Business Zakat Accounting: Fiqhi Basis
The available zakat accounting standards as well as laws governing business zakat reflect a sort of consensus that adjusted net working capital of a business may be regarded as the base for computation of zakat liability. The second accepted alternative is the adjusted growth capital which essentially arrives at the same outcome, given the accounting equality between total assets and total liabilities and equity in the balance sheet of a business organization. The apparent consensus follows from fiqhi prescription of imposing zakat on urud al-tijarah or the inventory of goods available for trade.
Â Zakatability of Urud Al-Tijarah
We briefly summarize below the fiqhi basis for zakat liability on urud-al-tijara. The full line of arguments and counterarguments are available in chapter 4 of the text Fiqh Al-Zakat by Dr Yusuf Al-Qaradhawi.
Urud al-tijarah, according to Islamic jurists implies business inventory, which means any commodities obtained for the purpose of resale for profit, except liquid monetary assets. Some jurists define ‘urud al tijarah as anything that one buys in order to sell for profit. We quote here from the work of Dr Qaradhawi the evidence from the Qur’an, the Sunnah and Ijma for zakat obligation on business inventory.
“O ye who believe, give of the good things which ye have honorably earned, and of the fruits of the earth which we have produced for you.” (Surah Al-Baqarah No.2, Verse: 267)
Scholars interpret the words ‘that you have earned’ as things earned by means of trade, and the words ‘that we have produced from the earth for you’ as things earned by means of agriculture. This is supported by other verses about zakah that are general and therefore include business assets, such as the verse:
“and on their wealth and possessions there is the right for he who asked and he who is deprived,” (Surah al Dhariyat, 51:19)
“and on those in whose wealth is a recognized right for he who asks and he who is deprived,” (Surah al Ma’arij, 70:24-25)
“Out of their goods take sadaqah so by it thou might purify and sanctify them.” (Surah al Tawbah, 9:103)
Abu Daud reports from Samurah bin Jundub that ” the Prophet (p) used to order us to pay al sadaqah out of what we have for sale.” (Mukhtasar Al Sunan, Vol. 2, p.175)
Al Daraqutini reports Abu Dharr “I heard the Messenger of God (p) saying ‘Camels are zakated, lambs are zakated, and clothes and housewares are zakated.â€ (Al Muhalla, Vol. 5, pp. 234-235)
There is no disagreement that clothes and other housewares for personal or household use are exempt, which means that housewares and clothes mentioned in this saying refer to business inventory for resale. This is in addition to the general sayings that obligate zakah on all kinds of wealth without discrimination, such as “give zakah on your wealth.” (Al Tirmidhi, Vol. 3, p. 91)
The ijma’ of Companions and Followers
Abu ‘Ubaid reports from ‘Abd al Qari, “I was appointed as treasurer at the time of ‘Umar bin al Khattab. When the time of collection came, he used to calculate the assets of merchants, both present and absent assets, and then take zakah on them all, out of the assets that were present.” (Al Muhalla, Vol. 6, p.34)
There is a report from Abi ‘Amr bin Hammas, from his father, who said “‘Umar passed by me and said, ‘Oh Hammas, pay the zakah due on your wealth.’ I answered, I have no wealth except hides and bags.’ ‘Umar replied, ‘Evaluate them and pay the zakah due on them.â€ (al Umm of al Shafi’i, Vol. 2, p. 38, Sunan al Baihaqi, Vol. 4, p.147)
The author of al Mughni comments that “the likes of such a story are common, and none of the Companions negate this ruling, which implies a sort of ijma’ on this matter.” (Al Mughni, Vol. 3. p. 35)
Abu ‘Ubaid reports from Ibn ‘Umar that “Slaves and clothe intended for trade are zakatable.” (Al Amwal, p. 425)
Al Baihaqi and Ibn Hazm report from Ibn ‘Umar that “There is no zakah on housewares and cloths, except when they are used for trade.” (Al Muhalla, Vol. 5, p. 234, and al Sunan al Kubra, Vol. 4, p. 147)
Abu ‘Ubaid also reports the obligation of zakah on trade from Ibn ‘Abbas. (Al Amwal, p. 426)
Abu ‘Ubaid says, “all Muslims unanimously agree that trade assets are zakatable, and no other opinion is attributed to any of the knowledgeable people.” (Al Amwal, p. 429)
Other Rules Governing Business Zakat
Trade assets are commodities obtained for the purpose of selling for profit. Changing the intention from selling for profit to personal use of an item must remove its zakatability. (Radd al Muhtar, Vol. 2, p. 19)
There should be no duplication in zakah on any item in one single zakah year, since the Prophet (p) said “There should be no duplication in sadaqah.” (Al Amwal, p. 375)
There are also the general conditions of zakatability, which are the same as those of zakatability of money, i.e. nisab, the passage of one full lunar year, the absence of debts and similar liabilities, and being in excess of essential needs.
Abu Ubaid reports the ways of calculating zakah as perceived by some of the great Followers. He quotes Maimun bin Mahran as saying, “When zakah is due, calculate the amount of money, add to it the value of inventory and the amount of debts on customers that you expect to be paid, sum the total, deduct whatever debts you owe to others and pay zakah on the net.” Al Hasan al Basri says, “When zakah is due, one must add the amount of money, plus the value of inventory, plus the amount of debts, except the amount of hopeless debts, and pay zakah on the total.” Ibrahim al Nakha’i indicates that one must evaluate one’s trade assets and pay their zakah along with zakah due on one’s other holdings.” (Al Amwal, p. 426)
Malik distinguishes between monopolistic and non-monopolistic merchants According to Malik, a monopolistic merchant is one who buys commodities and waits until prices go up to sell, while a non-monopolistic merchant is one who buys to sell on regular basis without giving much attention to storage or to waiting for a price change. Ibn Rushd writes “Malik says a monopolistic merchant must pay zakah on his inventory when he sells them, once only, even if his stock was kept for several years,Â while the other merchant is required to pay zakah on the inventory each year. (Bulghat al Salik, Vol. 1, p. 224)
Fixed assets are not subject to zakah. The saying narrated by Samurah states that “the Prophet (p) used to ordain us to pay the sadaqah on what we designate for sale.” Consequently, it is said that containers, cages, scales, machinery and tools are not included in zakatability. (Fath al Qadir, Vol. 1, p. 527)
Pricing of inventory for zakah purposes: The majority’s view is to use current prices on the due dates of zakah. This is also reported from the Follower Jabir bin Zaid: Evaluation is done at the prices of the day zakah becomes due. Ibn Abbas is reported to have said that “It is allright to wait untill the merchandise is sold, and then the due zakah is paid according to the actual proceeds.”( Al Amwal, p. 426) A third view is reported by Ibn Rushd without attribution to any specific jurist, which is to appraise the inventory at its purchase price.(Bidayad al Mujtahid, Vol. 1, p.260)
Payment of zakah in kind or in value: Ibn Taimiyah was asked whether a merchant could pay zakah in kind or not, and he answered, “That depends. Some people say it is paid in kind always, others say it should always be in value, while the third opinion says it depends which is most beneficial and convenient method of payment for the payer, the receiver, and the collector in each particular case.” “The last view, he continues, seems to be the most fair, i.e., zakah be paid in kind when it benefits the poor most or paid in value when this is better for him.” (Fatawa Ibn Taimiyah, Vol. 1, p.299)
An Alternative View
Dr Qaradhawi belongsÂ to what may be termed as the â€œorthodoxâ€ school which treats zakat as a form of devotional law (`ibadah) Â and therefore, its provisions are applicable in letter and spirit in the same form as received from the Prophet and his companions. Therefore, the form and procedural details must remain intact as handed down. However, contemporary Islamic economists, such as, Akram Khan argue that zakat should be classified as a transactional law and not a devotional law. He is supported by other scholars (e.g. Sadeq 2002; al-Jarhi and Zarqa 2007: 63) have emphasized the need for ijtehad in the law of zakat. They point to the need for the redefinition of exemption limits (nisab), recognition of new forms of income and wealth, definition of the poor and needy, meanings of ‘in the way of God’ (fi sabil Allah), methods of distribution of zakat proceeds, role of government in zakat collection and distribution, application of zakat on public assets and financial assets represented by the shares and certificates of companies, rates of zakat, and so on. As Khan points out:
â€œOrthodox scholars oppose any reconsideration of the zakah law. The maximum concession they make is to accept ijtehad in cases that are not explicitly covered in the Qur’an or Traditions of the Prophet. While there is no doubt that the Traditions have sanctity, the Prophet made some decisions as head of state in a certain temporal context.’ As a first step we should carefully identify the context of the Prophet’s decisions. For deciÂsions taken in the context of his own time, we should think of present-day solutions even though we find explicit Traditions of the Prophet available on the subject. This may appear iconoclastic but is necessary in achieving the overall objectives of the Shari’ah. A blind application of the Traditions can defeat the objectives of the Shari’ah itself.â€
Khan disagrees with the classical view of considering inventory or urud-al-tijarah as the zakat base. According to him, this approach does not handle the issue of zakah on business firms in a comprehensive manner. Some of the issues raised by him are as follows. First, there is the practical problem associated with valuation of inventory. There are several methods familiar to accountants (such as LIFO, FIFO, average and so on), and each of these would provide a different zakat base. However, we feel this can be easily resolved through appropriate accounting standards relating to valuation of inventory. As discussed before, Islamic jurists have voted in favor of alternative bases for inventory valuation, e.g. on the basis of prevailing market price, cost of acquiring the assets. Standard accountancy textbooks tell us that each of these methods have pros and cons and one of these may be used consistently.
Second, Khan asserts that there is no sound reason why zakat on business should be treated differently from zakat on agriculture. While, zakat on agriculture is on the output or income, zakat on business, according to the classical view, is on current assets irrespective of whether the business is profitable or not. It is perhaps unfair to impose zakat liability on a business even though it is incurring losses.
This suggestion seems to take a rather narrow view of the financials of a business organization restricting its wealth to the current year earnings. To be fair, similar to individual savings, â€œcorporate savingsâ€ should also be zakatable and this brings us back to adjusted growth capital that would give same result as adjusted net current assets based on urud-al-tijarah. Agriculture in the traditional sense does not involve similar issues. Land itself is non-zakatable while the output is zakatable as and when it is reaped. If the farmer is able to meet all its life-expenses and able to hold a surplus for over a year (hawl), the same will be zakatable as individual savings. Of course, if agriculture is undertaken as a business, it should be treated as such for zakat purposes.
Third, Khan asserts that there is no sound basis for exempting fixed assets from zakat and imposing the same on current assets, while the fact remains that the business concern generates profit by use of all resources and not just by current assets. This also seems to backed by the view of Monzer Kahf, a well-known contemporary scholar of the Fiqh of Zakat and the translator of Qaradhawiâ€™s celebrated book on the subject.
There is merit in incentivizing productive investments or creation of productive assets. Given that tools of trade in a micro-economy have always been deemed free from zakat liability, there should be no issue in treating large plants, equipments and other fixed assets as non-zakatable in a modern large economy. There is also merit in disincentivizing individual savings (the component that takes the form of hoarding and not what gets transformed into productive assets) as well as corporate savings that is in the form of working capital. Such savings both at individual and corporate levels may take the form of or encourage unproductive hoarding, thereby, bringing down the economic efficiency of the individual, the organization and the economy.
The fairness, consistency or the lack of these inherent in the orthodox position may perhaps be explained better with a simplified model of a business organization. Let us say, a business firm is set up with its total assets in Year 0 valued at TA. We make the following assumptions:
- TA is financed entirely through Equity (EQ), with zero financial leverage.
- Current assets (CA) in the beginning are x percentage of TA (CA/TA= x)
- There are no current liabilities.
- The firm generates an ROA (=ROE) of k percent for n years.
- The firm has a 100% payout policy for n years.
It follows from the above that our firm would now experience zero growth in Profits (P = k*TA)
The zakat base every year under the three positions would be as follows:
- Current Profits = P = k*TA
- Total Assets = TA
- Current Assets = CA = x*TA = x*EQ
The first position relies on an analogy with traditional agriculture where zakat base is equal to the current output net of costs or net profits (P). According to this traditional view of agriculture, land is cost-free (TA = 0) and zakat-free. If this assumption regarding traditional agriculture holds good, P as the zakat base will be a gross understatement. Indeed if agriculture is undertaken as a business, rules of the game will change.
The second position where zakat base is equal to TA is an overstatement. Shariah does provide exemption to the fixed assets and the basis for treating the CA only as zakatable is proved by the primary sources of fiqh as well as ijma of the companions.
Therefore, the third position where zakat base is equal to CA = x*TA = x*EQ is sound. It is not too difficult to find an economic rationale to this rule. Now that the firm management may reduce its zakat liability by using its current assets more efficiently it will be inclined to push x downwards over subsequent time periods. It will seek to reduce its investment in inventory by avoiding â€œunethicalâ€ hoarding and by enhancing its efficiency in all its operations â€“ procurement, production and marketing. The operating cycle will tend to become shorter. Every dollar investment in CA will tend to generate more Sales (S). A higher current assets turnover (S/CA) will lead to an improvement in total assets turnover (S/TA) and eventually to a higher ROA and ROE. Given that ROA = P/TA = P/S (Profit Margin) * S/TA (Asset Turnover), the outcome of â€œsubjecting CA and not TA to zakatâ€ will be an improvement in operational efficiency and profitability of the business.
Yusuf Al Qaradawi, Fiqh Al Zakah: A Comparative Study of Zakah, Regulations and Philosophy in the Light of Qur’an and Sunnah, Volume 1, Translated by Monzer Kahf, Scientific Publishing Centre, King Abdulaziz University, Jeddah, Kingdom Of Saudi Arabia
Akram Khan (2013), â€œContemporary Application of Law of Zakatâ€, What is Wrong with Islamic Economics?, Chapter 22
Mohammed Obaidullah | October 03, 2014