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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Deemed loan relationships: alternative finance: investment bond arrangements: conditions: exclusion of ‘profit-sharing’ arrangements

Reasonable commercial return and accounting tests

The Islamic concept of sukuk is an extremely flexible one. Sukuk that are issued to raise finance in capital markets will, in most cases, be economically equivalent to conventional debt securities, giving the holder a predictable return akin to interest. But this is not necessarily so: there is nothing to stop a company issuing sukuk which have the economic effect of profit-sharing or partnership arrangements, or which resemble equity rather than debt.


X Ltd is a company carrying on a trade of cattle breeding. It wishes to improve its herd. It therefore issues a 3-year sukuk to investors and uses the subscription proceeds to buy a pedigree bull. The sale proceeds from calves or bullocks sired by the bull, and artificial insemination fees generated from the bull, are distributed to investors in proportion to their certificate holdings. After 3 years, the bull is sold at a profit, and the proceeds shared between the investors.

Here, the investors participate directly in the success (or failure) of the underlying husbandry business. The sukuk is less a financial instrument than an arrangement for sharing profits or losses. It would not be appropriate to tax this in the same way as an interest-bearing security.

Statutory provisions relating to other alternative finance arrangements require the alternative finance return to equate in substance to the return on an investment of money at interest. Such a test is not possible for sukuk, because the return may equate to discount rather than (or as well as) interest - or it may include the value of a conversion right. Instead, CTA09/S507(e) and (i) imposes two tests designed to distinguish those sukuk arrangements that are economically equivalent to debt securities. These are the requirement that the additional payments do not exceed a reasonable commercial return (CFM44200), and that they are accounted for as a financial liability (CFM44210).