Islamic Finance | Real Estate Finance | Real Estate
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This article was first published in Islamic Finance News on 7 September.
Can Islamic finance play a role in Non-Fungible Token (NFT) property? My instant reaction was that this would not be possible. However, after some thoughts I believe that it may be possible for NFT interest in a property but not the property itself.
The exchange of an NFT in and of itself would not transfer legal ownership or any property rights in respect of the physical property. The ownership of the NFT would only represent the ownership of the land. The purchaser of an NFT owns the token itself, which is a record of ownership of the unique digital version of the underlying asset. An NFT does not (unless stated otherwise) represent rights to the underlying asset. Transfers of underlying physical assets are only when specifically agreed and validly transferred. This means that if the property were destroyed, the NFT too would become worthless.
One of the attractions of the tokenization of real estate is the view that this would allow for the instant transfer of the "real asset" from one party to another. However, a key barrier to an effective instant transfer would be the settlement of tax every time the property changed hands. The UK government considered the issue of trading an interest in property and the liability to pay taxes in detail at the time of issuance of the UK government Sukuk in 2014. Tax relief for Sukuk issued under the Sukuk al-Ijarah was baked into government legislation, the effect of which was that a Sukuk holder is not treated as having a legal or beneficial interest in Sukuk assets for tax purposes and any dealing of the Sukuk would fall outside the scope of tax because it would not constitute a land transaction.
The method for applying an NFT to holding property using a Shariah compliant structure is to NFT the Sukuk holding of a Sukuk al-Ijarah where the underlying property asset is held by the issuer of the Sukuk on trust for the investors.
Depending on the requirements of the Sukuk issuer and local securities regulators to NFT their Sukuk holdings, it is possible for an investor to NFT their holdings. The main benefit of the Sukuk al-Ijarah structure is that dealings of the Sukuk are not treated (in the UK) as a land transaction and therefore become subject to tax.
However, the tax benefit that are enjoyed by Sukuk al-Ijarah in the UK are unlikely to be translated to the NFT owners. The benefit only applies to dealings of the Sukuk certificate itself which disregards any interest that the Sukuk holder has in the underlying land for tax purposes and means that only any dealings in the Sukuk certificate falls outside of the scope of tax.
An NFT over property may not be the solution to unlock instant transfers of real assets. With the growth of the metaverse, NFTs will very likely play a big role in the trading of assets in the virtual world.