With the sub-prime crisis challenging conventional banking and financial products, there is mounting interest in Islamic products which comply with the principles of shariah law. The size of the global market for shariah-compliant products is estimated at $800 billion. The increase in wealth in Islamic countries (especially in the Middle East with its accumulation of petrodollars), the growth in the Muslim population, the huge capital requirements for infrastructure projects across the Muslim world as well as the active participation of investors and sovereign nations in Islamic capital market have not only resulted in a remarkable growth in the Islamic finance industry but have also led to the development of a wide range of shariah-compliant products.
In Mauritius too, there is a growing demand for shariah-compliant products based on the sharing of risks and rewards. Over the past few years the government has taken an array of measures to encourage the development and promotion of Islamic banking and financial services. This has led to HSBC offering Islamic banking services in Mauritius. Islamic insurance (takaful) and Islamic leasing (ijara) are also available in Mauritius while microfinance is being offered by credit cooperative societies based on Islamic principles such as murabaha (deferred sale).
Mauritius is also an active player in the global Islamic finance industry. Indeed, a combination of fiscal and non-fiscal factors has made Mauritius particularly attractive as a jurisdiction in which to structure Islamic financial products. A number of shariah-compliant global funds have already been set up in Mauritius and there is an increasing interest in Mauritius as a place to structure Islamic bonds (sukuk).
Shariah-compliant funds
It is important to note that shariah-compliant funds are not meant for Muslim investors only. Non-Muslims can and often do invest in shariah-compliant funds. The investors can agree on the profit-sharing formula but loss must always be shared in proportion to the capital invested. This is an important factor to bear in mind as guaranteed returns on investment and uneven distribution of loss such as in the case of subordinated shares may be prohibited.
A shariah-compliant fund can only invest in companies whose core activities are not prohibited according to shariah. Thus it is generally not permitted to invest in entities whose core activities involve financial services based on interest (riba) such as conventional banks and insurance companies, gambling, manufacturing or sale of illicit products (haram) such as pork, alcoholic beverages, obscene material, weapons or tobacco. However, it is to be noted that some scholars allow investment in the equities of companies which derive a minor part of their income from haram activities if it is justified on the grounds of public interest or is inevitable. In that respect, the Dow Jones Islamic Market Index has laid down certain norms for determining whether a company is shariah-compliant. In practice, most shariah-compliant funds have their own independent shariah board or adviser which scrutinises the investment made by the fund and lays down investment guidelines to be followed by the investment manager of the fund. The fund will also need to pay 2.5% of its annual profit as zakaat to charity.
A number of shariah-compliant funds have been set up in Mauritius because of its attractive taxation regime. Mauritius generally imposes a flat rate of income tax of 15%. However, funds holding a Category 1 Global Business Licence are effectively taxed at a maximum rate of 3% and can end up paying no income tax depending on the foreign tax credit. Dividends paid by a Mauritius company are exempt from tax and there is no capital-gains tax in Mauritius other than on sale of immovable assets in Mauritius. More importantly, Mauritius has entered into double taxation agreements (DTA) with 33 countries; this makes it particularly attractive for efficient tax structures. For example, a Mauritius fund does not pay any capital-gains tax upon the disposal of shares in an Indian company.
Mauritius's strategic position in the middle of the Indian Ocean between Africa and Asia, and its time zone (four hours ahead of Greenwich Mean Time) makes it a preferred jurisdiction for structuring investments into those emerging markets. It has a multicultural society and a pool of qualified professionals able to speak English, French, and an ancestral language such as Hindi or Arabic, thus easing communication with clients in the Middle East and other Arabic-speaking countries. Mauritius has adequate anti-money laundering legislation and KYC (Know Your Client) regulations in place to curb the risk of attracting unlawful funds. In addition, Mauritius is not blacklisted by the OECD or Financial Action Task Force (FATF).
| Typical ijarah sukuk transaction |
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Sukuk
Sukuk which are commonly referred to as Islamic bonds are more accurately defined by the Accounting and Auditing Organisation for Islamic Financial Institutions (Aaoifi) as "certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services (in the ownership of) the assets of particular projects or special investment activity". It is important to note that unlike conventional bonds, sukuk do not represent debts owed by the issuer and cannot be issued against a pool of receivables. The sukuk must always be backed by tangible assets.
The global market for sukuk is increasing as countries such as Malaysia, Bahrain and Qatar issue sovereign sukuk to finance major projects. Even outside the Muslim world, in countries such as Germany, the UK and Japan, there is an increased interest in sukuk as an alternative way to raise funds. Sukuk that are traded and listed are also particularly attractive for investment or for treasury management purposes. This has led to considerable innovation in structuring sukuk. Some sukuk are based on leasing (ijara), others on partnership (musharaka), or build-to-order projects (istisna). In fact, Aaoifi allows 14 different categories of sukuk. It is beyond the scope of this paper to analyse each and every permissible type of sukuk. We shall however briefly consider ijara sukuk based on the concept of sale and lease back mechanism which has been used by sovereign as well as corporate bodies.
In an ijara sukuk the owner of an asset will typically sell the asset to a bankruptcy remote Special Purpose Vehicle (SPV), set up solely for the issuance of the sukuk. Once it has acquired the asset, the SPV will lease back the asset to the original owner and typically the original owner/lessee will undertake to purchase the assets at the end of the lease term. The SPV will issue certificates conveying undivided percentage interests in the underlying asset to the sukuk holders. The SPV will distribute the rental payment upon receipt to the sukuk holders in accordance with their percentage interests in the underlying asset and upon the sale of the asset to the original owner/lessee, distribute to the sukuk holders a return of their capital. The rental income is used to make periodic payments to the sukuk holders. The original owner of the underlying asset will usually provide an irrevocable third party guarantee. The guarantor will provide the shortfall amounts in case the issuing vehicle, the SPV, cannot make payment. It is important that the rights and obligations of the issuer and the investors are clear and transparent in compliance with the principles of Islamic finance.
Mauritius is an ideal location for setting up an SPV as the issuer in a sukuk transaction. The SPV can be set up in Mauritius as a company holding either a Category One Global Business Licence (GBL 1) or a Category two Global Business Licence (GBL 2) or as a trust. A GBL 2 is a tax-free entity while a GBL 1 is tax resident in Mauritius and can enjoy the full advantages of the double-taxation treaties signed by Mauritius. Provided that its settlor and beneficiaries are non-resident, the trust can either opt to be resident in Mauritius and pay income tax at the rate of 15%, or opt to be treated as non-resident and be exempt from income tax. There will be no withholding tax in Mauritius on the periodic payments or on the reimbursement of capital to the sukuk holders which are not resident in Mauritius.
If the underlying assets are located in a country with which Mauritius has a double taxation agreement then, depending on the terms of the DTA, there may be no capital-gains tax payable when the Mauritius SPV sells back the assets to the original owner. If the underlying assets are not immovable assets and the Mauritius SPV does not have a permanent establishment in the source country, then the Mauritius SPV may end up not paying any tax in the source country on the rental income derived from the lease of the assets.
If the underlying assets are not located in a country with which Mauritius has a DTA, then the SPV can be set up as a GBL 2 or as a non resident trust and be exempt from all income tax.
The SPV can be structured to be bankruptcy remote and such bankruptcy remoteness will be enforceable in Mauritius. In the case of a dispute, the courts in Mauritius will give effect to any arbitration clause chosen by the parties and the parties can have recourse to the Privy Council in England which is the ultimate court of appeal. There are also no exchange controls.
Challenges ahead
Islamic finance market has tremendous potential for growth. However, there are still a number of controversial issues which need to be resolved to provide the market with the necessary comfort that products which are today marketed as shariah-compliant will not be subsequently held not to be shariah-compliant by other scholars.
There is also a need to standardise the legal documents relating to the Islamic products. With respect to sukuk there is a need to have an efficient secondary market on which sukuk can be traded and which complies with the shariah principles governing the trade in underlying assets.
This being said, considerable efforts are being made by scholars and institutions such as Aaoifi to develop shariah-compliant products that meet the expectations of the ever more sophisticated investors and ever more complex business realities. Mauritius is closely monitoring the evolution of the global Islamic finance industry and has a flexible and efficient regulatory and taxation regime which makes it particularly attractive as a jurisdiction in which to structure Islamic financial products.
| Author biographies |
Muhammad Uteem
Muhammad Uteem is the founder and head of Uteem Chambers, a leading chambers of barristers in Mauritius. His practice concentrates on international commercial law, banking, trusts, tax consultancy and litigation. He has a diverse portfolio of international clients that ranges from sophisticated institutional investors, merchant banks and government-linked agencies to high-net-worth individuals that require international tax and estate planning solutions. He has also been involved in legislative drafting in Mauritius.
Prior to returning to Mauritius, he worked for a number of years as an associate of Winthrop Stimson Putnam & Roberts (now Pillsbury Winthrop Shaw Pittman LLP), an American law firm, in Singapore, Hong Kong and Japan.
Muhammad Uteem holds a Masters in International Business Law from King's College, London. He was called to the Bar at the Middle Temple and won the first prize for best overall performance at the Bar Exams of England. He is also a Chevening scholar. |