Land Registry- Practice Guide 69 – Islamic financing (Islamic Mortgages)

http://www.landregistry.gov.uk/professional/guides/practice-guide-69

Issued: August 2010

Scope of this guide

This guide deals with the registration requirements for certain types of Islamic financing arrangements used in the purchase of land. In the United Kingdom Islamic mortgages have generally been structured in one of three ways. Now referred to as ‘home purchase plans’ by the UK Treasury and Financial Services Authority, the three forms of contract are:   Ijara wa Iqtina  Diminishing Musharaka  Murabaha. This guide also discusses the emergence of the Islamic bond or sukuk market. These and other modes of Islamic finance are generic forms of financing that can be applied in many of the same areas as traditional techniques, such as asset finance or trade finance for commodities as well as for the acquisition of residential and commercial property, which is the focus of this guide. We have set out the principles of these schemes below, but the details may vary from bank to bank. In this guide the Arabic names of each product are used, but banks may call them something else. The spelling may also vary, as there is no agreed standard for transliterating Arabic words into the Roman alphabet. In this guide we have used the term ‘bank’ to describe the finance provider – this should be read as including other types of finance provider where appropriate. Land Registry is grateful to Mr Mohammed Saqub, solicitor, for his assistance in the preparation of this guide. 1 Abbreviations and terms used In this guide: ‘e-DS1’ means an electronic method of discharge lodged through the portal ‘ED’ means an electronic discharge ‘Fee Order’ means the current Land Registration Fee Order ‘HMRC’ means Her Majesty’s Revenue & Customs ‘SDLT’ means stamp duty land tax. 2 Background The theological basis for Islamic finance stems partly from the traditional prohibition of usury or interest, which means that interest-based lending may not appeal to followers of Islam. Islamic finance products have been structured so as to avoid the payment of interest. These financial products have been developed so that they fall within the regulatory and legal framework of England and Wales and so introduce no new concept in Land Registry terms. They are available in the UK to Muslims and non-Muslims alike. 3 Ijara wa Iqtina mortgage Ijara is a lease of an item by its owner to a customer and Ijara wa Iqtina is a lease of an item usually followed by the eventual sale of the item to the customer at the end of the lease term. In the case of a property purchase using Ijara wa Iqtina, the bank will purchase the property chosen by its customer for an agreed price and then will grant a lease to the customer. The lease will usually be long enough to require registration under the Land Registration Act 2002. This type of mortgage is used both for financing a house purchase, and for existing homeowners switching from an interest-bearing mortgage. The customer’s monthly ‘mortgage’ payments will normally comprise both the rental payment as well as an amount held by the bank to act as a guarantee that the customer will be able to pay for the purchase of the property at the end of the lease term. The monthly ‘mortgage’ payments are fixed in such a manner that the bank gets back its principal sum along with some profit. The bank also gives an undertaking to the customer to transfer the reversion of the property to the customer at the end of the term or when the arrangement is ended. When the customer wants to sell or end the arrangement, they can give notice at any time to the bank and the property is then either transferred to the customer for the price originally agreed less the on-account payments, or the customer can direct the lender to sell on to a third party, arrangements being made for the termination of the lease. 3.1 Documents required You will need to send us:   a transfer of the reversion to the Islamic financier (the reversion is the estate out of which the lease is granted; it might be freehold, but could be another leasehold), and  a lease of whole to the customer. If there is an agreement or ‘promise to sell’ the reversionary estate, you may apply to note this on the register as an agreed or unilateral notice. See Practice Guide 19 – Notices, restrictions and the protection of third party interests in the register. The customer might also sign a ‘promise to buy’ the reversion but if this does not create a burden on land (which is unlikely) it will not be capable of being noted. 3.2 SDLT Provided the statutory conditions are fulfilled the lease, the transfer of the reversion and any intermediate transfers of shares in the freehold are relieved from SDLT, as is the initial transfer if the customer is the registered proprietor. Both the transfer to the Islamic financier and the lease to the customer are potentially notifiable transactions. If they exceed the threshold for notification to HMRC, you will need to send us a Land Transaction Return Certificate (form SDLT5). Please contact HMRC for further details regarding SDLT. 3.3 Fees In common with other government departments, our fees are based on the amount of work involved and are assessed under the Fee Order as follows.   Transfer to lender – scale 1 (if for value) or scale 2 (if not for value).  Lease to customer – scale 1.  Agreement – schedule 3; no fee is payable if it is lodged at the same time as the other applications. Details of current fees are available at www.landregistry.gov.uk 3.4 When the Ijara wa Iqtina arrangement has come to an end When the Ijara wa Iqtina arrangement has come to an end, you should send us a transfer of the reversion to the customer and, if desired, an application to merge the lease back into the reversion. If you have registered an agreement, this can be removed using form CN1 (agreed notice) or forms UN2 or UN4 (unilateral notice). The transfer to the customer is a potentially notifiable transaction for SDLT. If the consideration exceeds the threshold for notification to HMRC, you will need to send us a land transaction return certificate (form SDLT5). A fee is payable on the transfer to the customer, assessed under scale 1 of the Fee Order (if for value) or scale 2 (if not for value). No fee is payable for the merger or removal of notice, provided the application is made at the same time as the transfer. 3.5 Default by the customer Should the customer default there may be a provision for the bank to require the customer to repurchase the property or to allow for its sale, free from the occupational lease. In that case we would expect to see a transfer to the customer or a third party, together with an application to merge the lease into the reversion. Alternatively the bank may rely on the usual remedies for non-payment of rent and seek determination of the lease. See Practice Guide 26 – Leases – determination. 4 Diminishing Musharaka (partnership) Musharaka means ‘partnership’ or ‘joint venture’ and is used for home purchase financing. There are various ways in which this partnership can operate in the context of a home purchase plan. Typically, a customer would like to purchase a house for which they do not have sufficient funds. In these circumstances the bank might, for example, agree to pay 80 per cent of the purchase price, the remaining 20 per cent being paid by the customer. The legal title is transferred to the bank notwithstanding the customer’s 20 per cent contribution, and then the bank leases the property to the customer. In some forms of diminishing partnership contracts, the property is held by the bank in trust for itself and the customer. A separate diminishing partnership contract is entered into between the bank and the customer to split the beneficial interest in the property depending on each party’s contribution to the purchase price. In our example, the bank would be entitled to 80 per cent of the beneficial interest while the customer’s beneficial interest would be 20 per cent. After the property is purchased, the customer uses the property for their own residential purposes and pays rent to the bank for using its 80 per cent share in the property. The lease to the customer will normally be a registrable disposition and may also be charged to the bank. In addition to the rental payment, over time the customer buys the bank’s beneficial interest in the property and eventually becomes owner of the bank’s 80 per cent share. At this stage, the customer’s total rental payment is zero and the bank will transfer the legal ownership to the customer at Land Registry. This example is illustrated in Diagram A below. The Diminishing Musharaka mode of finance allows the bank to claim rent according to its proportion of ownership in the property and at the same time allows the bank periodic returns of the principal finance sum, as it is repaid in stages. The bank will give an undertaking to the customer at the outset to transfer back the property at the end of the term or when the arrangement is ended. This type of mortgage is used for financing a house purchase, and for existing homeowners switching from an interest-bearing mortgage. Diagram A – Diminishing Musharaka mortgage  4.1 Documents required You will need to send us:   a transfer of the reversion to the bank and customer; given the nature of the transaction, it is likely that the bank and customer will be tenants in common in unequal shares  a lease of whole to the customer. If there is an agreement or ‘promise to sell’ the reversionary estate, you may apply to note this in the register as an agreed or unilateral notice. See Practice Guide 19 – Notices, restrictions and the protection of third party interests in the register. 4.2 SDLT Provided the statutory conditions are fulfilled the lease, the transfer of the reversion and any intermediate transfers of shares in the freehold are relieved from SDLT, as is the initial transfer if the customer is the registered proprietor. Both the transfer to the Islamic financier and the lease to the customer are potentially notifiable transactions. If they exceed the threshold for notification to HMRC, you will need to send us a land transaction return certificate (form SDLT5). Please contact HMRC for further details regarding SDLT. 4.3 Fees In common with other departments, our fees are based on the amount of work involved and are assessed under the Fee Order as follows.   Transfer to the bank – scale 1 (if for value) or scale 2 (if not for value).  Lease to customer – scale 1.  Agreement – Schedule 3; no fee is payable if it is lodged at the same time as the other applications. Details of current fees are available at www.landregistry.gov.uk 4.4 When the Diminishing Musharaka arrangement comes to an end When the Diminishing Musharaka arrangement has come to an end, you should send us a transfer of the property back to the customer, and, if desired, an application to merge the lease back into the reversion. If you have registered an agreement, this can be removed using form CN1 (agreed notice) or forms UN2 or UN4 (unilateral notice). The transfer to the customer is a potentially notifiable transaction for SDLT. If they exceed the threshold for notification to HMRC, you will need to send us a land transaction return certificate (form SDLT5). A fee is payable on the transfer to the customer, assessed under scale 1 of the Fee Order (if for value) or scale 2 (if not for value). No fee is payable for the merger or removal of notice, provided the application is made at the same time as the transfer. 5 Murabaha Murabaha is a sale of an item to a buyer where the seller expressly mentions the cost they have incurred on the commodities to be sold and sells it to another by adding some profit or mark-up which is known to the buyer. In order to implement a Murabaha mortgage, a bank will buy from the seller the property that is required by its customer for an agreed price, and immediately sells it to the customer at an agreed profit margin over cost. Thus Murabaha is not a loan given on interest; it is a sale of a commodity for money. The customer will pay the price of the property in instalments over several years, and mortgage the property to the bank in order to secure the instalments that are due. A simple Murabaha arrangement for home finance is shown in Diagram B. Diagram B – Murabaha  5.1 Documents required You will need to send us:   a transfer of the property to the bank  a transfer by the lender to the customer, and  a charge in favour of the bank. 5.2 SDLT The liability to pay SDLT is structured to mirror a conventional mortgage financed purchase, so SDLT will be payable on the first sale by the seller to the bank, if it exceeds the threshold. Relief can be claimed on the second sale, subject to a few exceptions. Both transfers are potentially notifiable transactions. If they exceed the threshold for notification to HMRC, you will need to send us a land transaction return certificate (form SDLT5). Please contact HMRC for further details regarding SDLT. 5.3 Fees In common with other departments, our fees are based on the amount of work involved and are assessed under the Fee Order as follows.   Transfer to the bank – scale 1 (if for value) or scale 2 (if not for value).  Transfer to customer – scale 1.  Charge – scale 2 (no fee if lodged at the same time as the transfer). Details of current fees are available at www.landregistry.gov.uk 5.4 When the Murabaha arrangement has come to an end You should discharge the charge using DS1, ED or e-DS1. See Practice Guide 31 – Discharge of charges. 5.5 Default by the customer The bank’s remedies in the case of default are the same as for a conventional charge. Therefore a transfer under power of sale using form TR2 would be the usual application. 6 Sukuk Sukuk can be regarded as a form of investment-backed bond (sukuk is the plural of ‘sakk’ and means ‘financial certificates’). However, a sukuk is distinctively different from a bond issued to evidence a loan (where the loan must be repaid with interest) and instead constitutes a partial ownership in an asset (Sukuk al Ijara) or business (Sukuk al Musharaka). For the purposes of this guide we are only looking at Sukuk al Ijara. Sukuk al Ijara is likely to be used in connection with very large property transactions, such as shopping centres, hotels or portfolios of properties. In this arrangement, the finance provider will buy the customer’s property themselves, or more likely it will be sold to a specially established company known as a ‘special purpose vehicle’ (SPV). The SPV (or the finance provider) will lease back the property to the customer, who pays rent. The SPV or finance provider then issues sukuk or bonds to investors, who derive an income based on the property asset. When the arrangement comes to an end, the bank transfers the property back to the customer. Such arrangements are exempt from SDLT, but to prevent stamp duty evasion by others, a charge is placed on the property by HMRC, which is removed when the property is transferred back to the customer. By way of illustration, company X requires £100 million for the purposes of expanding its business. X sells land valued at £100 million to a SPV. Company X also promises to buy back the land at the end of year 10. The SPV issues a 10-year sukuk to the investors. In return for the £100 million, the SPV leases back the land to X for a period of 10 years for £12 million per year. From the perspective of Company X this is a way in which they can raise capital. From the investors’ point of view, the sukuk is a type of bond investment where the initial capital is repaid together with a rental return (rather than interest). This above example has been illustrated in Diagram C below. Diagram C – Sukuk al Ijara  6.1 Documents required You will need to send us:   a transfer of the property to the bank or SPV  a lease by the bank or SPV to the tenant, and  a first legal charge in favour of The Commissioners of HMRC – see section 6.2 – SDLT (if there are other charges registered, they will have to be postponed in priority to the HMRC charge). 6.2 SDLT HMRC has agreed that such arrangements are exempt from SDLT, provided certain conditions are met to prevent them being used for SDLT avoidance. One of these conditions is that the bank or SPV will execute a first legal charge in favour of HMRC to cover any liability for SDLT, interest and penalties that may become due. If they exceed the threshold for notification to HMRC, you will need to send us a land transaction return certificate (form SDLT5). Please contact HMRC for further details regarding SDLT. 6.3 Fees Our fees are based on the amount of work involved and are assessed under the Fee Order as follows.   Transfer to the bank or SPV – scale 1 (if for value) or scale 2 (if not for value).  Lease to customer – scale 1.  Charge – scale 2 (no fee if lodged with the transfer application). Details of current fees are available at www.landregistry.gov.uk 6.4 When the term of the sukuk ends When the term of the sukuk ends, you should send us a transfer of the property back to the customer subject to the charge in favour of HMRC and, if desired, an application to merge the lease back into the reversion. Once you have the registration completion statement and title information document, you should send them to HMRC, who will then discharge its charge. The transfer to the customer is a potentially notifiable transaction. If it exceeds the threshold for notification to HMRC, you will need to send us a land transaction return certificate (form SDLT5). A fee is payable on the transfer to the customer, assessed under scale 1 of the current fee order (if for value) or scale 2 (if not for value). No fee is payable for the merger or removal of notice, provided the application is made at the same time as the transfer. 7 Property price information Transactions that are not open market sales are not included in our database of property prices, to ensure these figures are not distorted. 8 Enquiries and comments If you have a particular concern that is not covered by this guide, please contact Customer Support in advance of the transaction – see Contact details. If the transaction is particularly complex, it may be better if you make your enquiry in writing at the Land Registry office that will process your application. If you have any comments or suggestions about our guides, please send them to: Central Operations GroupLand RegistryTrafalgar House1 Bedford ParkCroydonCR0 2AQ (DX 8888 Croydon 3) You can obtain further copies of this and of all our guides free of charge from Customer Support (see Contact details) or you can download them in English and Welsh from our website. Land Registry advisory policy We offer advice to our customers through our publications and Customer Support information and through the day-to-day handling of applications.  We provide factual information including official copies of registers, title plans and documents, searches and details of our forms and fees.  We provide procedural advice to explain how the land registration system works and how to make applications correctly. This includes:  advice in advance of an application, where this is requested  where an application is defective, advice as to the nature of the problem and what options, if any, are available to put it right  an approval service for estate layout plans and certain other land registration documents.  There are limits to the advice that we will provide. We will not provide legal advice.  This means that:  we will not approve the evidence to be produced in support of a registration application before we receive the application  apart from procedural advice, we will not advise on what action to take  we will not recommend a professional adviser but can explain how to find one.  We provide advice only about real cases, not about theoretical circumstances. We will not express a view on questions where the law is complex or unclear except where the question arises on a live registration application.  In providing this factual information and procedural advice we will:  be impartial  recognise that others may be affected by what we say  avoid any conflict of interest. Contact details For customer enquiries and to request this publication in an alternative format please contact Customer Support at customersupport@landregistry.gsi.gov.uk or telephone 0844 892 1111, or 0844 892 1122 for a Welsh-speaking service, from Monday to Friday between 8am and 6pm. Calls cost 3p a minute on a BT standard tariff, in addition to the current set up/connection charge. Calls from other tariffs, service providers and mobile phones may cost more. We do not receive any revenue from these calls. To obtain copies of this and all our other guides, free of charge:  view/download guides in English and Welsh at www.landregistry.gov.uk  contact Customer Support. Information in this guide The information in this publication is for the purpose of providing general guidance about Land Registry’s procedures and policies. It is intended only as a guide and does not cover every situation that may arise. It also does not limit Land Registry’s ability to use its discretion when appropriate to do so, within the land registration legislation.

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