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It is really amazing to note that the zakath system, which came into effect 14 centuries ago, is still compatible with the modern tax system
Zakath is the direct tax that Islam has imposed upon every Muslim who has annual net wealth exceeding a threshold. Income tax is also a direct tax that the Government imposes on every person who has an annual net income exceeding a threshold.
It is clearly evident from the definition that both zakath and tax have similarities as well as differences. The purpose of this study is to give the readers a comparative understanding of zakath and the tax system as the Muslims traditionally pay their zakath during this month of Ramazan, which is the ninth month of the Muslim (lunar/Hijri) calendar, which is 354 days while the Gregorian calendar is 365 days.
It is underlined here that the laws and practices were taken from the Sri Lankan context in authoring this article.
Religious and statutory duty
Zakath is a religious duty imposed by the holy Quran upon Muslims, while tax is a statutory duty imposed by the Parliament upon its residents and non-resident persons living in its jurisdiction.
Accordingly, zakath is a self-assessment payment; namely, every Muslim who has, at the end of the lunar year, net wealth exceeding the threshold pays (individually or collectively) zakath on his own assessment and calculation. The tax has a hybrid of self-assessment and an official assessment system. Generally, taxpayers pay their taxes on a self-assessment basis. In the event of failure by a taxpayer to pay the tax on a self-assessment basis, the default (official) assessment would be issued to such a person.
Hence, zakath is paid by a Muslim (male and female) in accordance with his consciousness, and he is accountable only to his Omnipotent. So the room for the evasion and avoidance of payment of zakath is minimal, unless his consciousness is corrupted. The tax is mostly paid by a person only for the law. As a result, a human being inherently looks for loopholes and ways for the evasion and avoidance of the due tax.
Preconditions for zakath liability
There are five basic conditions one should have fulfilled so that he would become liable to pay zakath on his wealth. These features are unique to zakath and are not available in the tax system.
Each condition needs a detailed explanation. For the want of space, it is very briefly explained.
Full ownership of the wealth: This means that a person who has such wealth should have acquired it legally and morally. For illustration, if he had acquired it illegally (Non-Halal) such as by robbery, theft, or deception, or by illegally obtained money, such as by bribery and interest, he or she would have no full ownership of that property. So he is not required to pay zakath for that “haram” wealth, and he cannot launder that wealth by paying zakath for it.
As for the income tax, the way of earning an income is immaterial in the case of charging tax on it. Even if the income was earned through smuggling or by way of soliciting bribes, the Inland Revenue Department would assign him a TIN and impose the tax on him.
Attainment of the minimum value (threshold) of the wealth: Generally, the minimum value of the wealth (Nisab) is calculated on the equivalent value of the pure gold of 85 grams, which is currently valued at Rs. 2 million. Once the threshold is reached, he is liable to pay zakath on the entire value of the wealth, including the threshold, while income tax is paid on the income in excess of the threshold.
Wealth should be an investment asset. This means that the wealth should have the potential to grow and produce income. Accordingly, a person who has cash in a business or in a safe is liable to zakath as it has the natural potential to grow and earn income.
However, domestic and personal assets such as a living house and jewellery or business fixed assets such as property, plant, and equipment (PP and E) are not liable to zakath as they do not have the potential to produce income while used for personal or business purposes.
The wealth should be in excess of his essential needs and debts. Zakath is not payable by a person on his wealth, even if its value exceeds the minimum threshold, provided his and his dependents’ basic needs, such as food, shelter, education, health, and a vehicle, are not satisfactorily fulfilled. Hence, the excess wealth after deduction of the expenditures incurred and of the current liabilities taken for meeting those essential needs is liable to pay zakath on it.
As for the income tax, no such personal and domestic expenditures are allowed for the deduction, as the income tax is imposed on the excess of the threshold of Rs. 1.2 million in the case of an individual.
The wealth should be in his possession for not less than one year. Liability to pay zakath commences after the completion of one lunar year from the day the value of the wealth reaches its threshold (Nisab).
Accordingly, any Muslim who possesses wealth and has fulfilled the said five preconditions is required to pay zakath each year on a self-assessment basis, at a rate of 2.5%.
However, the tax is paid on the income earned during a year, whether it was with him throughout the year or not, at a relatively higher rate.
Zakath is paid annually, and tax is paid once and for all
Generally, zakath and tax are paid annually. Zakath is payable each year repeatedly on the wealth one possesses, irrespective of the fact that it was subjected to zakath during the previous years. As for the tax, it is paid on the income once and for all. It becomes white, and it does not attract the tax again.
Since zakath is paid annually on the same wealth that was subjected to zakath in previous years, it is taxed at a rate of 2.5%, and the threshold is also calculated after deducting all the essential expenditures for the basic needs of the entire household.
Since the tax is charged on the income once and for all, the tax rate is relatively higher than the zakath rate. It is to be underlined here that even though the income is subjected to tax once and for all, any additional income derived from the investment of that income will become liable to tax.
Zakath is wealth-based, and tax is income-based.
Zakath is generally paid on the basis of annual net wealth, while tax is generally paid on the basis of annual net income.
The fundamental difference between the zakath and tax systems is that zakath is calculated on the basis of the net wealth a Muslim possesses throughout the year. Tax is charged on the basis of the net income a person earns during the year.
Net wealth and net income
Net wealth means current assets such as cash at hand and banks, closing trading stocks, and debts and receivables reduced by short-term liabilities. With this net wealth, any extravagant (non-Halal) expenditures he made and the cost of any asset he purchased for the purpose of saving or trading will be added.
Income tax is paid on the net income, which is calculated after deducting all the expenses incurred in the production thereof, excluding the capital expenses.
Threshold (Nisab) for zakath and income tax
As stated earlier, the threshold for liability of zakath on the net wealth is calculated on the basis of the value of 85 grams of pure (24 karat) gold, which is estimated at Rs. 2 million. A Muslim possessing wealth in excess of the threshold, after having fulfilled all the preconditions for the liability of zakath, is required to pay zakath for such wealth.
Similarly, an entity (partnership or company) is required to pay zakath, just as an individual calculates and pays zakath. Any zakath paid by such an entity is claimable by the partner or the shareholder either as credit against his total zakath liability or as the exemption or exclusion of the wealth attributable to such zakath from the calculation of total net wealth. As for the income tax, thresholds of Rs. 1.2 million and Rs. 1 million are allowed, respectively, for individuals and partnerships. There is no such threshold for any other person or entity. Any amount of net income derived by such an entity is subject to tax.
Disbursement of zakath and taxes
It is evident that during the last several decades, billions of taxes were collected, and the country was in a gradual recession and decline. It is widely alleged that hardly earned tax money was not properly disbursed and spent; in contrast, it was misused and wasted. The inevitable result is the bankruptcy of the country that we are witnessing today.
As for zakath, much more focused attention is paid to the disbursement of zakath than to its collection, as the earlier one is more susceptible to corruption than the latter one. Specific divine guidelines have been there from the very inception as to whom and for what the disbursement of zakath should be made. Hence, no one has the authority to deviate from those principal guidelines.
Even though the Constitution has laid down checks and balances through Articles 148 and 149 to streamline the tax system, corruption and malpractice have crept in, and regrettably, they have eroded the confidence of the public.
It is really amazing to note that the zakath system, which came into effect 14 centuries ago, is still compatible with the modern tax system. This fact is further confirmed by the recommendation of the IMF given to the Government to introduce the wealth tax system, which is the core backbone of zakath, with effect from January 2025.
(The writer is a retired Deputy Commissioner General, Inland Revenue Department and could be reached via email at [email protected].)
