State Tax Snapshot: Could Bans on Shariah Law Raise Tax Issues?

The United Kingdom recently announced its plans to become the first country outside the Muslim world to sell a Shariah-compliant bond as soon as next year. Meanwhile, several states in the U.S. have been moving in a decidedly different direction.

Since 2010, seven states have enacted laws barring judges from considering foreign law in their decisions, according to USA Today. As many as 25 states have considered such measures without enacting them, the article says.

Some critics of these laws contend that they are intended to draw scrutiny to Shariah law, which applies to all aspects of Muslim life and includes a prohibition against entering into financial transactions involving interest.

Oklahoma’s ban on applying foreign laws or Shariah law was overturned in August by a federal court, which found that the provision violated the U.S. Constitution’s First Amendment.

These developments raise questions for tax practitioners.

Could the divergent state policies regarding Shariah law have income tax implications? Transactions such as mortgages that typically involve the payment of interest are sometimes modified to comply with Shariah law. But it is unclear whether the parties to these transactions would be eligible to receive the same deductions under the federal or state tax codes. Would a state that prohibits its judges from considering Shariah law be more likely to deny these deductions or find that such transactions lack economic substance?   

By Steven Roll

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