Zakat can be considered a type of tax on wealth. This point is important because zakat has to be paid on qualifying wealth, irrespective of the owner’s age or mental ability (in the event the owner of the wealth is incapable of paying the zakat, his or her guardian(s) should administer the zakat). These days, when a Muslim lives in a non-Muslim country, there is no requirement from the tax department to pay the zakat. Yet, Muslims still pay the zakat; it’s still an obligation for qualifying Muslims to pay this. Nowadays zakat is seen less as a tax and more as charity. Either way, it’s a flow of wealth from the ‘wealthy’ to the ‘poor’. Of course, both those terms are relative, and perhaps slightly subjective too.
Since stocks and shares are a form of wealth, zakat is payable on them. Broadly speaking, there are two types of zakat that investors should be aware of (but this does not mean investors have to pay zakat twice – investors pay one type of zakat or the other):
1. Zakat on ‘capital gains’ stock
2. Zakat on ‘income stocks’
1. Capital gains stocks
This is when investors buy shares in the hope the value of those shares will rise in the future, and if it does, the investor will sell it.
For this type of investor, he or she must pay zakat on the shares at the price it sells at.
Readers may be familiar with ordinary zakat, that is, when individuals pay zakat on their personal wealth. When ordinary zakat is calculated, the ‘nisab’ (the threshold after which zakat becomes compulsory) is determined, and then whatever wealth a person possesses in excess of the nisab, zakat is payable on the excess wealth only at a rate of 2.5% (if that wealth had been possessed for a whole (lunar) year).
Notice, however, that the zakat on stocks and shares does not require a nisab. The investor simply pays the zakat on the sale value of the share(s). This is an important point because some investors may be inclined to deduct the cost price from the sale price of the shares – but this would be wrong. The reason for paying zakat on the sale price (without deducting the costs) is because “the share itself has become an article of trade and zakat is fardh on the current value of merchandise.” (Mufti Muhammad ibn Adam, Issue of Shares, p17-18).
To summarise, zakat must be paid on the sale price of shares at a rate of 2.5%.
2. Income stocks
This is when investors buy shares in a company in the hope that it will pay out a dividend (a dividend is a sum of money a company pays to its shareholders from the profit it earns).
Zakat on income stocks is more difficult to calculate and it will probably be necessary to get a copy of the company’s annual report.
For income stocks, it is permissible to deduct the cost of assets that are exempt from zakat, such as land, machinery, furniture/ fixtures and fittings. After doing this, the zakatable assets (such as cash, raw materials, produced goods (not yet sold) and goods under process) will remain and zakat is payable on that portion only.
The distinction between the two categories seems to be that zakatable assets are things that will eventually be sold by the business (as well as cash the business already possesses). The non-zakatable category, meanwhile, seems to be composed of items that will not be sold and intangible assets.
But if you’ve bought shares worth only £100, how is it possible to deduct the non-zakatable assets (whose value may reach into the billions)? By using some basic math and following the steps below:
1. Obtain the company’s latest annual report
2. From the assets section of the report (balance sheet), identify what is ‘zakatable’ and ‘non-zakatable’
3. Work out the non-zakatable assets as a percentage of the company’s overall value
4. Whatever the non-zakatable asset percentage turns out to be, deduct that percentage from the dividend pay-out.
Continuing with the example above of shares worth £100 in company X. Suppose company X has a valuation of £100, 000.
Let us further suppose company X has zakatable assets worth £40,000 (40% of the company’s value in other words) and non-zakatable assets worth £60, 000 (60% of the company’s value).
Now, say company X administered a dividend pay-out of £10, then zakat must be paid on 40% of that only (because only 40% of the company’s assets are zakatable in our example).
So, 40% of £10 is £4 (the zakatable amount). And 2.5% £4 is £0.10. So, the zakat payable on company X’s dividend of £10 would be £0.10.
Do also bear in mind that assets of a company are not fixed for life. A company may sell some assets or acquire new assets. Therefore, every time the zakat has to be paid, the assets of a company would need to be checked to ascertain if it is zakatable or not on the date that you calculate your zakat. And finally, remember, if in doubt, you should just pay extr; anything over necessary zakat amount will count as sadaqah inshaAllah.
Zakat is just one of the rules that Muslims investors need to be aware of. If you’re totally new to trading and want to learn more, consider joining my free 30 Day Trading Programme, where I cover zakat and much more.
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