWU Group

2002 First Western stock exchange to enter the Sukuk mark et (Malaysia Global Sukuk)

2010 Luxembourg Central Bank first EU Central Bank to become a member of the Islamic Financial Services Board (IFSB)

2011 Luxembourg banks requested to join the Islamic Liquidity Management Corporation

2011 First Annual IFSB meeting in a Western country (May 2011)

� 37 Shariah compliant funds and sub-funds created under Luxembourg law as of March 2011

� Luxembourg is the largest European domicile for shariah compliant investment funds

I. Introduction to Islamic finance in Luxembourg (2 )

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� 16 Sukuk listed on the Luxembourg stock exchange since 2002

� Large number of non-regulated structures

� Specialised teams and dedicated services for Shariah compliant structures and funds offered by Luxembourg service providers

II. Legal tax framework

A) Tax in Luxembourg

� Flexible and secure tax environment

� Advantageous domestic tax system

II. Legal tax framework

� Advantageous domestic tax system

� Well-developed tax treaty network

B) Tax and Islamic finance

� No need for specific legislation for Shariah compliant transactions as thetax system is based on:

� an economic approach; and� a substance over form principle

� Tax Circular on Islamic finance:

� The Luxembourg tax authorities published an administrative Circular related toshariah compliant finance instruments (Circular L.G.-A n°55 dated 12 January2010)

� In particular, the Circular clarifies the Luxembourg direct tax treatment of murabahaand sukuk:

� economic approach confirmed� Luxembourg UCIs investing in Islamic finance instruments are excluded from

the scope of the Circular

III. Existing opportunities in Luxembourg

A) Regulated structures

III. Existing opportunities in Luxembourg

A) Regulated structures

1. Overview

� Broad range of investment vehicles available

� Worldwide distribution capacities to retail and institutional investors

� Integration of Shariah special features:

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� Integration of Shariah special features:

� Shariah board

� Ban of haram activities

� Exclusion of riba (specific limits)

� Purification of haram income

UCITS

Strong SupervisoryFramework

Retail and institutionalInvestors

2. UCITS as illustration

�Luxembourg law perfectly allows the integration of such specific features inconventional regulated vehicles

UCITS

High Risk Diversification

TS, MMI, UCI, Cash, Derivatives,

No short selling

PassportEU

EEA, Asia, Middle East, Americas

B) Non-regulated structures – Case studies

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Real Estate Acquisition in Europe

Luxembourg

Shareholder

UAEUAE

LuxCo LuxCo

GCC

PPL and IFL IFL

Equity (1%) Convertible loan (99%)

Shareholder Shareholder Loan

Target Jurisdiction

ItalyCo FrenchCo

Shareholder Loan

Project Company(Jersey)

LuxCoCaymanCo

Private Placement

Memorandum

JVCO(Cayman)

Joint Venture Agreement

Real Estate: UK Mixed-Used Development

Conventional Funding Shariah Compliant Funding

(Cayman)

Finance Company

(Luxembourg)

Occupational Tenants

Private Equity: Shariah compliant transaction GCC-Turkey

Investment Bank & Investors

Offshore SPV

Murabaha & Mudaraba

LuxCo 1

Luxco 2

Real Estate Private Equity Company

Equity, Murabaha

ShareholdersShareholders

Shareholders

Private Placement of Shares

Luxembourg Holding Company S.A.

Holding Structure for a foreign Islamic Bank

Real Estate Education Other

BanksTakaful Re-Takaful

Holding Company Other

Islamic Bank

Tax treatment of Murabaha transaction

� Analysed as a sale, the gain i.e. the difference between acquisition andsales price realised by the financing entity under the murabahatransaction – the “Gain” – being as a rule taxable upon signature of theagreement

� However, the Gain being the remuneration of a deferral of payment(comparable to an interest), in such case possibility of a deferred taxationi.e. taxation on a straight-line basis during the period of the deferral ofpayment

Tax treatment of Murabaha transaction (2)

� The Gain qualifies as interest if:

�pursuant to the murabaha agreement, it is clear that the financing entity acquiringthe asset sells it back simultaneously or in a period not exceeding 6 months

�the murabaha agreement distinguishes between (i) the remuneration of thefinancing entity for its intermediation (ii) the acquisition price paid by thefinancing entity and (iii) the acquisition price paid by the investorfinancing entity and (iii) the acquisition price paid by the investor

�the Gain of the financing entity must be clearly stated, known and accepted byboth parties

�the Gain must be expressly qualified as being the counterpart of the servicerendered to the client and resulting from the deferral of payment granted to theclient and

�from an accounting and tax perspective, the Gain is accounted for on a straight-line basis by the financing entity, irrespective of the actual payments made

C) Sukuk and structured products

Sukuk al Mudaraba/Musharaka structure

Partners(Mudarib/Musharik)

Sharia’h-compliant Sharia’h-compliant

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Sukuk

Issuing sukuk

Risks (Returns or possible losses)

Sharia’h-compliantAgreement

(Mudaraba/Musharaka)

Sharia’h-compliantProject

Luxembourg SPV Investors(Sukuk Holders)

Investors(Sukuk Holders)

Luxembourg SPV

Project Company

Sukuk Payments

Sukuk al ljara Lease (ljara)

Rent

Sukuk al Ijara structure

OccupationalTenants

Sukuk PaymentsRent

RentOccupationalTenant Lease

Sukuk Issuance Platforms in Luxembourg

� Deutsche Bank: Al Miyar S.A.

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� Dar Al Istithmar: Al Waseelah Capital S.A.

Sukuk Issuance Platform

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Tax treatment of Sukuk

� Analysed as debt instrument from a Luxembourg tax perspective

� Thus, the remuneration paid to the sukuk holder = interest payment

� remuneration is tax deductible at the level of the sukuk issuer

� not subject to a WHT in Luxembourg

� Remuneration = income from transferable securities

� Luxembourg tax provisions related to typical silent partners andprofit-linked obligations are not applicable

IV. Conclusion

� Luxembourg is a primary hub for the development of Islamic finance

� first European stock market to launch and list Sukuk

� availability of regulated and non-regulated structures compliant with Shariah principles

� first European Member State to be admitted to the Council of the Islamic finance Services Board

⟹⟹⟹⟹ Luxembourg legal framework largely compatible with Islamic finance and suitable for issuance of Shariah compliant products but operational challenges need of industry standards based on IFSB guidelines

Thank you

Florence Stainier, PartnerThierry Lesage, PartnerBishr Shiblaq, Head of Dubai Representative Office