Islamic products: shared ownership (diminishing musharaka)
This product involves the use of two written contracts, being a lease agreement (‘Ijara’) and a diminishing ownership agreement (‘Musharaka’), where two or more parties share ownership of an asset.
Example: A customer wishes to purchase a residential property for £200,000. He/she pays a deposit of £20,000 to the vendor of the property and then enters into a diminishing ownership agreement with the bank, under which the bank pays the outstanding £180,000, taking title to the property by way of a sub-sale between the vendor and the bank. The bank’s customer now has a 10% beneficial interest (or share) in the property, with the remainder being with the bank. The bank allows the customer to defer payment of the £180,000 over a period of twenty-five years. It does not (and cannot) add any interest to the £180,000 and so under this contract the customer pays back the exact amount paid out by the bank.
At the same time as the customer enters into the diminishing ownership agreement he also enters into a lease agreement, whereby the bank agrees to lease its share of the house to the customer for a variable amount of rent. This lease agreement runs concurrent with the diminishing ownership agreement.
The customer may also be expected to pay any outgoings related to the property as well as all administrative and legal costs, arrangements fees, Stamp Duty Land Tax, HM Registry fees and VAT (if applicable).
Both the amount repaid under the diminishing ownership agreement and the amount paid under the lease agreement are amalgamated and used to calculate how much of the bank’s share of the property has been purchased per month by the customer. As the bank’s share in the property decreases so does the amount paid under the lease agreement.
At the end of the twenty-five years, and if all the conditions contained within the two contracts have been met, the bank will pass title to the property to customer under the diminishing ownership agreement, normally for an additional payment.
NB - whilst some banks also require the customer to sign a third agreement under which the customer provides some form of security against payment of the amounts due under the other two contracts, other banks may also require more than three agreements to be signed.
The central supplies are (i) the gradual sale of equitable interest, and (ii) lease of property. As such consideration for supplies made under this form of arrangement will follow the normal rules for property. See VAT Notice 708 Buildings and construction, VAT Notice 742 Land and Property and VAT Notice 742A Opting to tax land and buildings.