Q- My client purchased their buy to let property using an Islamic finance Murabaha arrangement. As the provider cannot charge interest does this mean that my client can’t claim any of these finance costs against their rental property income?
A- For income tax purposes Part 10A of ITA 2007 relates to the treatment of interest in alternative finance arrangements with financial institutions. Although these Islamic finance arrangements do not charge interest HMRC deem these charges incurred in these arrangements to be, in effect, interest. As such part 10A ITA 2007 clarifies this point and explains how the tax relief is calculated in these circumstances.
With this Murabaha arrangement, the financial institution offering Islamic finance will purchase the property from the vendor, first purchase, and immediately sell it to your client, second purchase, at an agreed cost plus. There will be an effective charge to cover the costs of the financial institution in carrying out this process. Therefore the Murabaha agreement is not for a loan given on interest, it is the sale of an item for money. As the financial institution resell this to the eventual owner this would fall under the purchase and resale arrangement (ITA2007 s564C).
The financial institution should break the costs that your client is paying between the capital and the financial charge for the purchase and resale arrangement. The difference between the first purchase by the financial institution and the second purchase by your client will be an allowable financing cost. These costs can then be offset against their rental business, assuming these costs will be wholly and exclusively for the letting business.
However, as this Murabaha arrangement is, in this case, used to finance a dwelling it will also fall under the current dwelling related loan arrangements restrictions. As such there will be some potential restrictions on the amount of the finance costs that may be allowable against the rental profits via ITTOIA 2005 s272A.