09/12/16

AL-MAKTOUM COLLEGE OF HIGHER EDUCATION

PROFESSIONAL DIPLOMA IN ISLAMIC ECONOMICS AND FINANCE

H46X04 Islamic Commercial Law

Lecture 8:
Islamic Finance and Legal Systems

Alija Avdukic
alija.avdukic@almcollege.org.uk
alija.avdukic@mihe.ac.uk

Winter Term 2016, Dundee

Presenta@on Plan
•  Legal Systems
–  Islamic, Common, Civil

•  Islamic Finance under Different Legal Regimes

•  Islamic Finance and Dispute Resolu@on

•  Islamic Finance and Tax Laws

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Introduc@on (1)
•  Islamic law - jurist’s/scholars law
•  Remained in private domain
•  States implemented the law
•  Under the influence of Western legal systems, the
OUomans adopted a code called Majallah (1877-1926)
-legal rules mainly on commercial transac@ons
•  19th century - many Muslim countries adopted
Western laws due to coloniza@on
•  Middle of 20th century - independent Muslim states
inherited and imitated Western legal systems

Introduc@on (2)
•  1970s - Islamic banks emerged
–  Rules/resolu@ons (fatawa) from Shari’ah academy/
boards/scholars
–  Laws created in the private domain related to Islamic
finance
•  Contemporary laws made by the na@on state
•  Common law and Civil law regimes
•  Islamic finance raises certain issues:
–  Status of law created by Shari’ah boards/scholars
–  Applica@ons under non-Islamic legal regimes
–  How to deal with disputes/conflicts?

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Contemporary Legal Regimes

•  Most Muslim countries use Islamic personal
law, but have adopted some variant of Western
commercial law
•  Variants of Western laws
–  English Common law
–  Con@nental (European) Civil law
•  While they are different in form, they have
similar social objec@ves (individualism,
liberalism, and personal rights)

Civil Law - Features

•  Roots in Jus@nian’s Roman Law
•  Strong central legal system, state above the courts
•  Civil laws are codified in complete, coherent,
systema@c and exhaus@ve codes
•  Statutes complement and complete the codes
•  Judges enjoy authority of reason - interpret codes and
rules for specific cases.
•  Judgments of one court has no bearing on other courts
•  Con@nental Europe (France, Germany, Italy, Poland,
etc.) and ex-French Colonies (Northern and sub-
Saharan Africa), Middle East, Indonesia, etc.

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Common Law - Features

•  Developed in England in the 11th Century
•  Emphasis on property rights and sanc@ty of contracts
•  Law above the state
•  Jurisprudence (case law and judgments) forms the core
of the law
•  Judges can interpret and create new laws as
circumstances change
•  Reason of authority exists - lower courts are bound by
decisions of higher courts (stare decisis)
•  Statutes completes/complements the case laws
•  UK, USA, ex-Bri@sh Colonies, Indian sub-Con@nent,
Malaysia, etc.

Comparison of Legal Systems (1)

Features Civil Common Islamic
Origins Rome England Advent of Islam
(6th century CE) (11th Century (7th century CE)
CE)

Sources of Legislature Precedent Shariah and

(Codes and judgments of Fiqh
Law statutes) courts
Law- Legislatures Judges Shariah
scholars/ jurists
makers
Role of State above the Law above the Law above the
courts (law) state state
State

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Comparison of Legal Systems (2)

Features Civil Common Islamic
Sources/ Legislature Courts create and Shari’ah scholars
creates, courts apply create and courts
executors of apply (judges) apply
law
Rulings of one Lower courts Judgments of one
Status of court have no follow the decision court no bearing
court bearing on others of higher courts on others, but can
be based on
judgments (Stare decisis)
previous fatawas
Closed-all Open-new rule Shariah - Closed
Adaptability situations may be created Fiqh - Open
(Closed/Open) governed by based on new
broad principles facts
Rigid and slow to Can change with Can change
Evolution change new court within the
decisions boundaries of
Shariah

Presenta@on Plan

•  Legal Systems
–  Islamic, Common, Civil

•  Islamic Finance under Different Legal Regimes

•  Islamic Finance and Dispute Resolu@on

•  Islamic Finance and Tax Laws

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Islamic Finance and Legal Regimes

•  Three types of legal regimes can be iden@fied
–  Islamic Legal Systems
–  Common Law Systems
•  With Islamic Banking Laws
•  Without Islamic Banking Laws
–  Civil Law Systems

Islamic Legal Systems

•  Saudi Arabia
–  Islamic legal regime
–  Banking law is not Islamic
–  Shari’ah Boards at organisa@onal levels
•  Iran
–  Islamic legal system (ager the revolu@on)
–  Islamic Banking Law (1983)
–  No Shari’ah Boards (at na@onal or organiza@onal levels)
•  Sudan
–  1980s: Banking sector transformed to Islamic
–  Islamic Transac@ons Law (1984)
–  Shari’ah Board at na@onal level and Shari’ah boards/
advisors at organisa@onal levels

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Common Law Countries with Islamic

Banking Laws
•  Malaysia
–  Islamic Banking Act (IBA 1983) and Bank and Financial
Ins@tu@ons Act (BAFIA 1993, amended)
–  Shari’ah Board at Na@onal level with Shari’ah boards/
advisors at organiza@onal Levels
•  Pakistan
–  In 1980s, several laws amended to accommodate Islamic
finance (Banking and Financial Services Ordinance 1984)
–  Shari’ah Board at Na@onal level with Shari’ah boards at
organiza@onal Levels

Common Law Countries without

Islamic Banking Laws
•  Britain
–  No Islamic banking law
–  FSA uses similar regulatory framework as
conven@onal banks
–  Shari’ah Boards at organiza@onal level (market
driven)
–  Changes in tax laws to accommodate Islamic
finance

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Civil Law Countries with Islamic

Banking Laws
•  Indonesia
–  Islamic Banking Act No. 10 (1992, amended 1998)
–  Central Banking Act 1999 (created instruments of liquidity
management for IBs)
–  Na@onal Shari’ah Council (body of Indonesian Council of
Ulemas) at na@onal level with Shari’ah boards/advisors at
organiza@onal levels
–  The laws of 1998 and 1999 not comprehensive enough
–  The laws are worded in general terms - interpreta@on
in courts uncertain
–  Bank Indonesia trying to fill in gaps with regula@ons
–  Na@onal Shari’ah Arbitra@on Board established in 1992

Legal Systems in the GCC

•  Cons@tu@ons of all countries indicate Islamic law
to be one of the sources of law
•  Most countries have adapted features from
Western legal systems (for commercial aspects)
•  Sanhuri adopted European civil laws for Egypt
•  Other countries in the region followed Egyp@an
model
–  Bahrain has elements of common and civil law
–  Kuwait, Qatar and UAE adopted the civil law models
–  Oman - Most of the law is Islamic (yet no Islamic banks
un@l recently)

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Presenta@on Plan

•  Legal Systems
–  Islamic, Common, Civil

•  Islamic Finance under Different Legal Regimes

•  Islamic Finance and Dispute Resolu;on

•  Islamic Finance and Tax Laws

Disputes in Islamic Transac@ons in

Different Legal Regimes
•  Islamic Law Regime - applicable law is Islamic,
but without codified law outcome uncertain
•  Common Law Regime - sanc@ty of contracts
(would allow use of Islamic contracts)
•  Civil Law Regime - difficult to judge without a
detailed codes/statutes on Islamic finance

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Dispute SeUlement/Conflict
Resolu@on Ins@tu@ons
•  Lack of courts to enforce Islamic contracts increases
legal risks
•  In case of disputes - law of the country will prevail over
principles of Shari’ah
•  ‘Choice of law’ and ‘dispute seUlement clauses’
included in contracts
•  Usually ‘English Law’ or ‘New York Law’ is chosen
•  If Shari’ah is chosen as governing law - disputes seUled
by commercial arbitra@on
•  Dispute seUlement ins@tu@ons (Islamic courts or
arbitra@on centers) needed to reduce legal risks

Dual Dispute Resolu@on Ins@tu@ons

•  Dual dispute-resolu@on ins@tu@ons exist in many
countries
•  Common in most Muslim countries
–  Islamic courts deal with personal issues
–  Conven@onal courts deal with civil and commercial
issues
•  Islamic courts in Western legal regimes
–  Islamic Arbitra@on Centres (Malaysia, Indonesia)
•  Special courts in Islamic legal regimes
–  In some Islamic legal systems, the commercial codes
are conven@onal
–  Specialized courts ‘CommiUee of SeUlement of
Commercial Disputes’ (in Saudi Arabia)

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Court Cases in Common Law

Countries - UK
•  London High Court 2002 - Islamic Investment Co.
of Gulf (IICG) vs. Symphony Gems (SG)
•  IICG and SG signed an agreement to provide
revolving murabahah facility to purchase
precious stones from third party (Precious Ltd)
–  Precious to supply SG rough diamonds
–  Upon receiving instruc@ons from SG, IICG paid for
diamonds to Precious
–  Precious could not deliver the diamonds

IICG an SG Case contd...

•  As diamonds not delivered, SG didn’t pay IICG in
full
•  IICG enforced security and sought to reclaim the
balance (through li@ga@on)
•  Court judged in favour of IICG (SG had to pay the
balance)
–  Shari’ah expert opined - murabahah did not fulfil
pillars of sale (the English court didn’t consider this a
problem)
–  Contract not a sale contract (delivery not pre-
requisite for payment to IICG by SG)
–  Payment by SG regardless of failure to deliver

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Malaysian Case - High Court

•  Several cases related to BBA (bai’ bithaman ajil)
during 1994-2007
•  Judges ruled - par@es bound by contracts (BBA)
•  2008 - 12 civil suits in High Court by Bank Islam
Malaysia Berhad & Arab-Malaysian Finance
Berhad asking defaulters in BBA to pay full price
•  Defendants - BBA not an Islamic contract

Malaysian Case contd... (1)

•  Verdict by Judge Abdul Wahab Patail (2008):
–  BBA is a financing contract (not a bona fide sale
contract)
–  The excess over original amount is riba and as such
contradicts IBA and BAFIA
–  The banks are en@tled to only the original amount
extended
•  The case was appealed at the Court of Appeal by
plain@ffs

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Malaysian Case Contd... (2)

•  Court of Appeal Verdict (31 March 2009)
–  Reversed the earlier High Court verdict
–  Judges cannot decide on religious maUers without
consul@ng jurists
–  BBA is a sale agreement and profit earned by Islamic
banks not riba
–  BBA does not contradict IBA and BAFIA
•  Central Bank of Malaysia Act (Sep. 3, 2009):
–  The rulings of Shari’ah Advisory Council (SAC) are
binding on Islamic FIs, courts and arbitrators
–  Shari’ah maUers in Islamic finance has to be referred
to SAC

Presenta@on Plan

•  Legal Systems
–  Islamic, Common, Civil

•  Islamic Finance under Different Legal Regimes

•  Islamic Finance and Dispute Resolu@on

•  Islamic Finance and Tax Laws

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Islamic Finance & Tax Laws*

•  Two types of taxes
–  Profit Tax and Transac@on Tax
Profit Tax
•  Machine purchase by a firm worth 1000
–  Life is 5 years (depreciates to value 0 at the end of 5th
year)
•  Conven@onal—loan with simple 5% interest, to
be paid in 2 years (total due 1100)
•  Islamic—murabahah with a sale price of 1100
payable in 2 years
*The slides are taken from Mohammed Amin

Conven@onal Purchase Tax

Deduc@ons

Year Amortisation Interest Total

1 200 50 250

2 200 50 250

3 200 200

4 200 200

5 200 200

Total 1,000 1,100

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Islamic Purchase Tax Deduc@ons

(under legal approach)

Year Amortisation Interest Total

1 220 0 220
2 220 0 220
3 220 220
4 220 220
5 220 220
Total 1,100 1,100

Economic Evalua@on of Islamic

Finance Purchase
•  Machine value on delivery 1,000
•  Agreed price 1,100
•  Excess 100 price must be finance cost
•  Payment due ager two years è 50 per year
finance cost

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Islamic Purchase Tax Deduc@ons

(under economic approach)
Year Amortisation Finance cost Total

1 200 50 250

2 200 50 250

3 200 200

4 200 200

5 200 200

Total 1,000 1,100

UK Solu@on
•  Use the economic approach instead of the legal
approach
•  Some countries already has economic approach
to tax laws (no need to change tax laws for
Islamic finance)
–  Examples US, Netherlands

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Transac@on Tax
•  Diminishing musharakah
–  Client and Bank purchase house, 25% owned by client
and 75% by bank
•  Transfer of property requires payment of Stamp
Duty Land Tax (SDLT)
•  At the end of contract, the Bank needs to transfer
75% of house to client
•  Legally, should pay SDLT again (double stamp
duty?)
•  UK - Change is tax law to eliminate double SDLT

UK Legisla@ve History
•  2003 – Islamic mortgages: eliminated double stamp duty land
tax (SDLT) on individuals’ mortgages
•  2005 – Income computa@on for murabahah and mudarabah
•  2006 – Tax rules for wakala and diminishing musharakah.
Islamic mortgages for partnerships and companies
•  2007 – Tax framework for sukuk
•  2008 – Countered of SDLT avoidance scheme enabled by
2006 changes
•  2009 – Eliminated SDLT, capital gains tax and tax
deprecia@on recapture on transfer of assets to sukuk issuing
SPV and transfer back

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Ques@ons
•  What would be the ruling of IICG & SG in Saudi
Court?
•  Is there a need for Islamic banking laws and
dispute resolu@on ins@tu@ons for the growth of
Islamic finance?
•  What are the legal issues that can arise in
applica@on of Islamic finance in your country’s
jurisdic@ons?

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