The Latest Development and Tax Issues of Islamic Bond Market in Hong Kong

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Islamic finance is one of the fastest growing sectors in the international financial market. Given the strategic importance and influence of the Middle East investors, Islamic finance is increasingly in demand by investors wanting investment and financing products compliant with Islamic law (known as “Shariah”).

During recent years, a number of Asian countries such as Japan, Malaysia and Singapore have captured a large portion of Islamic finance activity in the region and have changed their tax law to cater for this. In order to maintain competitive edge as an international financial centre and to enhance investment flows between Mainland China and the Middle East, the Hong Kong government have
already enforced some amended tax and stamp duty legislations to facilitate the Islamic bond (known as “Sukuk”) market development in Hong Kong.

What is Sukuk?

Sukuk are a form of Shariah-compliant financial product, which essentially replicate the financial profile of a bond, but without the receipt or payment of interest (known as “Riba”), which is forbidden under Shariah.

A company hoping to raise finance through Sukuk shall normally issue certificates to investors for cash and identify assets that are then ring-fenced in some way. Essentially, the concept of Sukuk is similar to the securitization of assets. It is a process in which assets are pooled together, repackaged as tradable certificates of investments and transferred to a special purpose vehicle (SPV). Then the SPV funds the purchase of assets by way of issuing Sukuk to investors. The investors shall be able to earn revenue produced from the underlying assets during the life of the Sukuk.

Sukuk have a defined period of investment and provide investors with a relatively foreseeable stream of income or return, which is similar to conventional bonds. Sukuk, however, are distinguished from conventional bonds in that they do not represent the beneficial ownership of a debt instrument but tangible assets. As such, the risk and liability of the underlying asset rather than the risk of insolvency of debtors will be borne by the Sukuk holders. Moreover, the performance or the operation and management of the underlying asset, which are not fixed ex-ante, shall determine the return of the Sukuk holders. Nevertheless, Sukuk can be structured in a number of different ways and usually involve complex structures and multiple transfers of underlying assets, which may also give rise to different levels of risk, predictability of returns, periods of investment, types of assets and liquidity, that is, the tradability in the secondary market.

Most of the Sukuk issued are the leasing type (known as “Ijarah Sukuk”). Under an Ijarah structure, assets such as buildings, land, machinery and property are sold to a SPV using funds raised from investors. Lease income are paid by the issuer to the SPV, which are passed to investors until maturity when the issuer repurchases the assets.

The latest development of Sukuk in Hong Kong

Hong Kong issued its first USD 1 billion inaugural five-year Sukuk in September last year which used the Ijarah structure that has underlying tangible assets of 100 percent in the issued amount. The second government Sukuk to raise USD 1.1 billion in May this year used a structure called the Wakalah, which has one-third of assets invested in selected units in an office building in Hong Kong, and two-third of the assets underpinned by Shariah-compliant commodities.

The Hong Kong Monetary Authority, which handled the issue on behalf of the government, confirmed that the issue was popular and it received USD 2 billion in orders from 49 global institutional investors including central banks and sovereign funds among others. The orders were double its USD 1 billion issue size. The five-year bond was priced at 1.894 percent, which was lower than last year’s issue and was 35 basis points over 5-year US Treasuries. This new government Sukuk was listed on June 3 in the stock exchange of Hong Kong, Nasdaq Dubai and Bursa Malaysia. Buyers of the Sukuk included 42 percent from the Middle East, 43 percent from Asia and 15 percent from Europe. 23 percent of the bonds were sold to central banks or sovereign wealth funds while the rest to banks or fund managers.

The tax issues of Sukuk in Hong Kong

The key uncertainties arising from Sukuk transactions are that the arrangement itself operates in the form of equity finance but is in substance similar to debt finance. If the tax consequences of the constituent transactions are determined based on their legal form rather than their economic substance, simply applying the tax laws in the old days would undermine the economic purpose of the Sukuk transactions giving rise to the effective tax cost of the Sukuk transactions being largely higher than that of a conventional bond financing transaction.

To allow Sukuk to receive the same tax treatment, the Hong Kong government introduced legislative amendments to the Inland Revenue Ordinance and Stamp Duty Ordinance, thereby ensuring that Sukuk can enjoy the same treatment as traditional debt securities, which essentially involved an exemption from Profits Tax and Property Tax and a remission of Stamp Duty, achieving a level playing field for the development of Sukuk in Hong Kong.


The legal, taxation and regulatory frameworks in Hong Kong are readily available for supporting Sukuk issuance. The development pace of the Hong Kong Sukuk market will be market-driven, subject to a number of factors including the development of global Sukuk market, investor demand, funding cost, the availability of different fund-raising channels, etc.

As a mature financial centre, Hong Kong is well-positioned to develop as a Sukuk market. Hong Kong government has proved its commitment to provide the tax and regulatory framework to promote the industry. Hong Kong is already well-placed to provide a gateway for investors who are interested in Asia, particularly Mainland China, by structuring Shariah-compliant financial instruments with underlying Asian assets.

ABOUT THE AUTHOR: Catherine Le Bourgeois, Partner and Wilson Yeung, International Tax Director
Masson de Morfontaine is an international legal and tax firm based in Hong Kong specializes in providing comprehensive professional services for worldwide clients. We are experts particularly keen on helping our HNWI clients with practical legal and tax advices, immigration visa guidance and applications as well as Islamic financing and Islamic products advisory, in order to help investors to make successful cross-border investments in various kinds of property and project around the world. We are more than welcome to discuss with you about our services.

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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.

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