Regulatory Framework and Legal Issues Relating to Islamic Finance Presentation by Atiq S. Anjarwalla Anjarwalla & Khanna, Advocates ALN (Africa Legal Network) Kenya | Burundi | Rwanda | Tanzania | Uganda | Zambia 1 St East and Central Africa Conference on Islamic Banking

Legal Parameters Regulatory Framework Tax Documentation 1 St East and Central Africa Conference on Islamic Banking

Legal Parameters Applicable Law and Jurisdiction: – The Judicature Act – The Constitution – The Kadhis’ Courts Act 3 1 St East and Central Africa Conference on Islamic Banking

The Judicature Act Section 3 of the Judicature Act (Chapter 8, laws of Kenya) provides for the following as sources of law in Kenya: (a)the Constitution; (b)all other written laws, including the Acts of Parliament of the United Kingdom; (c)the substance of the common law, the doctrines of equity and the statutes of general application in force in England on the 12 th August, 1897, and the procedure and practice observed in courts of justice in England at that date; and (d)African customary law in civil cases in which one or more of the parties is subject to it or affected by it. 1 St East and Central Africa Conference on Islamic Banking

The Constitution Section 66(5) of the Constitution provides that: “the jurisdiction of a Kadhi’s court shall extend to the determination of questions of Muslim law relating to personal status, marriage, divorce or inheritance in proceedings in which all the parties profess the Muslim religion”. The jurisdiction of the Kadhi’s court does not, therefore, extend to commercial transactions like banking arrangements. 1 St East and Central Africa Conference on Islamic Banking

The Kadhis’ Courts Act Section 5 of the Kadhis’ Courts Act (Chapter 11, laws of Kenya) provides that: “A Kadhi’s court shall have and exercise the following jurisdiction, namely the determination of questions of Muslim law relating to personal status, marriage, divorce or inheritance in proceedings in which all the parties profess the Muslim religion....” The effect of this section is twofold, it only applies: (a)to matters relating to personal status, marriage, divorce or inheritance; and (b)where all parties profess the Muslim religion. 1 St East and Central Africa Conference on Islamic Banking

Regulatory Framework Principal Acts of Parliament in Kenya that regulate the banking industry in Kenya: (a)the Banking Act (Chapter 488, laws of Kenya); and (b)the Central Bank of Kenya Act (Chapter 491, laws of Kenya). 1 St East and Central Africa Conference on Islamic Banking

Prohibited Business under the Banking Act Banks in Kenya are prohibited under section 12(1) of the Banking Act from the following, to: “…(a) engage, alone or with others, in wholesale or retail trade, including the import or export trade, except in the course of the satisfaction of debts due to it; and any trading interest carried on by an institution at the commencement of this Act shall be disposed of by the institution within such time as the Central Bank may allow…....(c) purchase or acquire or hold any land or any interest or right therein except such land or interest as may be reasonably necessary for the purposes of conducting its business, or for housing or providing amenities for its staff, where the total amount of such investment does not exceed such proportion of its core capital as the Central Bank may prescribe…” 1 St East and Central Africa Conference on Islamic Banking

The Central Bank of Kenya Act The Prudential Guidelines on Prohibited Business under the Prudential Guidelines reiterate the position stated by the Banking Act under section 12 prohibiting banks from engaging in trade. 1 St East and Central Africa Conference on Islamic Banking

Saving Provisions Section 53 (1) of the Banking Act states: “The Minister may, by notice in the Gazette, exempt an institution from the provisions of section 12 or 14 subject to such conditions as the Minister considers necessary.” Section 52(1) of the Banking Act states: “ For the avoidance of doubt, no contravention of the provisions of this Act or the Central Bank of Kenya Act shall affect or invalidate in any way any contractual obligation between an institution and any other person.” 1 St East and Central Africa Conference on Islamic Banking

Islamic Finance Products Caught Under Certain Acts Ijara and the Hire Purchase Act (the “HPA”) Murabaha and the Sale of Goods Act (the SGA”) Murabaha and other Statutes, for example, the Energy Act 1 St East and Central Africa Conference on Islamic Banking

Ijara and the HPA An Ijara can be classified in conventional terms as a leasing arrangement. The HPA defines a “hire-purchase agreement” to mean “an agreement for the bailment of goods under which the bailee may buy out the goods or under which the property in the goods will or may pass to the bailee”. Certain Ijara transactions could be deemed to be hire purchase transactions, and would accordingly require a licence issued under HPA to conduct such business. 1 St East and Central Africa Conference on Islamic Banking

Murabaha and the SGA Islamic banks may be perceived as “sellers” under the SGA. The SGA places by operation of law a number of obligations on a seller of goods which include an implied warranty that the relevant goods are of merchantable quality and fit for their purpose. Passing of risk under the SGA. A bank undertaking a Murabaha transaction should therefore consider the application of the SGA and consider how to limit its exposure under the SGA. 1 St East and Central Africa Conference on Islamic Banking

Murabaha and other Statutes Implications of the Bank as “seller” of certain goods. Section 80 of the Energy Act provides that: “…(1) a person shall not conduct a business of importation, refining, exportation, wholesale, retail, storage or transportation of petroleum, except under and in accordance with the terms and conditions of a valid licence; and (2) a licensee shall not sell petroleum to a person for the purpose of exportation or for resale in Kenya unless that person has a valid exporters or retail licence under this Act…” 1 St East and Central Africa Conference on Islamic Banking

Tax Issues Stamp Duty Income tax Customs duty VAT Withholding tax 15 1 St East and Central Africa Conference on Islamic Banking

Stamp Duty Financing of immovable property: – Diminishing musharakah or murabaha? 1 St East and Central Africa Conference on Islamic Banking

Income tax Application of default damages for charitable purposes. Tax treatment of default damages. 1 St East and Central Africa Conference on Islamic Banking

Customs duty Who is importer and consignee on shipping documents? Who takes risk and obligation to clear goods and therefore pay custom duty? 1 St East and Central Africa Conference on Islamic Banking

VAT In the case of a Murabaha: – Financing transaction or a contract for sale and purchase? 1 St East and Central Africa Conference on Islamic Banking

Withholding tax Customer as bank’s agent pursuant to the Agency Agreement in a Murabaha transaction. Income may be deemed to be in the hands of the customer as an agent of the bank. Would withholding tax be deductible? 1 St East and Central Africa Conference on Islamic Banking

Documentation Requirement to ensure that documentation accords with applicable common law principles and statutes of Kenya. Exclusion of relevant provisions of SGA. Inclusion of limitation of liability language with regard to the duties and obligations and liabilities of an agent. Consideration of appropriate dispute resolution forum arising from governing laws of documentation being Kenyan law. 1 St East and Central Africa Conference on Islamic Banking

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