By SIMON WALTERS

Last updated at 18:08 17 February 2008

A new sharia law controversy erupted last night over Government plans to issue special "Islamic bonds" to pay for Gordon Brown's public-spending programme by raising money from the Middle East.

Britain is to become the first Western nation to issue bonds approved by Muslim clerics in line with sharia law, which bans conventional loans involving interest payments as "sinful".

The scheme would mark one of the most significant economic advances of sharia law in the non-Muslim world.

It will lead to the ownership of Government buildings and other assets currently belonging to British taxpayers being switched wholesale to wealthy Middle-Eastern businessmen and banks.

The Government sees sharia-compliant bonds as a way of tapping Middle-East money and building bridges with the Muslim community.

But critics say the scheme would waste money and could undermine Britain's financial and legal systems.

Senior Conservative MP Edward Leigh, chairman of the Commons Public Accounts Committee, said: "I am concerned about the signal this would send – it could be the thin end of the wedge.

"British Common Law must be supreme and should apply to everyone."

A spokesman for the National Secular Society said: "There are lots of different ways to arrange financing.

"Constructing financial instruments to be sharia-compliant seems to me to involve a lot of unnecessary complication, which will serve only to make a lot of lawyers very rich."

The attempt to embrace Islamic financing would also appear to be at odds with Mr Brown's promise to promote Britishness and British values and institutions.

The Treasury has already faced heavy criticism for removing Britannia from 50p coins.

Other Western nations have been reluctant to issue Islamic bonds.

In the United States the bonds are banned partly as a result of claims that the money could be linked to terrorism.

Approval: Chancellor Alistair Darling is ready to give the go-ahead to sharia-compliant bonds

The Treasury proposal follows the heated debate over the Archbishop of Canterbury Dr Rowan Williams's claim that the spread of elements of sharia law in parts of Britain was "inevitable".

Downing Street distanced Gordon Brown from Dr Williams's comments.

A spokesman said: "The Prime Minister is very clear that British laws must be based on British values and that religious law, while respecting other cultures, should be subservient to British criminal and civil law."

However, The Mail on Sunday has established that Chancellor Alistair Darling is ready to give the go-ahead to sharia-compliant bonds – known as "sukuk", an early Arabic form of cheque.

Treasury officials have been working behind the scenes for months on the plan.

The deadline for responses to Mr Darling's consultation document setting out how the bonds will work expires on Thursday.

The Islamic bonds proposal was devised by Mr Brown's former Treasury adviser Ed Balls, now Schools Secretary and the Premier's most powerful Cabinet ally.

He claims it is a vital way of improving relations with Muslims in Britain as well as helping the UK to obtain vast sums from Middle-East banks in oil-rich nations such as Dubai and Qatar.

Sharia-compliant bonds have been issued by the governments of Pakistan and Malaysia and private banks but never by a Western government.

Treasury officials say the aim is to attract big investors as well as making it easier for British Muslims to invest in National Savings products at banks and post offices.

The Government has already backed Islamic car loans and mortgages.

Sharia-compliant bonds were designed to get round the ban on paying interest – "riba" in Islamic law.

The Koran says it is sinful to make money from money.

Unlike a conventional bond which is debt-based, a "sukuk" is asset-based. Instead of receiving interest, bond holders receive "rent" on the asset, thereby complying with sharia law.

The Treasury consultation document says Government assets such as "buildings or a piece of infrastructure" would be switched to a "special-purpose vehicle" set up to administer the bond.

This would be carried out by a contract known as an "ijara".

The asset would then be leased back by the Government, generating rental payments for the Islamic bond holders.

When the "sukuk" matured, the Government would guarantee to buy back the asset, allowing the bond-holders to get their redemption payments.

"Sukuk are akin to Islamic investment certificates," the document says.

"They are designed to be in compliance with sharia law, the divine law in Islam which is based on the Quran."

Islamic bonds are slightly more expensive than Western-style bonds, mainly because they require extensive legal and religious advice.

The Treasury initiative has been given added impetus by the worldwide credit squeeze, which is making it harder for all governments to raise money.

The Government says the bonds will also help London retain its position ahead of New York and Frankfurt as the world's leading financial centre.

Global Islamic finance assets, including private equity and bonds, are now said to be worth up to £150 billion. Sukuk volumes have soared from almost nothing to £35 billion in the past ten years.

Maurice Fitzpatrick, a senior tax partner at accountants Grant Thornton, said: "The Treasury wants to borrow money from as wide a range of sources as possible.

"Sharia bonds might well prove to be more expensive, but we would not know for sure until it was put into practice."

Special rules for Islamic finances have been challenged by Mahmoud El-Gamal, chairman of Islamic economics at Rice University, Houston.

"The main beneficiaries are lawyers, multi-national banks and self-styled religious scholars retained as consultants to certify the Islamicity of re-engineered financial products," he said.

Muslim Labour peer Lord Ahmed said: "This is a positive step for Muslims in Britain but the main reason for doing it is to attract money to the UK from Middle-East investors. Claims that it is connected to terrorist funds are absurd."