Business Zakat Accounting & Taxation in Malaysia

Unlike Saudi Arabia, Malaysia doesn’t have an integrated zakat and taxation system.

Zakat management like all religious matters in Malaysia is the reponsibility of each of its thirteen states  and a prerogative of its ruler (sultan). The Shariah-legal and regulatory framework, infrastructure for collection and distribution of zakat is provided the respective State Islamic Religious Councils (SIRCs) or Majlis Agama Islam Negeri. The only exception is the Federal Territory, where the zakat law and administration are governed by the federal government. Further, the Federal Territory has a Department of Islamic Development (i.e., JAKIM) functioning under the Prime Minister’s Department to coordinate and bring uniformity to administering Islam in Malaysia. However, its function remains purely advisory in nature. In addition, the recently established Department of Zakat, Waqaf, and Hajj (JAWHAR), which is a unit under the Prime Minister’s Department, has a very limited role as regards monitoring the country’s zakat practices.

Taxation in Malaysia is managed by the Internal Revenue Board, an agency under the Ministry of Finance of the Federal Government. A wall of separation is carefully erected between zakat and income tax conceptually and for all practical purposes.

Zakat is the compulsory charitable giving by high-networth Muslims. It is a personal responsibility for Muslims. Income tax, on the other hand, refers to a charge imposed by government on the annual gains of a person, corporation or other taxable unit derived through work, business pursuits, investment and other services determine in accordance with the Income Tax Act of the country. A Muslim has to make two compulsory payments on the same source of income every year, namely income tax and zakat. Zakat is obligation to the Creator while tax is obligation to the Federal government. Failure to pay zakat as well as tax should invite punishment for the defaulter, even though the enforcement of the same is extremely weak in case of zakat-related default.

Tax Incentives

For individual zakat and tax payers, zakat payment attracts full tax rebate under Section 6A(3) of the Income Tax Act, 1967; which means for every one ringgit of zakat given to the SIRC, the tax payable by the zakat payer is reduced by one ringgit during the same assessment year. Rebate is a deduction from tax payable. If zakat paid is less than tax payable then the balance must be paid to IRB. However, if zakat paid is more than tax payable then the difference cannot be claimed from IRB – Sec 6A(4)

Offshore companies also enjoy the benefit of tax rebate. Zakat on business income paid by the Labuan offshore companies is given a rebate equivalent to the amount of business zakat paid to the religious authority. It is subject to a maximum of 3% of net profit or RM20,OOO.

For onshore companies however, there is no rebate admissible. They however, enjoy the benefit of treating zakat paid as a tax-deductible expense. The tax-deduction allowed is subject to a maximum of 2.5% of the aggregate income – Sec 44(11A)

In order to accord equal tax treatment between companies and trust bodies, zakat settled by cooperatives, trust bodies and societies is also allowed as a tax deduction up to 2.5% of the Aggregate Income.

Zakat paid by Limited Liability Partnership (LLP) is also treated as tax deduction up to 2.5 % of the Aggregate Income.

Thus, zakat paid to the SIRCs are treated favorably by the IRB. The total tax payable is reduced when there is zakat paid during the year of assessment. However, the zakat must be paid to an appropriate religious authority established under any written law or any person authorized by such religious authority. – Sec 44(11A) Further, the tax payer must also obtain and keep original receipts for future references.

Various tax incentives for zakat on business coupled with the fact that various SIRCs at the state level were following divergent zakat practices led to a realization that there is a need for guidance on the recognition, measurement and presentation and disclosure of zakat by entities that pay zakat. For example, a study by Mohamed Abdul Wahab et al. (1995) found three methods of business zakat accounting being practiced in various states and institutions in Malaysia – current assets only; current assets plus profits from investments; and net working capital plus current profits. Another study by Nasir and Hassan with a similar objective found at least five assessment methods recommended by zakat centers for companies to calculate the amount of their corporate zakat: the net assets (or working capital), net equity (growth model), net profit after tax, combined methods, and dividend methods.

There was therefore, the need for an accounting pronouncement that would improve the comparability of reported financial information on zakat. In 2002, a working group on zakat was formed with the responsibility for identifying the need for an accounting pronouncement on zakat, and ensuring that the proposed standard is consistent with the requirements of current law and regulations. As part of the project, a survey was conducted by mail questionnaires to the 14 zakat authorities with the objectives to:

(a) understand the methods used by the zakat authorities in determining zakat base; and

(b) seek opinions from the zakat authorities relating to harmonisation of methods used in determining zakat payable.

All the 14 zakat authorities responded to the survey and indicated that they would welcome a uniform accounting pronouncement on zakat for business to streamline the accounting treatment of zakat.

The Board also considered AAOIFI’s Financial Accounting Standard 9 (FAS 9), Zakah. However, AAOIFI’s FAS 9 is inappropriate in the Malaysian context because:

(a) the accounting treatment prescribed are specific for application by Islamic financial institutions that also act as collectors and distributors of zakat; and

(b) the accounting treatments prescribed might run contrary to state or federal legislation in Malaysia.

Technical Release (TR i-1)          

The Board decided to issue the pronouncement in the form of a Technical Release to provide guidance on the accounting treatment for zakat on business. TR i-1 deals only with entities that pay zakat in their capacity as separate entities that carry out business.

When an entity pays zakat on business, the amount of zakat assessed is recognised as an expense and included as a deduction from net income in the income statement of the entity. This treatment is appropriate as it reflects the discharge of a financial obligation of the entity. In addition, the treatment also complies with the definition of expenses in MASB’s A Proposed Framework for the Preparation and Presentation of Financial Statements which is defined as decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

Zakat Rate

The survey responses indicated that zakat authorities use zakat rate of 2.5% in determining zakat on business. The same rate was prescribed in a resolution by the National Fatwa Council (Majlis Fatwa Kebangsaan) dated 9 December 1992. Notwithstanding that, the Board recognised that the state has jurisdiction on matters pertaining to Shariah, and decided that issues regarding the zakat rate on business shall be referred to and determined by the relevant zakat authorities.

Determination of Zakat Base

The Technical Release mentioned two methods of determining zakat base recommended by the Malaysian Islamic Development Department (JAKIM) in Panduan Zakat di Malaysia, 2001:

(a) Adjusted Working Capital method; or

(b) Adjusted Growth method.

The adjusted working capital method calculates zakat base as net current assets, adjusted for items that do not meet the conditions for zakat assets and liabilities.

Zakat base = Current Asset – Liabilities + / – Adjustments

The adjusted growth method calculates zakat base as owners’ equity and long-term liabilities, deducted for property, plant and equipment and non-current assets, and adjusted for items that do not meet the conditions for zakat assets and liabilities as determined by the relevant zakat authorities.

Zakat base = Equity + Long Term Equity – Fixed Asset – Non Current Asset + / Adjustments

The method used for the determination of zakat base would be applied consistently from one period to another. Both methods would result in the same amount of zakat base. Although the Board propagated these two methods, an entity was advised to refer to its relevant zakat authorities on the method of determining zakat base applicable in its jurisdiction. While FAS9 issued by AAOIFI applies to Islamic financial institutions, it provides useful guidelines regarding the adjustments to be made to current assets and current liabilities as follows:

 Adjustment Items

1. Items that are not zakat obligated: Items such as riba ’, gambling and liquor are to be withdrawn from the zakat calculations because they are items or products that are non-permissible i.e. ‘haram’.
2. Limited Ownership: Water, telephone, electrical and its similar kinds of deposit shall be deducted as it does not comply with the requirements of full rights.

iii. Loan Receivable: The money on loan to a borrower is based on the characteristics of full ownership that has been transferred to the borrower. The borrower then possesses the full right & freedom to exploit and manage the loaned financial resources for his own interest and gain. Thus the borrower is obligated to perform zakat on the amount of money loaned and NOT the Company.

1. No items are to be paid zakat for, twice: The dividend income that has already been deducted for zakat may be zakat exempted.
2. Current Assets must be productive: bad debts, expired stocks and depreciation that is permanent should be exempted.
3. Charitable Funds: Charitable funds such as khayrat and education funds in current assets may be exempted from zakat. Nevertheless, charitable funds that are business in nature such as a qard-hasan loan, the amount exempted from zakat is the principle value while funds that are charitable in nature such as donations and khayrat, only the balance amount is exempted.

vii. Inventory / Stock category: Only the end product is subjected to zakat. Raw materials or any items in production are exempted from zakat.

Items Added to Current Assets (+):

All contributions, donations and alms made by any of the business entity at the end of a (the last quarter) shall be added again (with the assumption that the donations made will not affect the company’s liquidity) into the current assets. This is because any amount channeled for charitable purposes, are still obligatory to zakat unless the source is from a charitable fund.

Items Added to Current Liabilities (+):

According to Imam Shafie, there are no debt requirements that pre-determine on whether the assets are qualified for the nisab or not. Imam Shafie’s opinion is that financial loans (not commercial liabilities) do not affect the obligations of zakat. Thus adjustments only involve those items that are not deductible such as:

1. Those not in the form of business operations such as financial loans and the classifications of scheduled refinance.
2. Dividends payable

iii. Overdraft

Measurement of Assets and Liabilities for Zakat

TR i-1 states that an entity shall measure assets and liabilities on the same measurement bases used in the preparation of its financial statements. In other words, preparers may use the amounts as reported in the balance sheet since assets and liabilities used in the calculation of zakat are to be measured in accordance with MASB approved accounting standards. The Board decided to adopt this view on the basis that it would ease zakat payers in performing their obligation, facilitate zakat collectors and distributors as well as preserve the rights of zakat beneficiaries.

During the Board’s deliberations, several issues related to zakat on business were encountered, e.g. zakat chargeability of an entity, calculation of zakat, determination of zakat base, and zakat eligibility of assets and liabilities. The Board noted that these were important issues, however the Board was of the opinion that such issues fall under the jurisdiction of zakat authorities and were outside the purview of the Board. Thus, the Board decided that TR i -1 shall deal only with financial reporting issues related to zakat on business.

Issues

It may be noted that the data used for business zakat accounting method and business tax deduction are different. Business zakat accounting uses data from the balance sheet, while business tax deduction gains information from the income statement. In other words, those methods demonstrate no relationship between business zakat accounting method and tax on business income due to the different sources of information usage. Zahri Hamat (2009) raises a pertinent issue, if the business zakat accounting depends on those methods, do entrepreneurs get benefits from the tax deduction allowable to them? He explains that zakat is payable on the business irrespective of whether profit has been earned or unearned if the business has positive working capital. The entrepreneurs would not utilize their benefits in two situations. The first situation is when their business suffers a loss but still has a positive working capital. The second situation is when tax deduction is smaller than the amount of business zakat paid.

According to the survey findings conducted by him involving 12 Malaysian scholars on business zakat accounting  it was found that the scholards agreed on ijtihad as the basis of decisions in this domain. All of them felt that one of the alternatives for business zakat which could be considered is to use “business income” as the basis of estimating zakat liability. In this case, according to the scholars, zakat on business income can be derived (qiyas) from zakat on agriculture yjeld. This opinion is in line with the position that business zakat accounting method can be changed according to the requirement of the current situation such as the conditions of economy and local laws. For them, this is one of the highly recommended options in order to harmonize business zakat accounting method and business tax deduction currently practiced in Malaysia. Therefore, if the business zakat accounting relies on the income base, the entrepreneurs can fully get benefits from tax deduction allowable to them under the section 44(11A) of the Income Tax Act 1967.

In my opinion, the above suggestion takes 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, “corporate savings” should also be zakatable and this brings us back to adjusted growth capital that would give same result as adjusted net current assets.

The issue of lack of harmonization between business zakat accounting and taxation (they use information from two distinct sources – balance sheet and income statement) need not be and should not be resolved by making changes in the former (because the same has a sound Shariah basis). It can be easily resolved, if need be, by making changes in methods of taxation (tax deduction or tax rebate) and base them on specific items in the balance sheet or the income statement. Extending tax deduction or tax rebate is largely a state matter and does not involve any Shariah issues.

Further, it may be noted that zakat is payable on “accumulated” earnings of the business (minus productive fixed assets) while income tax is payable on “current” earnings of the business. Therefore, the case for extending tax benefits on income tax liability due to zakat payment does not stand on strong grounds. Indeed, it is rightly the prerogative of the Malaysian tax authorities to prescribe the tax benefits – magnitute (percentage of earnings) and form (rebate or deduction) – which need not bear any relationship with the zakat payment. Arguably, there seems to be a case in favor of enhancing the tax benefits (magnitude or form or both) to further incentivize zakat payments, since the current zakat collections fall far short of their potential.

References

Hj Musa Bin Othman (2013) Zakat and Tax Treatment, Paper Presented at National Business Zakat Symposium, October

Mohamed Abdul Wahab et al. (1995) “Malaysia: A Case Study of Zakah Management”, in elAshker and Sirajul Haq (eds). Institutional Framework of Zakah: Dimensions and Implications, Jeddah: Islamic Research and Training Institute, Islamic Development Bank.

Norita Mohd Nasir and Salleh Hassan (2005) “Zakat on Business in Malaysia: Issues and Current Treatment,” in Bala Shanmugam et al. (eds.), Issues in Islamic Accounting, Serdang, Malaysia: UPM Press, 2005), 165-78.

Zahri Hamat (2009) “Business Zakat Accounting and Taxation in Malaysia” Paper presented at Conference on Islamic Perspectives on Management and Finance, organised by School of Management, University of Leicester, United Kingdom, 2^nd-3rd July

Mohammed Obaidullah | October 02, 2014