Sharia compliant structures for purchasing UK property

How are financial institutions working within Sharia law?

Some financial institutions have developed financial arrangements to facilitate the purchase of property in a way that’s compliant with Sharia law. While such alternatives are increasing in popularity, there are still relatively few financial institutions willing and able to offer them, including most high street banks.

A common structure used by financial institutions is known as diminishing shared ownership or ‘diminishing Musharakah’. This is where you, as the purchaser, put down a deposit of typically at least 20% of the total purchase price and the financial institution purchases the remaining share in the property. The bank is the registered owner of the property. You then pay rent to the financial institution for the share of the property you don’t own.

As the purchaser, you make payments to the financial institution to purchase further shares in the property in much the same way as capital repayments are made. This in turn will reduce the amount of rent due over time as each instalment is paid and the bank’s share of the property diminishes. 

The amount of rent charged can be fixed at the outset with a payment plan to reflect the capital payments made towards owning the property outright. The rent is determined by a combination of market interest rates and the financial institution’s margin. Most financial institutions review the rent amount on a quarterly basis.

Once you have purchased the entire property, the full title of the property will be transferred to you and no further rent is payable.

The above method of property purchase is parallel to a repayment mortgage.  There is also a ‘rent only’ funding structure, parallel to a conventional ‘interest only’ mortgage. Under the rent only structure, you would pay a much lower monthly payment but you’re only able to purchase the bank’s interest in the property at the end of the finance term. 

The tax considerations for Sharia compliant structures

There are specific provisions in tax law for a Sharia compliant structure, such that there is no Stamp Duty Land Tax (SDLT) on the transfer from the financial institution to you as the purchaser (it’s still payable on the share initially purchased). The rent is also treated under the interest exemption for financial institutions.

However, there is one area that still hasn’t been addressed adequately, despite representations being made to HMRC on the matter. As an example - if you’ve completed the entire purchase of the property and wish to use that property as collateral for the purchase of a further property, or to extract funds for personal use, the property would need to be sold to the financial institution in order to release the funds. Under a conventional mortgage structure, the refinancing of the property wouldn’t be treated as a disposal for capital gains tax purposes, as you would still legally own the property but subject to a lien in favour of the financial institution. 

The refinancing under a Sharia compliant structure does crystallise a taxable capital gain, which in the past on properties sold before 5 April 2015 may have not been taxable if you were a non-UK resident purchaser. If the property is your main residence, then Private Residence Relief (PRR) may be available to alleviate the position, but often the property is a second home or an investment property, which will crystallise a taxable capital gain.

What should you do?

The cost of a Sharia compliant mortgage can sometimes be more than that of a conventional mortgage due to the increased administration costs and higher risk of the arrangement for the lender. If you’re considering a Sharia compliant structure to purchase a property portfolio in the UK, it's important to take UK tax advice to ensure the structure does not realise UK capital gains, which could be mitigated.

Timing is key, so it’s important to seek specialist advice early on in the process. For professional UK tax advice tailored to your unique circumstances, please fill in the form below and one of our experts will be in touch to discuss your requirements and how we can help.