In these times of ever increasing mortgage interest rates, borrowers are naturally shopping around for the best deal they can, whether they are buying for the first time or re-mortgaging. But beware, if you choose the wrong mortgage product, you may attract the attention of HMRC and become liable to a capital gains tax bill.

The majority of mortgages follow a similar pattern. The borrower will approach a lender for a mortgage to cover the cost of buying a property, or to seek a re-mortgage at the end of a mortgage deal.

Once a mortgage or re-mortgage has been agreed, it becomes a secured loan against the property, with the borrower having legal title and the lender having the right to repossess the property, if repayments are not made in accordance with the terms of the loan.

A Diminishing Musharakah is another type of property financing product, but it operates in a very different way.

This time the lender agrees to pay say, 80% of the purchase price, with the borrower paying the remaining 20%. The borrower then pays rent on the 80% to the lender.

A separate contract is entered into between the lender and the borrower to split the beneficial interest in the property depending on each party’s contribution to the purchase price.

Over time the borrower’s rent payments buy out the lender’s beneficial interest and the legal title of the property transfers to the borrower.

HMRC is actively pursuing borrowers, primarily landlords, who have switched from a conventional mortgage to a Diminishing Musharakah product because, in simple terms, the legal title has moved from the borrower to the lender. In HMRC’s view that is a partial disposal for capital gains tax purposes and it is busy issuing assessments, for the tax it believes to be due, to unsuspecting borrowers.

This compliance activity from HMRC is inevitably targeting Muslim borrowers, who are using Islamic finance products, like Diminishing Musharakah style mortgages, as a means to avoid paying interest and to comply with Sharia Law.

We are currently representing clients who have been caught completely unaware of the implications of HMRC’s approach and have received huge capital gains tax assessments. It is a very complex area, not just because of HMRC’s interpretation of the tax legislation it feels supports its approach, but because of the clear discriminatory behaviour of its actions, even if it is unintentional.

If you are in a similar situation, or you have clients who have been caught out, then please get in contact by calling us on 0800 001 6686 or by email at info@independent-tax.co.uk

This is the type of work we at Independent Tax do day in day out. Strong by your side and strong in your defence.