Sharia rules: Is purification necessary?

By: Hong Kok Cheong

When profits in an Islamic equity fund are earned through dividends, a corresponding proportion of interest earned by the company must be given in charity. This is known as purification.

Is purification necessary when profits are made through capital gains? Some scholars say yes, because the market price of the share may reflect some interest included in the company’s assets.

Other scholars believe purification is not required if the share is sold, even if there is a capital gain, because no concrete amount can be determined for the interest. If the halal share requirements are observed, then most of the company’s assets are halal, and only a negligible proportion of them is created by interest income. Therefore, the bulk of the share price is halal assets, not the negligible interest.

When no dividend is received from a redeemed unit of a fund, no amount of purification is deducted from its price, even though the price of the unit may have increased with the appreciation in the prices of the shares held by the fund.

When a unit is redeemed after some dividends are received and the amount of purification has been deducted (reducing the net asset value per unit), the price is less than the first scenario.

If purification is carried out on dividend and capital gains, the deduction amounts of purification are equal for all unit holders. It is therefore more equitable for all unit holders to carry out purification on the capital gains and can be carried out on an average percentage of the interest earned by the companies included in the portfolio.

How the fund is managed must be determined before its launch and disclosed in its prospectus. The managers of the fund act as mudaribs for the subscriber and receive either a percentage of the annual profit, a lump sum, or monthly/annual fee (which can be based on a percentage of the fund’s net asset value).

With all this in mind, a company’s front-, middle-, and back-office systems must have:

  •       classification tables that dissect the Sharia and non-Sharia funds that can be traded
  •       a reporting system with the Sharia Islamic terms to reflect the purity of investments
  •       The Islamic Tax (ZAKAT) element of 2.5% that’s imposed on the profit for every Sharia transaction

No

Conventional Term Islamic Term
1 Borrower

/

Customer
2 Bridging

/

Bridging finance-i
3 General Investment Account

/

General Investment Account-i
4 Insurance Premium

/

Takaful Premium
5 Interest

/

Profit
6 Interest In Suspense

/

Profit In Suspense
7 Interest Income

/

Profit Income
8 Islamic Accepted Bills

/

Accepted Bills-i
9 Lending

/

Financing
10 Loan

/

Financing
11 Non-Performing Loan

/

Non-Performing Financing
12 Overdraft

/

Cash line Facility-i
13 Penalty Charges

/

Compensation Charges
14 Provision

/

Allowance
15 Revolving Credit

/

Revolving Credit Facility-i
16 Revolving Facility

/

Revolving Credit Facility-i
17 Special Housing

/

House financing-i
18 Specific Provision

/

Specific Allowance

19

Syndicated Financing

/

Syndicated financing-i

Conclusion

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