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HMRC internal manual

Savings and Investment Manual

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Interest: specific inclusions: alternative finance return

Alternative finance return from alternative finance arrangements

Islamic law (the Shari’a) prohibits lending at interest. This stems from the principle in the Qur’an: ‘God hath permitted trade and forbidden usury’. Muslims (or anyone else) may enter into arrangements that have a similar economic effect to deposits or loans, but which do not involve interest. The tax treatment of some of the most commonly used ‘alternative finance arrangements’ is set out, for income tax purposes in Part 10A of the Income Tax Act 2007. Detailed guidance on alternative finance arrangements is to be found in the Corporate Finance Manual at CFM44000 onwards (SAIM20000). See SAIM2255 for a table of cross references from ITA 2007 to the relevant guidance in the Corporate Finance Manual.

In particular, the legislation defines three arrangements that give rise to ‘alternative finance return’ in the hands of an investor. ITA07/S564E is aimed at an arrangement known by the Arabic name of Mudaraba. The investor deposits money with a bank or similar financial institution, which pools such deposits and invests the funds in a way that complies with Shari’a law. The bank then credits the investor with part of the investment proceeds from time to time, in proportion to the amount they have invested. Such credits are likely to equate, in substance, to the return on an investment of money at interest. Where they do so, they come within the legislation - in other words, they comprise ‘alternative finance return’. CFM44090 has more details.

ITA07/S564F covers an agency arrangement known as Wakala. The investor appoints a bank or other financial institution as their agent, giving the bank a sum of money to invest on their behalf. The agent specifies an investment return it expects to receive. Provided that the investment achieves at least the expected return, this is the amount that is paid out to the investor (who is at risk if the return falls short of expectations). Any additional investment proceeds are retained by the agent as an ‘incentive fee’. ITA07/S564F also characterises the amount received by the investor under such arrangements as ‘alternative finance return’. CFM44100 has more details.

Alternative finance return may also arise to a person who holds a type of sharia-compliant bond known as Sukuk. ITA07/S564G refers to these as ‘investment bond arrangements’. Again, the interest-like amounts received under these arrangements are taxable as ‘alternative finance return’. CFM44120 has more details.

For non-corporate investors, ITA07/S564M provides that for the purposes of ITTOIA 2005, alternative finance return is treated as if it were interest. ITA07/S564Q further provides that in circumstances where interest would be paid under deduction of tax (see SAIM9000), income tax is also deducted from alternative finance return.