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client memorandum banking & finance
client memorandum luxembourg: a hub for islamic finance


Well established as a world leader in the
investment funds industry (second only to
the USA), Luxembourg firmly held its position
throughout the economic crisis, totalling EUR
1,840.993 billion net assets under management
as at 31 December 2009. This five decade long
success story originates from a continuing
intention on the part of the local authorities
to make the most of promising opportunities
in the financial market. Islamic Finance is
unquestionably one such opportunity and
initiatives taken by the various actors operating
in Luxembourg show how determined they are
to lead the way in this fast growing market.

The purpose of this article is to set out (i) the
use of Luxembourg investment vehicles (more
in particular, Luxembourg investment funds
(UCITS, SIFs) and special investment vehicles
such as the SICAR and the securitization
vehicle) for Sharia compliant investments and
(ii) to clarify the Luxembourg tax treatment of
Murabaha contracts and Sukuk transactions.

This publication has been prepared by the law firm Chevalier & Sciales and is for general guidance only. The contents
hereof are not intended to constitute legal advice and do not substitute for the consultation with legal counsel required
before any actual undertakings.

© 2010 Chevalier & Sciales
client memorandum luxembourg: a hub for islamic finance

i. introduction contract based on the occurrence or non-
occurrence of a future uncertain event is not
allowable. In addition, capital must have a
As of today, around 16 sukuks (asset backed social and ethical purpose beyond unfettered
securities) with a combined value of USD 6 returns, and speculation is strictly prohibited.
billion and around 42 Sharia compliant funds Finally, of course, Islamic finance is restricted
(out of a total of 560 funds) are already listed to islamically acceptable transactions, which
on the dynamic Luxembourg Stock Exchange exclude those involving alcohol, pork, gambling,
– the first in Europe to list a sukuk in 2002 -, etc.
while about 35 others are in the process of
being launched. This fast growing development One crucial element of Islamic finance is the role
results from a harmonious interaction of the Shariah board, which forms an integral
between Islamic finance mechanisms and part of every Islamic financial institution. This
the Luxembourg legal framework. Another board includes Islamic law scholars who are to
determining factor is the unique network of give their opinion on doubtful transactions from
investment treaties Luxembourg signed with 57 a Shariah point of view. It should be pointed
countries, including the United Arab Emirates, out that there might be divergence amongst
whilst others treaties with countries such scholars depending on the jurisdiction or
as Bahrain are currently under negotiation. geographical regions.
Those treaties aim at providing investors with
a great deal of protection, and are a key to the
development of Islamic finance in Luxembourg. iii. basic methods of islamic
Moreover, on January 12, 2010, to confirm
Luxembourg’s commitment to Islamic finance, Banning any charge of interest means that
the Luxembourg tax administration has issued most conventional fixed income instruments 3
a circular in order to provide guidance on the are not eligible investments for a shariah
Luxembourg tax aspects of certain Islamic compliant fund. Consequently, several Islamic
financing instruments (more in particular finance techniques have developed. Those
Murabaha contracts and Sukuk) (see section IV techniques include equity-related techniques
hereunder). such as Mudaraba (profit sharing agreement)
and Musharaka (Joint-venture), as well as debt-
related techniques such as Murabaha (forward
ii. basic shariah principles sale), Ijara (leasing) and Sukuk (asset backed
relevant in islamic finance
Mudaraba is a profit sharing contract in which
Islamic finance is finance under Shariah one party provides 100 per cent of the capital
principles, whose basic sources are the Qur’an whereas the other party provides its expertise
and the Sunna, followed by the consensus of the in order to assist in the process of investing
jurists and interpreters of Islamic law. Shariah the capital, managing the investment project
is the body of Islamic religious law, within and, if appropriate, providing labour. Mudaraba
which the public and private aspects of life structures are widely used by investment
are regulated for those living in a legal system funds, with investors providing money to the
based on Islamic principles of jurisprudence Islamic bank, which in turn invests it, taking a
and for Muslims living outside that domain. management fee.

The central, distinguishing feature of Islamic In contrast, the Musharaka involves a
finance is the prohibition of the payment and partnership between two parties who both
receipt of interest (or riba). Importantly, any provide capital towards the financing of new or

© 2010 Chevalier & Sciales
client memorandum luxembourg: a hub for islamic finance

established projects. Both parties are to share Such structures are listed on exchanges such
the profits on a pre-agreed ratio, whilst losses as the Luxembourg Stock Exchange, and
are to be shared on the basis of equity made tradable through organisations like
participation. Euroclear and Clearstream.

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 iv. luxembourg tax circular
sold and sells it to another person by adding on islamic finance
some mark-up / margin thereon which is known
to the buyer. In general there are two contracts The Luxembourg tax administration refers to
in a Murabaha financing: First the purchase Islamic Finance as the “financial instruments
by the financier (eg. the bank) of the asset on used by investors who wish to manage their
request of the client / buyer and secondly the investments observing the values of Islam”.
sale by the financier (eg. the bank) of the asset The objective of Islamic finance is, according
to the client / buyer with an agreed margin to such Circular, “to share profits and losses
(mark-up) and paid by the client to the financier between those who provide the capital and
on a deferred payment basis. those who use it.”

The Ijara is a contract where the bank buys The Circular in its first part provides a
and leases out equipments required by the description of the major Shariah principles and
client for a rental fee. Throughout the contract, Islamic finance techniques such as Murabaha,
the ownership of the equipment remains with Muchakara, Mudaraba, Ijara, Ijara- wa-Iqtina,
the lessor bank, which will seek to recover Istinah and Sukuk. The second part deals with
the capital cost of the equipment plus a profit the Luxembourg tax treatment of Murabaha
4 margin out of the rentals payable. contracts and Sukuk transactions.

A Sukuk can be considered as an Islamic
equivalent of a bond. Since fixed income, (a) murabaha contracts
interest bearing bonds are not permissible
The Circular mentions that from a Luxembourg
under Shariah law, Sukuk securities are
tax perspective the agreement between the
structured to comply with Shariah law and
person providing the financing (eg. the bank)
its investment principles, which prohibits the
and the client / buyer is to be assimilated as a
charging, or paying of interest. A Sukuk has a
sale agreement. As such, the realized gain on
pre-determined maturity and is backed by an
the sale is realized by the person providing the
asset that makes it possible to realize a return
financing at the date of signing of the agreement
on the investment. The remuneration on the
and the entirety of the revenue from the sale
Sukuk is linked to the performance of the asset
is immediately taxable (including the margin
held by the Sukuk issuer. The Circular defines
for the person providing the financing, in other
Sukuks as securities, whose yield and principal
words his profit).However, the Circular provides
depend on the performance of tangible assets
for an exception to the above principle of
or the usufruct of such assets. Sukuks can be
immediate taxation by allowing a taxation of the
structured alongside different techniques. While
gain on a deferred straight-line basis over the
a conventional bond is a promise to repay a
life of the agreement regardless of the actual
loan, a Sukuk constitutes partial ownership in a
repayments made by the client / buyer.
debt (Sukuk Murabaha), asset (Sukuk Al Ijara),
project (Sukuk Al Istisna), business (Sukuk Al
There are certain conditions set out in the
Musharaka), or investment (Sukuk Al Istithmar).
Circular that need to be complied with in order
Most commonly used Sukuk structures replicate
to be able to benefit from the taxation on a
the cash flows of conventional bonds.

© 2010 Chevalier & Sciales
client memorandum luxembourg: a hub for islamic finance

deferred basis, namely: from the scope of this Circular. This can be
• The agreement between the parties must explained as UCIs are tax exempt entities for
clearly demonstrate that the financier has Luxembourg corporate income tax purposes.
acquired the assets to resell them, either

v. main shariah compliant
immediately or in a maximum of 6 months, to
the buyer / client;
investment vehicles
• The agreement must mention (i) the
remuneration perceived by the financier for his
The Luxembourg regulatory authority does not
intermediation, (ii) the profit of the financier as
intend to issue specific rules or definitions for
consideration for the deferred payment and (iii)
shariah compliant funds. However, guidelines
the acquisition price paid by the client / buyer
may be issued in the future. For the time being,
and by the financier (eg. bank);
such rules and restrictions for shariah compliant
• The profit of the finanier must clearly be funds shall be detailed in the fund prospectus.
mentioned, known and accepted by both parties
to the agreement;
(a) ucits
• The profit of the financier must expressly be
designated as being the consideration for the Undertakings for Collective Investments in
service rendered by the financier to the client Transferable Securities (UCITS) are designed
/ buyer and which results from the deferred for retail investors and benefit from the
payment granted to the client / buyer; European Passport, enabling them to be freely
• For accounting and tax purposes, the profit marketed throughout the European Union (EU)
must be spread by the financier on a straight- with a minimum of formalities. These funds are
line basis over the period of the deferred open-ended and must comply with stringent
payment, regardless of the actual repayments requirements set down by the EU legislator in
made by the client/ buyer. terms of substance and supervision.As any
other Luxembourg UCITS, shariah compliant
UCITS need to be set up in accordance with
(b) sukuk transactions the law of 20th December 2002 (the ‘2002
law’), and may be in the form of either a SICAV
The Circular provides that that the Luxembourg (investment company with variable capital)
tax treatment of a Sukuk is identical to the or a FCP (common fund). A distinction with
treatment of debt in conventional finance traditional UCITS is that shariah compliant
(although the income is linked to the UCITS must exclude any reference to interest
performance of the underlying asset) and payments or investment in non-permitted
that the remuneration of the Sukuk is treated activities mentioned above. Importantly, the
for Luxembourg tax purposes as an interest board of directors, the conducting officers and
payment. As a result thereof, payments made the investment manager must all be supported
under the Sukuk (the yield on the Sukuk) qualify in their roles by a Shariah board, composed of
as interest and should generally be deductible scholars whose roles must be described in the
if incurred in the corporate interest of the prospectus. There is a minimum of three and
company / issuer of the Sukuk. The payments sometimes five scholars on the shariah board.
made on the Sukuk should not be subject to
withholding tax as under Luxembourg law, no Although the Luxembourg legislation prevents a
withholding tax is due on interest payments UCITS fund from exercising significant influence
(except for application of the Savings Directive). over an issuer, Shariah compliant UCITS will
generally make clear their views to the issuers
It should be noted that undertakings for in which they invest. Even though securities of
collective investment under Luxembourg law certain issuers can be per se eligible following
and investing in Islamic assets are excluded the initial shariah screening, such an issuer may

© 2010 Chevalier & Sciales
client memorandum luxembourg: a hub for islamic finance

nevertheless be considered to have performed (c) sicar
prohibited activities or have part of its income
generated by interest payments. In that context Luxembourg has long been a significant
– albeit only for equity funds -, a purification of domicile for private equity vehicles but the
the dividends received from the target issuers jurisdiction has emerged as a major European
shall take place. This is the shariah board who and international centre since the introduction
will determine what types of income need to be of the SICAR or risk capital investment
purified. This procedure will generally result in company five years ago (more precisely by the
the fund being credited with the dividends paid introduction of the SICAR law of 15 June 2004).
by the issuer, minus the purification ratio (which The SICAR is often used for private equity
will depend on the level of prohibited activities structures. A SICAR may issue Sukuk and
and interest based income). Any identified other Shariah-compliant securities.Moreover, it
impure income shall be donated to a charity is possible to implement in a SICAR a shariah
proposed by the shariah board and approved compliant prospectus, shariah board, shariah
by the board of directors. In order to avoid non audit etc as it is a very flexible vehicle.
halal income, the fund administrative agent may
calculate a Shariah compliant Net Asset Value SICAR offers the possibility to make investments
(i.e the proportion of non Shariah compliant in compliance with Islamic principles by opening
income which is determined at each valuation the right to the promoter to prohibit interest and
point is donated to a charity proposed by the to encourage risk-taking.
investment manager and approved by the
shariah board).
(d) securitization vehicle
It should furthermore be noted that the Since the groundbreaking law of 22 March
CSSF has recently signed a memorandum of 2004 on securitization (the “Securitization
6 understanding with the securities commission Law”) was adopted, offering investors a
of Malaysia in which they agreed that managers flexible regime for securitization vehicles (the
supervised by the Malaysian authorities are SVs), Luxembourg gained reputation as an
authorized or registered for the purpose of international securitization and structured
asset management of UCITS in light of article finance hub.A determining factor in Luxembourg’s
85 (1) (c) and (d) of the 2002 Law. success in this field is the wide range of eligible
assets which can be securitized. Under the
(b) sif Securitization Law, risks relating to the holding
of assets, whether movable or immovable,
Specialized Investment funds (SIFs) are lightly tangible or intangible, as well as risks resulting
regulated and tax efficient funds, hence enjoying from the obligations assumed by third parties
more flexibility than other regulated funds may be securitized. Even though Islamic
(such as UCITS). A SIF may for instance invest finance does not allow interest-bearing assets,
in any type of asset with less diversification shariah compliant assets are very diverse
requirements than UCITS. Flexibility is also and include real estate, equity participations,
present, inter alia, in the content of the ijara and murabaha contracts. Furthermore,
prospectus, the subscription and redemption the Luxembourg securitization vehicle can be
process, the reporting, the calculation of the Net unregulated (in other words not supervised by
Asset Value.Using Luxembourg’s specialised the Luxembourg supervisory authority on the
investment funds law, the Bank of London and financial sector (CSSF)) provided that such
the Middle East (BLME) has launched in 2009 securitization vehicle does not make more than
the first Shariah compliant money market fund three issuances of securities to the “public” per
in Europe. year. In such case, there is no need to appoint
a custodian bank and administrative agent. The
annual running costs will then also be lower

© 2010 Chevalier & Sciales
client memorandum luxembourg: a hub for islamic finance

than in case of the use of a fund vehicle.

A securitization fund is particular since it is
organised as a co-ownership, the joint owners of
which are only liable up to the amount they have
contributed. This co-ownership of assets, by
providing a higher connection to the securitized
assets, ensures a harmonious compliance
with the shariah principles mentioned above.
Importantly, this kind of fund does not have its
own legal personality and must be managed by
a management company based in Luxembourg.

The tax treatment of the securitization vehicle is
also advantageous. A securitization company is
a fully taxable entity. It means that it is eligible
for the application of double tax treaties entered
into by and between Luxembourg and more than
seventy countries. In other words, the income
earned and distributed by the securitization
company will be subject to reduced withholding
taxes. Furthermore, securitization vehicles are
able to deduct from their gross profits their
operational costs and any amount distributed
to the holders of the securities issued by the
securitization vehicle. 7

vi. conclusion

Luxembourg is currently considered as a major
international hub for financial services and
Islamic finance investments. Strong government
support and commitments to Islamic finance,
proactive regulatory and supervising authorities
and a flexible and secure legal framework offers
a wide range of opportunities for implementing
faith based ethical finance transactions, for
devising Islamic finance products adapted to
the needs of the most demanding investors and
promoters. In November 2009, Luxembourg
was the first European country to become an
associate member of the prudential standard
setting body for global Islamic finance, the
Islamic Financial Services Board.

© 2010 Chevalier & Sciales
client memorandum luxembourg: a hub for islamic finance

for further information please contact:

olivier sciales , partner

rémi chevalier , partner



51, route de Thionville Twin Towers
L-2611 Luxembourg Bldg. Baniyas Road,
Luxembourg Deira, Dubai,
P.O. Box 4404, Office
Tel : +352 26 25 90 30 #217, 2nd Floor,
Fax : +352 26 25 83 88 United Arab Emirates

Tel: +971 4 2937033
Fax: +971 4 2088699

© 2010 Chevalier & Sciales