Effect of Zakat on Asset and Capital Markets


Salman Ahmed Shaikh

Zakah is a religious obligation to pay a part of wealth and production to the government. In its economic character, Zakah is a combination of a net worth tax and production tax. Zakah would be levied as per the ceiling rates defined for each category of wealth or production.

The classification is as follows:

a) 2-½% on cash, wholesale value of held for trade inventory and capital in excess of need. It is payable once a year at a particular set date.

b) 5% on production using both labor and capital. It is charged at the completion of the production process. Modern day analogous extension could be to use that to collect Zakat from manufacturing and service industries.

c) 10% on production using either labor or capital. It is charged at the completion of the production process. Modern day analogous extension could be to use that to collect Zakat from self-employed practitioners, like lawyers, doctors, consultants, teachers, engineers etc. It could also include income from such sources where only capital is invested like equity investments in stocks, mutual funds, REITs etc.

d) 20% on production using neither labor nor capital. This is applicable on treasure or any other natural gift obtained without using neither labor nor capital. Modern day analogous extension could be to use that to collect Zakat from inheritance etc.

The derivation for production tax comes from the fact that rain-fed lands were subject to 10% production tax whereas, the irrigated land (which had to be provided with
capital) were subject to 5% production tax.

Effects of Proposed Zakah System on Property Market

If the tax (Zakah) program implemented as proposed, there will be a 10% income tax on the proceeds of sale of a property. The tax will be more if the property is kept than when it is sold. This will increase the supply of land that was not presented for sale before. The increase in supply will bring the prices of properties down. Hence, affordable housing and commercial facilities i.e. office premises, factories etc will come in the reach of consumers and commercial enterprises respectively. A simplified model is presented below:

Property value at t0 : USD 1,000,000

Property Prices increase at t1 by 10%: USD 1,100,000

If property kept at t1, 2.5% tax on property: USD 27,500

If property sold at t1, 10% tax on Gain       : USD 10,000

Net Tax Gain: USD 17,500

If the property owner does not want to sell the asset and use it in future, but still wants to benefit from the fiscal incentive, he can give it on rent. It will be considered an investment and hence instead of wealth tax, 10% income tax will be charged.

Property value at t0 : USD 1,000,000

If property given on rent @10%/year of property value

If property kept at t1, 2.5% tax on property: USD 25,000

If property rented until t1, 10% tax on Rent: USD 10,000

Net Tax Gain: USD 15,000

Effects of Proposed Zakah System on Equity Markets

With interest-based deposits discontinued, savers will have to make a choice between keeping their money idle and pay wealth tax or invest it in some asset and pay the tax only on income if it is earned. A simplified model is presented below:

Value of Stock of Company A at t0 : USD 100

Stock Prices increase at t1 by 10%: USD 110

If no investment in stock or other assets              : USD 2.5

If stock sold at t1, 10% tax on Gain on Sale          : USD 1

Net Tax Gain: USD 1.5

 If the shareholder does not want to sell the stock, but still wants to benefit from the fiscal incentive, he can keep the stock and pay tax on dividend. Purchase of stocks for capital gain/dividend will be considered an investment and hence instead of wealth tax, 10% income tax will be charged. A simplified model is presented below:

Value of Stock of Company A at t0 : USD 100

Company A is profitable & pays 10% dividend

If no investment in stock or other assets              : USD 2.5

If stock kept at t1, 10% tax on Dividend               : USD 1

Net Tax Gain: USD 1.5

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One Response to Effect of Zakat on Asset and Capital Markets

  1. azam says:

    Masha Allah, Great illustrations

    Like this

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