Effect of Zakat on Asset and Capital Markets


Salman Ahmed Shaikh

Zakat is a religious obligation to pay a part of wealth and production to the government. In its economic character, Zakat is a combination of a net worth tax and production tax. Zakat is 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 income arising in 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 and engineers, for instance. It could also include income from such sources where only capital is invested like equity investments in stocks and mutual funds.

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 royalty income.

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

Effects of Proposed Zakat System on Property Market

If the tax (Zakat) program is implemented as proposed, there will be a 10% income tax on the proceeds of sale of a property. The tax liability will be more if the property is kept in ownership 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. residential properties, office premises and factories will come in the reach of consumers and commercial enterprises respectively. A simplified example is presented below:

Property value at t0 : PKR 1,000,000.

Property prices increase at t1 by 10%: PKR 1,100,000.

If property is kept at t1, 2.5% tax on property: PKR 27,500.

If property is sold at t1, 10% tax on gain on sale of property: PKR 10,000.

Net Tax Gain: PKR 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 on whole value of property, 10% income tax will be charged on income only.

Property value at t0 : PKR 1,000,000.

Property can be given on rent at 10% per year of property value.

If property is kept at t1, 2.5% tax on property: PKR 25,000.

If property is rented from t0 until t1, 10% tax on rent: PKR 10,000.

Net Tax Gain: PKR 15,000.

Effects of Proposed Zakat System on Equity Markets

With discontinuation of interest-based deposits, 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 example is presented below:

Value of stock of company A at t0 : PKR 100.

Stock price increase at t1 by 10%: PKR 110.

If no investment in stock or other assets, 2.5% tax on wealth: PKR 2.5.

If stock is sold at t1, 10% tax on gain on stock sale: PKR 1.

Net Tax Gain: PKR 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 on whole value of stock, 10% income tax will be charged on income only. A simplified example is presented below:

Value of stock of company A at t0: PKR 100.

Suppose company A is profitable and pays 10% dividend.

If no investment in stock or other assets, 2.5% tax on wealth: PKR 2.5.

If stock is kept at t1, 10% tax on dividend: PKR 1.

Net Tax Gain: PKR 1.5.

About Salman Ahmed Shaikh

PhD Scholar in Economics and works as GRA at UKM, Malaysia. He can be contacted at: salman@siswa.ukm.edu.my
This entry was posted in Articles on Islamic Economics, Articles on Islamic Finance and tagged , , , , , , , , , . Bookmark the permalink.

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