Luxembourg tax treatment of Murabaha contracts and Sukuk transactions – Islamic Finance

Olivier Sciales's Finance Legal Blogs

Attorney in Luxembourg, Luxembourg

On January 12, 2010, to confirm Luxembourg’s commitment to Islamic Finance, the Luxembourg tax administration has issued a circular L.G.-A No. 55 (12 January 2010) in order to provide guidance on Islamic Finance (the “Circular”).

The Luxembourg tax administration refers to Islamic Finance as the “financial instruments used by investors who wish to manage their investments observing the values of Islam”. The objective of Islamic finance is, according to such Circular, “to share profits and losses between those who provide the capital and those who use it.”

The Circular in its first part provides a description of the major Shariah principles and Islamic finance techniques such as Murabaha, Muchakara, Mudaraba, Ijara, Ijara-wa-Iqtina, Istinah and Sukuk. The second part deals with the Luxembourg tax treatment of Murabaha contracts and Sukuk transactions.

Murabaha contracts

General background

Murabaha is a kind of sale with a deferred payment where the seller expressly mentions the cost he has incurred on the assets to be sold and sells it to another person by adding some mark-up / margin thereon which is known to the buyer.

In general there are two contracts in a Murabaha financing: First the purchase by the financier (eg. the bank) of the asset on request of the client / buyer and secondly the sale by the financier (eg. the bank) of the asset to the client / buyer with an agreed margin (mark-up) and paid by the client to the financier on a deferred payment basis.

Luxembourg tax treatment

The Circular mentions that from a Luxembourg tax perspective the agreement between the person providing the financing (eg. the bank) and the client / buyer is to be assimilated as a sale agreement. As such, the realized gain on the sale is realized by the person providing the financing at the date of signing of the agreement and the entirety of the revenue from the sale is immediately taxable (including the margin for the person providing the financing, in other words his profit).

However, the Circular provides for an exception to the above principle of immediate taxation by allowing a taxation of the gain on a deferred straight-line basis over the life of the agreement regardless of the actual repayments made by the client / buyer.

There are certain conditions set out in the Circular that need to be complied with in order to be able to benefit from the taxation on a deferred basis, namely:

  • The agreement between the parties must clearly demonstrate that the financier has acquired the assets to resell them, either immediately or in a maximum of 6 months, to the buyer / client;
  • The agreement must mention (i) the remuneration perceived by the financier for his intermediation, (ii) the profit of the financier as consideration for the deferred payment and (iii) the acquisition price paid by the client / buyer and by the financier (eg. bank);
  • The profit  of the financier must clearly be mentioned, known and accepted by both parties to the agreement;
  • The profit of the financier must expressly be designated as being the consideration for the service rendered by the financier to the client / buyer and which results from the deferred payment granted to the client / buyer;
  • For accounting and tax purposes, the profit must be spread by the financier on a straight-line basis over the period of the deferred payment, regardless of the actual repayments made by the client/ buyer.

Sukuk transactions

General background

A Sukuk can be considered as an Islamic equivalent of a bond. Since fixed income, interest bearing bonds are not permissible under Shariah law, Sukuk securities are structured to comply with Shariah law and its investment principles, which prohibits the charging, or paying of interest. A Sukuk has a pre-determined maturity and is backed by an asset that makes it possible to realize a return on the investment. The remuneration on the Sukuk is linked to the performance of the asset held by the Sukuk issuer. The Circular defines Sukuks as securities, whose yield and principal depend on the performance of tangible assets or the usufruct of such assets. Sukuks can be structured alongside different techniques. While a conventional bond is a promise to repay a loan, a Sukuk constitutes partial ownership in a debt (Sukuk Murabaha), asset (Sukuk Al Ijara), project (Sukuk Al Istisna), business (Sukuk Al Musharaka), or investment (Sukuk Al Istithmar). Most commonly used Sukuk structures replicate the cash flows of conventional bonds. Such structures are listed on exchanges such as the Luxembourg Stock Exchange, and made tradable through organisations like Euroclear and Clearstream. As of the date of this article, around 16 Sukuks with a combined value of USD 6 billion are already listed on the Luxembourg Stock Exchange, the first in Europe to list a Sukuk in 2002 while about 35 others are in the process of being launched.

Luxembourg tax treatment

The Circular provides that that the Luxembourg tax treatment of a Sukuk is identical to the treatment of debt in conventional finance (although the income is linked to the performance of the underlying asset) and that the remuneration of the Sukuk is treated for Luxembourg tax purposes as an interest payment. As a result thereof, payments made under the Sukuk (the yield on the Sukuk) qualify as interest and should generally be deductible if incurred in the corporate interest of the company / issuer of the Sukuk. The payments made on the Sukuk should not be subject to withholding tax as under Luxembourg law, no withholding tax is due on interest payments (except for application of the Savings Directive).

It should be noted that undertakings for collective investment under Luxembourg law and investing in Islamic assets are excluded from the scope of this Circular. This can be explained as UCIs are tax exempt entities for Luxembourg corporate income tax purposes.

In addition to the above, the recent entry into force of a tax treaty between the Grand Duchy of Luxembourg and the United Arab Emirates on January, 1, 2010 and the signing of a memorandum of understanding between the Grand Duchy of Luxembourg and Bahrain, and between the Dubai International Financial Center and Luxembourg for Finance, on 11 and 12 January 2010 confirm the will of the Grand Duchy of Luxembourg to become a global hub for Islamic finance in Europe.

For further information, please contact Olivier Sciales, partner at Chevalier & Sciales ( His email address is 

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