Zakat and Investments

Zakat is the third of five core pillars of Islam and by Quranic ranking, is next after Prayer in importance. It has been interlinked with Prayer 28 times in the Quran.

Zakat functions and is calculated in a similar manner to a wealth tax, but it is so much more wholesome than a tax. Zakat finances the growth of faith and the faithful. Zakat is a human capital fund which seeks to empower individuals. Zakat guarantees every struggling person a baseline provision and support to give them more opportunities to break out of the cycle of poverty. Zakat is liquidity injections to the market and acts as an economic stimulus by activating consumer spending. Zakat is a social contract between communities to look after one another and to grow together.

Zakat is not a burden; hence, when calculating Zakat, it is due on one’s personal assets. Zakat is never payable on one’s residence, vehicle, clothing, electronics so on and so forth. Zakat has been made obligatory on specific assets: gold, silver, cash, business stock, receivables, investments in these assets, agricultural produce and livestock.

When considering Zakat on investments, common investments include shares, ETFs and mutual funds. The golden principle which applies everywhere is that if any investment or equity is purchased for capital gain purposes, Zakat will always be due on the current market value of the holding. However, if equity is purchased for dividend income with a view to hold the equity, Zakat will only be on the proportion of underlying Zakatable assets of the investment. This necessitates the review of balance sheets of companies and the asset composition in funds.

When considering the balance sheets of companies to calculate Zakat on shares as investments, the net Zakatable assets value has to be determined. Thereafter, a Zakatable percentage or ratio needs to be deduced which can be applied to one’s shareholding for Zakat purposes. Scholars commonly use the market capitalisation or total assets to deduce this figure. If this is difficult for people to do, the National Zakat Foundation UK carried out a research on the FTSE 100 and opined that 25% was a safe proxy to apply for Zakat purposes. Hence, for a listed company, if a person paid Zakat (2.5%) on 25% of the current value of their shares, the Zakat liability can be considered as discharged. However, it is absolutely critical that only Shariah compliant shares are purchased.

Pensions are another common long-term investment and savings. Before addressing the Zakat treatment of pensions, it is important to take note that many pensions are not Shariah compliant. Whilst direct property funds have a low non-Shariah compliance risk, conventional equity funds, mixed-asset funds have a high non-Shariah compliance risk. Interest funds, gilt funds, bond funds and fixed income funds are not Shariah compliant. Thus, Muslims are encouraged to seek Shariah compliant pensions to ensure lawful savings and earnings.

In regard to the Zakat treatment of pensions, Zakat is not due on all pensions. Zakat is not due on defined benefit schemes. Zakat is due on defined contribution schemes. Ideally, Muslims who invest in defined contribution pension schemes should review their fund’s factsheet. The precise Zakatable assets composition should be determined to calculate the Zakat liability. If it is difficult for anyone to review their fund’s factsheet and discharge Zakat, they may apply the following percentages as proxies for the probable Zakatable assets composition for their type of fund. This will give a high degree of assurance in discharging one’s Zakat liability on their pension fund.

These were ascertained from a recent research undertaken by the National Zakat Foundation.

It is necessary to learn about Zakat for investors. As people of faith, we believe that Zakat will benefit us in this world in real terms; it will bring a growth in income or reduction in expense. Likewise, the payment of Zakat will bring spiritual blessings in this world and tangible gain in the Hereafter. Whilst we have the chance, let us maximise our giving and spending in good causes.