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The Perfect Storm: Understanding Sharia Law and Its Potential US Tax Impact

In today’s world, it is no longer possible for practitioners to ignore the possible implications of another country’s laws.  My earlier blog posts (here and here) set the stage for US tax practitioners to become aware that Sharia law issues can impact the US tax analysis of a particular case. Yet, guidance is lacking as to how the matter should be resolved.  My article, “When Sharia and US Tax Law Collide was first published in Tax Notes International, Volume 87, No. 8 (August 21 2017) and looks at this entire novel topic in depth.  For those wishing bite-sized pieces, I have prepared a series of blog posts summarizing salient portions of the article.

Today’s Post: As we have seen from my earlier posts, foreign law can indeed impact the US tax consequences of a transaction. While no clear standard has yet emerged to direct when and how foreign law should be taken into account, we know from precedent that the courts have been receptive to considering a foreign law’s influence on a US tax case.

Despite the growing awareness of Islamic or Sharia law in Western countries, I do not know of a single US tax case that has considered the impact of Sharia law on the US tax consequences of a fact pattern before the bench. The Internal Revenue Manual is likewise silent. With approximately 1.8 billion Muslims in the world as of 2015 (this was roughly 24% of the global population), US tax practitioners need to understand more than they currently do.

What is Sharia law and how might Sharia law affect US tax consequences?  A brief peek at one example (more examples will be examined in later blog posts) will serve to illustrate the point.

Multiple wives and the US Gift and Estate Tax Rules: Under Sharia, Muslim men may have up to four wives. Even though multiple wives are permitted under Sharia, from a US legal point of view, only one will be recognized as the lawful spouse.  Under the US Gift and Estate tax rules, a so-called unlimited marital deduction is permitted for the making of lifetime gifts, or for the passing of assets at death, to one’s “spouse”.

These two different sets of rules provide a perfect example of how Sharia and US tax law can meet and collide. Assume a wealthy US citizen Muslim man passes away leaving assets at death to all four of his US citizen wives.  Only the value of assets given to the wife recognized under US law as the legal spouse will be exempt from Estate tax under the unlimited marital deduction provisions of the tax law; the assets passing to the other three wives who are not recognized as his legal spouse, can be taxed to the estate at a 40% rate. (The result is similar under the US Gift tax rules with an unlimited marital deduction permitted only for gifts given to the legal spouse).

What is Sharia?

In Arabic, the word “Sharia” also means the “path”, and as such, Sharia serves as a guide or pathway for Muslims to lead an Islamic way of life.   For devout Muslims, Sharia governs many aspects of everyday life – from the ways in which they eat, the manner in which they treat animals or protect the environment, to how they manage financial dealings, conduct business, how they marry and how their estate shall be distributed after death.

Sharia is not a “law” in the sense that Westerners understand that term.  In the eyes of many Muslims, however, Sharia is a law.  It is not a code of statutory rules, regulations or judicial precedent set out by a government.  Sharia is predominantly derived from the Quran and from what is called the “Sunna”. Sunna are the sayings, practices, and teachings of the Prophet Mohammed whose life became an exemplary model for Muslims to follow. Sharia is also derived from what is known as Qiyas, or scholarly works; and Ijma, the consensus of the Muslim community.

The Prophet Mohammed’s sayings and practices were collected by scholars into the hadith.  The attempts by different localities to reconcile their local customs with Islam resulted in the growth of hadith literature and the development into distinct schools of Islamic thought – the Sunni and the Shiite. Each school of thought had special scholars that inspired them.  The various schools were named after these influential scholars (the Sunni schools of thought of Hanbali, Maliki, Shafi’i, Hanafi; and the Shiite school of thought, Ja’fari).  Each of these different schools varies in the weight that each applies to the sources from which Sharia is derived – the Quran, Sunna, Qiyas and Ijma. As a result, there are multiple interpretations of a position under Sharia with respect to certain issues.

Sharia Law Codified

Despite the different interpretations, and despite the fact that Sharia, or Islamic law, is divine-based guidance, Sharia strongly influences the legal code and the written laws in many Muslim-majority nations. Precisely how this is achieved varies greatly from country to country.

A dual legal system exists in many Muslim-majority countries. In these countries, the government is secular, but personal status issues may be brought by Muslims to the Sharia courts (e.g., familial disputes concerning marriage, divorce, inheritance etc.).

Some Western countries are now exploring implementation of this idea and it has been implemented to a certain extent in the United Kingdom. There are no Islamic courts in the United States and various US states have “banned” Sharia law, or passed some kind of ballot measure that prohibits the state courts from considering foreign, international or religious law.

In other countries, such as Lebanon and Indonesia, the courts render decisions based on a mixture of jurisdictions. The mixture is based on the legal systems that controlled during colonial rule in addition to Sharia teachings.

In countries such as the Kingdom of Saudi Arabia, the United Arab Emirates (UAE), Yemen, Kuwait and Bahrain, where Islam is the official religion, the law is sourced solely or predominantly from Sharia. For example, the UAE has constitutionally adopted Islamic law (Sharia) as a main source of legislation, and it serves as the foundation of the country’s legal system.

In some Muslim countries it is constitutionally forbidden to enact any law that is antithetical to Islam.  In other Muslim-majority countries, the constitution will declare that the government is secular and Sharia plays no role in the law per se, but Sharia will still influence local customs (e.g., Chad, Guinea, Mali, Niger, Senegal, Tunisia, Azerbaijan, Kazakhstan, Turkmenistan, and Turkey).

In summary, we see that Sharia is not a set of codified laws or statutes, but that it can and does influence the legal system of many a Muslim-majority country. How this is done and how strong the influence, varies greatly from nation to nation.

Next week’s blog post will examine how Sharia impacts various US international tax transactions and how tax practitioners must respond.

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