EIM26515 | The benefits code: beneficial loans: alternative finance arrangements; Islamic finance

Section 173A ITEPA 2003

From 22 March 2006 an alternative finance arrangement within Sections 46 to 57 Finance Act 2005 provided by an employer to an employee is taxed in the same way as a beneficial loan under the benefits code.

The alternative finance rules address arrangements that do not give rise to the payment or receipt of interest, ensuring that they are taxed no more or less favourably than equivalent arrangements that do give rise to interest.

From 22 March 2006 two types of contract under Islamic law are included in the rules for alternative finance arrangements -

• wakala - an investor appoints an agent to whom he gives a sum of money. The agent invests the money on behalf of the principal specifying the expected investment return. The principal is entitled to that specified “return”, but nothing more. Anything further that is earned is retained by the agent as a fee,

• A diminishing musharaka - a customer and a financial institution contribute to jointly acquire an asset. The customer makes a series of capital payments to the financial institution to acquire that institution’s interest in the asset. The customer makes other payments, a “return” to the institution in addition to the amount paid to acquire the institution’s interest - these other payments represent an amount equivalent to the commercial rate of interest on a conventional loan.

In each case, under the new rules from 22 March 2006 the “return” is taxed as if it were interest.