Islamic Finance in the UAE: Principles and Opportunities for Investors

Explore the fundamentals of Islamic finance in the UAE and discover a world of promising investment opportunities rooted in ethical principles. Learn how to grow your wealth while adhering to Sharia-compliant financial practices.

Islamic Finance

Islamic finance, also known as Shari’ah-compliant financing, is a financial system that works by Islamic regulations. It adheres to fundamental principles such as the prohibition of interest, fair and transparent dealings with the avoidance of speculation and uncertainty, real economic activity with underlying assets, and ethical investment opportunities.

Key Differences Between Green Bonds & Sukuk

One element of Islamic finance is sukuk, financial certificates that comply with Islamic Shari’ah regulation and give investors partial ownership of the issuer’s assets. The basic principle behind sukuk is that the holder has an undivided ownership right in a given asset and is entitled to the return generated by that asset. It might be useful to compare sukuk to green bonds, where governments and companies issue bonds to raise capital for eco-friendly initiatives. These financial instruments are purchased by investors who want to fund projects aimed at environmental reform while generating returns.

Green bonds are typically fixed-income. The issuer raises a fixed amount of capital from investors over a set period, repaying the capital when the bonds mature and paying an agreed amount of interest.

Green bonds and sukuk offer various benefits focused on addressing climate change. Finishing sustainable projects allows individuals and organizations to contribute actively to achieving the UN’s Sustainable Development Goals (SDGs) in line with COP28 goals.

Investing in green bonds and sukuk is helping Gulf Cooperation Council Countries strengthen their reputation for environmental responsibility and building trust.

With corporate tax effective from 1st June 2023, corporate tax considerations need evaluation.

Legislative and regulatory framework

The United Arab Emirates (UAE) has historically provided an attractive environment to provide Islamic finance services and products. This is in the Gulf Cooperation Council (GCC) and beyond.

In addition to being an established and wonderful global financial center. Also, having its central location in the middle of the Asian and Western financial markets, the UAE also has a legal system and a judiciary familiar with the principles of Shariah. The UAE’s Constitution identifies Shariah as a principal source of regulation. Also, the UAE Civil Code, two which is deeply anchored in Shariah,jUMEecognises the basic Islamic financing contracts, such as:

Murabahah (cost-and top-up financing): Article 506 of the UAE Civil law defines a murabahah sale as:

1. A sale may be by means of resale with a profit, a loss, or at an even price in case the capital value of the thing sold is known at the time of the deal and the amount of the profit or loss is mentioned 2. If it appears that the seller has lied in declaring the amount of the capital value, the buyer may reduce (the amount) by the sum of the excess.3. If the capital value of the goods sold is not known when the contract is made, the buyer may take back the contract when they learn of it, and the same shall apply if the seller hides a matter affecting the thing sold or the capital worth. Also, he shall lose his right to elect if the things are sold or consumed or pass out of his custody after delivery.

Mudarabah (trust-based finance): Article 693 of the UAE Civil law states that a mudarabah is a contract in which the person owning something puts in the funds, and so mudarib puts in capital or work, with a view to generating a profit.

Musharakah (joint financing). Article 654 of the UAE Civil law identifies musharakah mostly in the following statement. This is ‘A firm is a contract whereby two or more people are bound each to work together in a financial project by giving a share of property or work for the exploitation of that venture and the division of any profit or loss that may arise therefrom.’

Ijarah (leasing): Article 742 from the UAE Civil law. It defines ijarah as ‘the giving by the lessor on the lessee of the right of use intended for the thing bought for a specified period in lieu of an ascertained rent’.

UAE Civil law

Istisnah: while there is no particular article in UAE regulation that expressly refers to and deals with Isaiah, the official commentary to the UAE Civil law stipulates that the shariah principles of Isaiah are applicable in the case of construction deals (muqawala), which are defined in Article 872 as a contract whereby one of the parties to that undertakes to make a task or to perform work in consideration which the other undertakes to give.

The emirate of Dubai has made itself a major center for business and industry. The UAE is a relatively young country. Thus, the regulations and regulations applicable to financial goods and services (including Islamic finance) are basic. These are often just providing a mandate for the making of regulatory authorities to deal with the provision of the relevant financial goods and services in the UAE. Consequently, the detailed rules, regulations, and policies related to financial goods and services are left to the discretion of the given regulatory authorities. The internal laws, policies, and guidelines the authorities implement regarding the relevant financial products are not always made public. The regulations relevant to Islamic financial services are, in certain cases, diffused in multiple pieces of law. Also, the coverage of issues (including consumer protection) is general rather than comprehensive.

Impact of Corporate Tax – UAE

The United Arab Emirates has always enjoyed a reputation as being a tax-free haven for companies and investors from all over the world. 

From Investors’ perspectives

A. Taxability of income from Islamic Financial Instruments and the investment opportunities that arise from them. 

• In the case of individuals (including non-residents): As per Cabinet Decision No. 49 of 2023, individuals earning personal investment income (which shall include income from Islamic financial instruments) shall not be subject to the Corporate Tax UAE. This has led to more people exploring investment opportunities in the UAE. 
• In case of taxable persons (other than individuals): Income from investment opportunities in Islamic financial instruments shall be subject to the UAE Corporate income tax at the rate of 9%.

B. Withholding tax implications (if any)

• There is no withholding tax rate (as of the date of this article) on payment of returns made to investors of Islamic Financial Instruments.

From the Issuers’ perspectives

1. Taxability of business

• Islamic finance business operations will be subject to corporate income tax at 9% for their first tax period that commences after 30 June 2023.

2. Deductibility of payments of returns made to investors of Islamic Financial Instruments

• It is imperative to evaluate whether the payment of returns shall draw contour from interest, or any other term. These are defined under the Federal Decree-regulation No. 47 of 2022 on the ‘Taxation of Corporations and Businesses’ (hereinafter referred to as the ‘Corporate Tax UAE regulation’).
• It is pertinent to note that the definition of interest has been enunciated under Article 1 of the UAE Corporate Tax. regulation. As Any amount accrued or paid for using money or loans.
• On perusal of the above, it may be inferred that payment of returns made to investors of Islamic Financial Instruments. This is a form of consideration paid in connection with the raising of finance. Thus, shall fall within the ambit of ‘interest’ payment. These are defined under Article 1 of the UAE Corporate Tax regulation.
• Further, under Article 4 of the Ministerial Decision No. 126, it has been stated that ‘the interest equivalent component on Islamic Financial Instruments shall be treated as Interest for the purposes of the General Interest Deduction Limitation Rule.’

Conclusion

Accordingly, the payment of returns for Islamic Financial Instruments shall be deductible up to 30 percent of the earnings. This is before the deduction of interest, tax, depreciation, and amortization (EBITDA). It is in the hands of the issuing entity as per the general interest. under the Deduction Limitation Rule under Article 30 of the Corporate Tax UAE regulation. However, the above limitation shall be subject to the De Minimis threshold of AED 12 million. This is laid under Article 8 of the Ministerial Decision No. 126 (i.e., no disallowance shall be made until the payment of returns does not exceed AED 12 million).

It is pertinent to note that a 30% cap will not be applicable in case Banks are issuing such instruments.

As businesses navigate the complexities of corporate tax UAE and its provisions. A clear understanding of key definitions and regulations becomes vital. Delving into the meanings of terms like interest and Islamic financial instruments. Also, shedding light on the treatment of interest components. This knowledge will equip businesses with valuable insights to navigate the UAE tax landscape confidently.