The search for Sharia compliance

Date: 19 Jun 2024

Ashleigh John

With enormous wealth coming from the Middle East, and more UHNWIs emigrating that way, wealth advisors need to keep ahead of how Islam and its culture can impact their advisory work. Citywealth summarises what is means for transactions to be Sharia-compliant and speaks to experts for insights on Sharia trust structures and private wealth work.

What is Sharia law?

Britannica defines ‘Sharia’ as “the fundamental religious concept of Islam—namely, its law. The religious law of Islam is seen as the expression of God’s command for Muslims and, in application, constitutes a system of duties that are incumbent upon all Muslims by virtue of their religious belief. Known as the sharīʿah (literally, “path leading to the watering place”), the law represents a divinely ordained path of conduct that guides Muslims toward a practical expression of religious conviction in this world and the goal of divine favour in the world to come.”

In the wealth management industry, Sharia compliance means that investments, transactions, and other instructions carried out by wealth managers in the interest of their clients must align with the nature and rules of Sharia.

Connections with the private wealth industry

According to Hourani & Partners, the UAE has “emerged as a leading destination for HNWI migration, attracting 4,000 more millionaires in 2022 than those departing, making a 208% increase in just two years”. Anyone who has spent any time in the private wealth industry knows that there is a huge market for their services in the Middle East; old and new wealth in abundance pours from this part of the world, and a number of UHNWIs from Europe and Asia are emigrating to the area to capitalise on the rapid growth and resulting opportunities afforded by the area.

In an article for Boodle Hatfield, Kyra Motley, Partner, summarises the factors drawing wealthy individuals to the region: “[T]he UAE’s favourable tax regime; the unfettered freedom in using foundation structures; the ease at which family offices can operate and do business in the region and globally; the growing commercial hubs in the DIFC, RAKICC and the ADGM; and, of course, the UAE’s Golden Visa. It is clear that the UAE has established itself as an attractive hub for migrating HNW individuals to take advantage of opportunities for substantial investments or entrepreneurial ventures. With such an increase of migration to the UAE, it is inevitable that the amount of investible wealth held in the region is only going to grow larger.”

Moltey adds: “Such a trend should be both applauded and encouraged, as the growing millionaire population in the UAE will serve to enhance the economic prosperity of the region as a whole. It is, however, critical that HNW individuals maintain an approach of some caution so that they make serious efforts, if they have not done so already, to protect their ever-growing wealth and ensure that such wealth is invested in a diversified portfolio. Whilst the UAE has systems in place that are indeed friendly to HNW individuals, it is not uncommon for such individuals to both hold foreign assets in other jurisdictions, such as the UK, and to seek to invest more in those jurisdictions.”

A PwC report on Sharia-compliant funds suggests that “[p]erhaps the single most important factor behind the powerful growth of the Shariah-compliant funds industry lies in the simple fact that Muslims represent about a quarter of the world’s population.” However, the report goes on to note that: “Yet, at the same time, less than 1% of global financial assets are Shariah-compliant in an era of enhanced religious sensibilities. This implies a great many first-time investors potentially interested in Shariah products as well as many who have dipped a toe in the water and may be ready to invest more.”

The increase in Muslim clients reaching across to the West, and its wealth advisors, does not seem to be slowing down any time soon. As a wealth manager, having an understanding of both the letter and the spirit of Sharia law is a huge asset.

Sharia & trust structures

Despite debate at the recent Citywealth Forum, trusts are still the bread and butter of the wealth management industry. Historically a British invention, a number of jurisdictions have adopted the structure and adapted it for their clients. Citywealth spoke with experts from Charles Russell Speechlys to learn more about the intersection between trust structures and Sharia law.

Robert Blower, Partner, specialises in all aspects of private client work, in particular lifetime tax and estate planning, issues relating to offshore assets, trusts, UK landed estates and heritage property. He has a large Middle East practice and a particular expertise in structuring trusts so that they comply with the Islamic Shariah rules on the devolution of family assets.

Oliver Little, Senior Associate, provides advice to UK and non-UK individuals, families, trustees and beneficiaries regarding taxation, trust and estate planning matters. He has a particular focus in advising high-net-worth individuals to coordinate their tax and estate planning across multiple jurisdictions, including the application of the statutory residence test for clients who are either moving to or leaving the UK.

Considering that trusts are a historically British structure, when dealing with clients from the Middle East, does the interest in setting up a trust come from their end or is it something that you bring to them as an offer? What benefits do trust structures afford for Muslim families in particular, who are looking to structure their assets for both tax-efficient purposes and succession purposes?

“Trusts are often a novel concept to Middle Eastern clients who can be concerned about the loss of control over their assets to an unknown third party located in a different jurisdiction.  While trusts can offer tax benefits, we also suggest them as a potential solution to clients’ planning or protection concerns.  Trusts allow the Settlor to determine who benefits, when and to what extent, from their wealth and can ensure it is held centrally in trusted hands for subsequent generations.  There are different ways in which the clients can continue to have some form of influence over the trusts during their lifetimes, as outlined above.  A well-designed trust structure can help prevent the fragmentation of business assets into the ownership of multiple individuals with disparate interests, which can have potentially damaging implications for the management and continuity of the business, while allowing a wide range of family members to benefit from the structure.

Clients are becoming increasingly aware of the flexibility and benefit of trusts – this is reflected in the inclusion of English trust law in the legal code of many recently-established special economic zones in the Middle East, such as Dubai’s DIFC and Abu Dhabi’s ADGM.”

What are some of the key tenets of Sharia law to be aware of as it pertains to the structuring of trusts for UHNW clients?

“The central relevance of Sharia for our clients when creating trusts is the forced heirship provisions.  Sharia imposes mandated shares for the surviving spouse(s) and children (with different entitlements for sons and daughters). The exact rules vary according to the Sharia school involved but one of the main principles is that sons inherit twice the share of daughters. A Sharia-compliant trust will replicate these provisions – often the most effective way to do this is by means of a discretionary trust with a letter of wishes setting out the request for Sharia shares to apply.

Sharia also imposes restrictions on investment in assets or industries considered harmful to people and society in general – this applies to lending or borrowing at interest and investments into gambling, alcohol, pornography and arms dealing, for example.

Trusts can offer UHNW clients considerable flexibility in structuring their assets. It may be preferable, for example, for certain individuals to benefit from the income generated by capital rather than having outright ownership. Trusts also offer control – Settlors can specify for example that a spouse is to be supported during their lifetime but for the assets to pass to their children after the spouse’s death or remarriage.

Sharia permits lifetime gifts (unless the donor is terminally ill or lacks capacity) but does not allow the donor to exercise any further control over the gift once gifted. Some Settlors establish trusts but reserve personal veto powers, appointing themselves ‘protector’ (a supervisory role in relation to the trustees, with veto powers) or by using a private trust company as trustee, where they can have significant influence. These are all valid options from a Sharia perspective because a right of veto is not considered ‘control’ and this can offer an attractive compromise for many UHNW clients. Practitioners nevertheless need to be cautious to ensure the trustees retain a degree of independence, or else there is a danger the trust arrangement could be treated as a sham.”

Have there been any recent legislation or regulatory changes that have helped/hindered trustees’ abilities to accommodate for Muslim families/clients? Either intentional changes or as a by-product of general changes

“UK legislative changes have made purchasing, holding and disposing of UK residential property for non-resident individuals, companies and trustees more difficult – particularly relevant to UHNW clients who hold their wealth via one holding company.

The Annual Tax on Enveloped Dwellings, introduced in 2013, subjects companies holding UK residential property to an annual tax of up to £287,500 (rates have increased in recent years). A 2% stamp duty land tax surcharge is imposed on non-resident purchasers, while non-resident sellers pay increased capital gains tax on UK real estate on disposal.

The use of UK holding companies as ‘blockers’ for UK inheritance tax (IHT) purposes was ended in 2017 – shares in the holding companies are now considered UK assets, subject to IHT on death and if held via trust will be taxed at a rate of 6% every ten years. The rules on the deductibility of debt have also been tightened in relation to the taxable value for IHT purposes.

Finally, UK trusts are now subject to registration requirements which can involve the publication of information which many clients would prefer not to divulge.

The changes above mean that trusts are generally no longer an attractive way for holding UK residential properties. However, trusts remain an appealing option for holding non-UK financial and other assets due to the asset protection and flexibility outlined above.”

Providing private client services

Citywealth also got the opportunity to speak to Simon Goldring, Private Client Director – Middle East for Ogier. Based in Dubai, Goldring provided first-hand insights into the provision of private client services for Muslim families.

What does it look like to provide private client services that are Sharia-compliant? What accommodations need to be made that will differ from your approach with other clients?

1. Prohibition of Interest (Riba):

• Standard Approach: Interest-based investments, such as bonds and savings accounts, are commonly used.
• Sharia-Compliant Approach: Use of interest-free financial instruments like Sukuk (Islamic bonds), profit-sharing arrangements, and Islamic savings accounts that operate on profit-and-loss sharing.

2. Avoidance of Unethical Investments:

• Standard Approach: Investment options can include a wide range of industries, including alcohol, gambling, and tobacco.
• Sharia-Compliant Approach: Investments must avoid industries that deal with alcohol, gambling, pork, and other activities considered haram (forbidden).

3. Risk Sharing:

• Standard Approach: Conventional insurance policies where risk is transferred to the insurer.
• Sharia-Compliant Approach: Takaful (Islamic insurance) operates on the principle of shared responsibility and mutual assistance among participants.

4. Asset Ownership and Leasing:

• Standard Approach: Leasing agreements often involve fixed interest payments.
• Sharia-Compliant Approach: Ijarah (Islamic leasing) agreements that are structured to avoid interest, focusing instead on rent-based models.

5. Estate Planning and Inheritance:

• Standard Approach: Use of standard wills and trusts without specific religious considerations.
• Sharia-Compliant Approach: Inheritance and estate planning must comply with Islamic laws, ensuring specific shares for heirs as dictated by Sharia.

Have there been any recent legislation or regulatory changes that have helped/hindered advisors’ abilities to accommodate for Muslim families/clients?

Positive Changes:

• Regulatory Support: Some countries have introduced legislation to support Islamic finance, such as the UK, which has adapted its tax and regulatory framework to accommodate Sukuk issuance.
• Financial Inclusion: Efforts to include Islamic financial products within mainstream financial systems have increased, providing better access and integration for Muslim clients.

Challenges:

• Lack of Uniformity: Different interpretations of Sharia across jurisdictions can complicate compliance for international advisors.
• Regulatory Gaps: Some countries may still lack comprehensive frameworks for Islamic finance, leading to inconsistencies and difficulties in implementation.

As more people from North America, Europe and Asia are drawn to the Middle East (particularly Dubai), what are a couple of things they should be aware of if looking to structure their assets in a Muslim country?

Structuring Assets in a Muslim Country (e.g., Dubai):

1. Legal and Regulatory Framework:

• Awareness: Understand the local legal and regulatory environment, which may include specific rules for Sharia-compliant financial products.
• Compliance: Ensure all financial transactions and asset structures comply with both local laws and Sharia principles.

2. Cultural Sensitivity and Practices:

• Cultural Norms: Be aware of and respect local customs and traditions, including business practices and social etiquette.
• Community Engagement: Engage with local advisors and community leaders to ensure a culturally sensitive approach and to gain deeper insights into the local market.

3. Taxation and Economic Policies

• Tax Benefits: Explore any tax benefits or incentives available for foreign investors, especially those designed to attract Sharia-compliant investments.
• Economic Stability: Consider the economic stability and growth prospects of the region, particularly in rapidly developing areas like Dubai.

4. Legal Dispute Resolution:

• Dispute Mechanisms: Familiarize yourself with the dispute resolution mechanisms available, including any special Sharia courts or arbitration processes that may be relevant.

Thank you to all of the experts who participated in this article. Eid Mubarak to all of our readers and clients celebrating, from the team at Citywealth.