Zakat on Stocks: 3 Methods to Calculate Zakat on Shares | Musaffa Academy

After buying and selling shares, every investor wants to profit from the global, increasingly important and popular stock market and be part of it as a Muslim. Wherever you are and at whatever time, you can deal with shares and increase your capital. In a large number of Islamic countries and cities, the subject of the stock market has turned into a part of everyday financial language that everyone is talking about. One of the most confusing aspects for every investor is undoubtedly the Zakat calculation for shares. Should the value of the shares be taken as a whole, part of it, only a fraction, or only the capital value and not the dividend, which is calculated on it, when the Zakat is calculated for a share? Should it be calculated for the capital of the investor and when should it be calculated for long-term investments and not for short-term trading and vice versa.

Depending on the method used there are three different scholarly opinions that can be applied. First and foremost, all three methods are based on perfectly legitimate Islamic jurisprudence. Below are the explanations for each along with an example for each. There are three scholarly opinions in regards to calculating the end date. Please select the appropriate method for your individual situation.

What Do You Own When You Buy a Stock?

So before we look at the ways in which to value a share, we need to refresh the fact that share ownership is what it says on the tin! Purchasing shares in a company results in the purchase of a proportion of that company and ownership of an infinitesimally small proportion of its assets, dividends and other benefits. It is not just borrowing money from the company, it is being a genuine owner.

The majority of the contemporary scholars who are well-versed in the principles of Islamic jurisprudence in relation to business ownership and partnership (şirika) agree that shares are zakatable wealth. However, they disagree with respect to the method of determining the zakatable amount of shares. There are therefore three different methods with respect to this issue.

Method 1: Market Value Method

The Approach

One common method for calculating Zakat on shares is by using the value of the shares on the Zakat anniversary date. So if you have 1000 shares and their value on your Zakat anniversary date is $200 per share, then you calculate 2.5% of $200,000. Others treat shares in the same way as cash or mutual fund units, where one calculates 2.5% of the value of the shares on the Zakat anniversary date.

This method is widely endorsed by recent scholars and institutions of Islamic finance. It is particularly advocated for retail clients where the management and internal accounts of the company concerned are not readily available. This method of valuation has the merits of being simple, consistent and easy to apply. However, a counter criticism of this method is that it includes non-sharable assets, such as fixed assets, in the total market value, which may, therefore, lead to an overstatement of the value of the trading assets that are to be included in the zakatable base.

When to Use It

The market value method is particularly relevant to active traders. The active trader, who buys and sells securities many times in an accounting period with the intention of earning net gains from movements in market prices, treats such securities as ‘uruuḍ al-tijāra, or trade goods. Trade goods are valued at their current market price. This method is also appropriate in situations where the investor prefers an objective method with an auditable calculation free from any accounting complexity, irrespective of whether assets are classified as trade or non-trade.

Worked Example

Company A 200 shares – $45 Company A shares are valued at $45 per share. The total market value of Company A shares is $45 x 200 = $9,000. Company B 150 shares – $60 The value of Company B shares is $60 per share. The total market value of Company B shares is $60 x 150 = $9,000. Total Portfolio Market Value The combined total market value of your shares in Company A and Company B is $9,000 + $9,000 = $18,000. Zakat to be paid The zakat rate on your combined shares is 2.5% of $18,000, which is $450.

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Method 2: Zakatable Assets Method (Underlying Balance Sheet)

The Approach

Zakat on Shares (4): Method 2 — The Approach of Albani This post is part of a series exploring four Islamic legal opinions on the imposition of Zakat (Zakāt) on listed shares and equities. The second approach for calculating the value of Zakatable assets held in shares, is based on identifying the Zakatable portion of the Company’s asset base that reflects the Zakatable value of the underlying Share. The justification is that the value of company assets like factories, plant and machinery, technology, information and other intangible assets are all fixed capital assets that fall outside the definition of wealth. They comprise cash, accounts receivable and inventory. As mentioned above Zakat is levied on liquid and trade assets only.

In this model you calculate zakatable assets per share (such as cash, receivables and stock inventory) and exclude non-zakatble assets such as fixed assets, land, and equipment, and then calculate zakat only on your proportionate portion of the total zakatable amount.

This method is supported by some scholars including scholars affiliated with the AAOIFI and is based on a more precise principle. In order to apply this formula, it is required to know the last balance sheet which in the case of listed companies is available from annual reports or quarterly reports.

When to Use It

The Zakatable Assets Method is suitable for long term investors who hold their stocks as shareholders of a company for the long run, rather than for traders. If you are looking to benefit from the long term potential of a company over several years, rather than trying to make short term gains from buying and selling, then the Zakatable Assets Method is a more accurate reflection of your participation in the company. This method generally results in a lower zakat liability as compared to the market value method due to the exclusion of market value of fixed assets.

Worked Example

You own 500 shares of Company C. Company C balance sheet information as it pertains to each share is as follows: Cash & Equivalents $4.00 Accounts receivable $2.50 Inventory $1.50 Property & Fixed Assets $12.00 So for each share the total zakatable assets are: $4.00 + $2.50 + $1.50 = $8.00 Total zakatable value of your holding in the company = $8.00 x 500 shares = $4,000 Zakat at 2.5% of $4,000 is $100.

Unlike other methods, the zakatable assets method does not consider the market value of Company C’s assets, meaning the value of its property and plant is excluded. Currently, Company C’s share price is $20. Therefore, with 500 shares, the value of the assets for zakat purposes will be $10,000 x 5% = $250. The zakatable assets method has produced a smaller value as the value of the company’s assets, which consists largely of property and plant, has been excluded.

Method 3: Dividends-Only Method

The Approach

A small minority of scholars suggest that if the long term, extremely passive investor that has no intent to purchase or sell shares and no ability to influence the company has zakat only applied to the dividend that is received and not to the value of the shares. Their argument is that the passive investor has more of a relationship to the company similar to a lender or a silent partner. What the passive investor receives is the dividend income of the company, and the shares themselves do not represent a liquidating wealth that circulates in the market on a daily basis.

This approach is held by the least number of scholars compared to the other two. The majority of Islamic Finance institutions and banks also object to this approach due to the market value approach and zakatable assets approach. Nevertheless, the majority of the scholars do have legitimate justification for this approach and it is also applicable for securities that are highly illiquid or hard to assess a market value.

When to Use It

This approach is applicable only in a few cases where it is applicable for very closely held companies with infrequently traded shares, typically where minority shareholders in a family-owned business or such like receive occasional dividends, but are unable to price their tiny portion of equity because it is nearly or completely illiquid. This approach is not generally accepted for such normal cases as buying and selling trades a large number of shares of listed companies on a commercial exchange such as the NYSE.

Worked Example

You hold shares in Company D and for the zakat year you received dividends of $1,200, which are credited to your current account, along with other savings. You therefore have the $1,200 in cash on the relevant zakat anniversary date and it is therefore treated as cash for zakat purposes. Zakat is then payable at 2.5% on $1,200 being $30. The value of the share in Company D is not taken into account for the purpose of the calculation.

Zakat on Trading Stocks vs Long-Term Investments

It makes a difference to you whether you hold shares for trading or investment purposes. (Just thinking this through should convince you that it makes a difference. This is not a legal nicety. It's a significant consideration.)

If you are an active trader buying and selling shares, reacting to market moves, and looking at your portfolio as a business you are holding trade inventory. In this case the market value method would be appropriate. You would add up the value of all the shares you hold on your zakat anniversary and pay 2.5%.

If you are a long term investor who holds stocks for years, has more interest in the underlying business rather than the fluctuations in share price and who has invested their dividend shares, we believe you should follow the zakatable assets method that reflects your true ownership of the business in which you have invested. You are a partner in the business, and your zakat should be determined from the zakatable portion of the business, rather than the total market capitalization of the shares of the company.

Both are right. The decision is personal. The important point is to make a choice and abide by it, year in and year out, without succumbing to the temptation to switch approaches from one year to the next in an attempt to gain an advantage in settlement negotiations.

Zakat on Dividends: How They Fit In

Irrespective of whether you are calculating the underlying shares for the purpose of your investments or not, dividends on such investments will always be considered as cash. So if you have dividend income in your brokerage account or sitting in the bank on your zakat anniversary date, you will have to include it as part of your overall savings, gold, other investments etc. for the purpose of calculating your total zakatable assets.

If you choose to follow the market value or zakatable assets approach, you’ll only pay zakat on the dividends once, i.e. on the shares. You will include any uninvested cash dividends in your cash amount. If you choose to follow the dividends-only approach then the dividend income will be the basis of your zakat calculation for those shares.

Dividends that were received and spent before your zakat date are not counted – since they’ve already left your possession.

Comparing the Three Methods: Quick Reference

A Note on Purification

It is a huge mistake to treat Zakat and purification as one and the same thing. In simple terms: say for instance that your investment is in a Company whose business is such that a small fraction of the net profits will be derived from immoral sources, like interest income. In this case you must purify such gains to the extent of that fraction of total income and give it as charity. Do not treat it as part of the Zakat.

A number of Shariah screens and Islamic brokerage houses will report a “purification ratio” along with their screen results. In these cases, the portion of your portfolio which requires purification should be calculated and reported separately from your zakat calculation. It should not be included within the figure.

The Bottom Line

Zakat on stocks is not something you can apply in a single way; there are three ways that have been narrated and are evidence, and each has been adopted by the scholars to suit the situation, and accordingly the owner can apply whatever suits him. In the case of the traders, the market value is simplest and agreed upon by scholars. In the case of those owning shares with the intention of being a shareholder in that company and thereby benefiting from its growth, then using the value of the zakatable assets is more relevant. And finally, in the case of someone owning shares, but does not have the ability to give them out to benefit from their market value or viewing them as shares in a company and expecting to reap the reward from them, then he can rely upon the method of dividends.

It is important to consider which method you choose to use, to zakaat annually using the same method and to include dividends as cash in your total assets. Consistency from year to year is the scholars’ verdict and the practical measure to avoid short changing one’s zakaat.

And Allah knows best.

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