Islamic Revenue vs. Modern

Islamic Revenue & Taxation vs. Modern Practices

By: Prof. Dr. Mohd. Ma’sum Billah masum2001@yahoo.com applied-islamicfinance@yahoo.com

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Introduction

A tax is a compulsory levy made by public authorities for which nothing is received directly in return. We have seen that the levy is partly used to provide public goods in return, but that its size is also determined by many other factors. Taxes are, therefore, transfers of money to the public sector, but they exclude loan transactions and direct payments for publicly produced goods and services. As for our 3rd assignment, we have chosen the topic “Comparison between Islamic Revenue & Taxation and the Modern Practices.

So we decided to discuss on the Islamic part first, then only we will explain on the modern practices of revenue and taxes and distinguish between these two. According to Chaudhry (1992), economists would consider a levy as ‘tax’ if it fulfills all these 3 basic conditions[1]:- a) it is compulsory payment b) there is no quid pro quo c) it is levied on all citizens. In an Islamic state where all the citizens are Muslims then zakat and khums would be construed as ‘tax’. However, where there are some non- Muslims minorities, the above conditions might not be fulfilled.

Only (a) and (b) would be applicable here. As far as the non-Muslims living in an Islamic state are concerned, they become citizens of an Islamic state through an agreement between themselves and the Islamic state. Taxes upon these non-Muslims shall be governed by the agreement that was mutually agreed upon between them and the Islamic state.

ISLAMIC TAXATION No system for social justice can work in this world without an effective mechanism for collection of taxes and redistribution of wealth for the good of the society. Islam is no exception. It is not a sin to become wealthy as a Muslim. It is not against Islamic laws to own, inherit and bequeath private property, industries, businesses and even paid servants. In parallel with that right, Islam imposes a duty on each Muslim, that is, the duty of paying taxes on all that one owns. There are two types of taxes in Islam which are zakat and khums.

Both zakat and khums are acts of obligatory worship. So there is one act of worship like salat, in which man dissociates himself from this world for a few moments and communicates with his Lord, then there is fasting, in which man abstains from food and drink, and then there are zakat and khums in which man parts with his hard-earned money. While salat is making sacrifice of time and dedication, zakat and khums are a sacrifice of wealth to please Allah. Zakat and khums take us away from selfishness and greed.

All wealth belongs to Allah. It is his rahmat that he bestows his bounties upon us. Now it is up to us to be grateful to him by paying these obligatory taxes. So we see that paying the religious tax is a devotion to Allah, it is ibadat, and it is obligatory. Not doing it will be a sin. It uplifts the human spirit because it gives the payer the joy of giving and he/she feels that his wealth is being used to build the society and help his less fortunate brothers. But he cannot become condescending towards the Muslim who is receiving that wealth, because it is being done through the State nobody knows whose money is going to whom.

Paying the religious tax are the duties which in addition to bringing him close to Allah, bring Muslim brothers close to each other. [2] THE NEED FOR TAXATION Taxation is one method of transferring resources from the private to the public sector. No system for social justice can work in this world without an effective mechanism for collection of taxes and redistribution of wealth for the good of the society. Islam is no exception. It is not a sin to become wealthy as a Muslim. It is not against Islamic laws to own, inherit and bequeath private property, industries, businesses and even paid servants.

In parallel with that right, Islam imposes a duty on each Muslim, that is, the duty of paying taxes on all that one owns. 2 TYPES OF ISLAMIC TAXATION:ZAKAT AND KHUMS ZAKAT Although there are arguments where some of the Islamic scholars are of the opinion that zakat should not be described as tax, but most of the Islamic scholars agreed that the term zakat brings the same meaning as Islamic tax.[3] As many economists would still consider zakat as tax, however be stressed here that zakat is more than just an ordinary tax.

Zakat is an obligation for Muslims to be paid once a year given the percentage of required amount to be paid by the zakat institution. It is derived from the wealthy people who possess minimum of property liable to payment of zakat. This obligation is given according to the need without a condition or return because Islam concerns about the right for the poor and needy person.[4] The wealth of people should not be in the hands of the rich instead there should be circulation to the needy to maintain the balances between these two groups.

Such practice is in line with the concept that the ownership of wealth is only belongs to Allah and people carry it as amanah. Moreover, Islam reminds its people to the need of purification and sanctification of wealth by the means of zakat. Zakat was deducted from the income and then taxation take place. This practice is an example deduction of income of individual adopted by Malaysian government in several years. Because majority of Malaysians is Muslim then to lessen the burden of taxation imposed by them, government deduct the payment of zakat before the taxation take place.

[pic] Of their wealth take alms, that so thou mightest purify and sanctify them; and pray on their behalf. Verily the prayers are a source of security for them: and Allah is One who heareth and knoweth.” Surah At-Taubah (verse 103) [pic] Of their wealth take alms, that so thou mightest purify and sanctify them; and pray on their behalf. Verily the prayers are a source of security for them: and Allah is One who heareth and knoweth.” Surah At-Taubah (verse 103)

Zakat is one of the major religious duties in Islam. It is obligatory charity that every Muslim should pay year around. Zakat literally means grow (in goodness) or increase, or purifying.[5] The vital importance of zakat is reflected in God’s law. "My mercy encompasses all things, but I will specify it for the righteous who give Zakat" (7:156). Zakat must be carefully calculated and given away on a regular basis whenever we receive any income. Government taxes should be deducted, but not other expenses such as debts, mortgages, and living expenses.

It is obligatory upon all Muslims to give 2.5% of wealth and assets each year (in excess of what is required) to the poor. The 2.5% here means that it’s a levy on most valuables and savings held for a full year if their total value is more than a basic minimum known as nisab. Zakat is distributed among 8 asnaf (categories) of people, namely: a) Fakir – One who has neither material possessions nor means of livelihood b) Miskin - One with insufficient means of livelihood to meet basic needs c) Amil – One who is appointed to collect zakat d) Muallaf – One who converts to Islam e) Riqab – One who wants to free himself from bondage or the shackles of slavery. f) Gharmin - One who is in debt (money borrowed to meet basic, halal expenditure) g) Fisabilillah – One who fights for the cause of Allah h) Ibnus Sabil - One who is stranded in journey "Zakat is for the poor, and the needy and those who are employed to administer and collect it, and the new converts, and for those who are in bondage, and in debt and service of the cause of Allah, and for the wayfarers, a duty ordained by Allah, and Allah is the All-Knowing, the Wise".

(At-Taubah-60) Zakat not only purifies the property of the contributor but also purifies his heart from selfishness and greed. It also purifies the heart of the recipient from envy and jealousy, from hatred and uneasiness and it fosters instead good-will and warm wishes for the contributors. Khums Khums literally means one-fifth or 20%. In Islamic legal terminology, it means one-fifth of certain items which a person acquires as wealth and which must be paid as an Islamic tax.[6] The Qur’an says: “Know that whatever of a thing you acquire, a fifth of it is for Allah, for the Messenger, for the near relative, and the orphans, the needy, and the wayfarer...” (8:41).

Khums is meant to tax savings and therefore is applied to net savings after deducting all legitimate expenses. Khums is obligatory on these following seven things:- a) Profit or gain from earning b) Minerals c) Treasure trove d) Amalgamation of halal wealth with haram e) Gems obtain from sea diving f) Spoils of war g) As commonly held, a land which a zimmi (a non-Muslim living under the protection of Islamic Government) purchases from a Muslim. Another source of other revenue are waqf (religious endownment), religious expiation, voluntary charity and the will.[7] The waqf played an important role in developing the Muslim community.

Ibn Qodamah said “ What is possible to be a waqf is what can be sold, be used while keeping it, and is an asset that can continue to exist like real estate, weapons, furniture,etc.The waqf is divided into : 1. Charitable waqf: endowments paid with the aim of all forms of charity. 2. Family waqf: the family descendants deserve a part of the income together with a charity association. Waqf endowments involve an asset existing for service not for investment and went to the construction and maintenance of the mosque, and to social care exemplified by paying the expenses of the poor and needy.

From the economic context, lands were reclaimed and cultivated to serve the purpose of waqf. Historical documentation assert the waqf helped in interviewing the coherence, strength and persistence of the Islamic society. Religious expiation refers to estimated penalty for a forbidden deed or not doing some duties. The oath expiation is a religiously estimated penalty for the violation of an oath. In the Islamic jurisprudence, there are four expiation, all contribute to supporting the needy, except for the expiation of killing by mistake.

1. The expiation of al-zihar, swearing the assimilation (of wife to mother). 2. The expiation of killing. 3. The expiation of sexual intercourse or deliberate eating during a day in Ramadhan. 4. The expiation of oath. The charity or alms should be of good nature due to the Quranic verse: 2:267 Alms are permissible to paid when the person has more than his subsitence and that of whom he is responsible to support. Contrary to zakat, it is preferable to pay the voluntary charity secretly. The other revenue to Islamic state is the will or al-wasiya that is a special pledged to be executed after the death.

An intention of someone to spend some of his wealth for charitable purpose adding to his good deed after his or her death.

MODERN TAXATION Taxes are imposition of compulsory levies on persons or other entities by governments. Taxes are levied in almost every country of the world, primarily to raise revenue for government expenditures, although they serve other purposes as well. According to Professor Bastable, “A tax is a compulsory contribution of the wealth of a person for the service of the public powers.”[8] The government is expected to use the contributions made by the individual for the benefit of all; that is, so as to advance the interests of all, regardless of who pays heaviest or who benefits most.

This idea was undoubtedly in Adam Smith’s mind when he laid down his first canon of taxation, which holds well today: “The subjects of every state ought to contribute toward the support of every state ought to contribute toward the support of the government as nearly as possible in proportion to their respective abilities.” [9] Unlike Islamic taxation, the modern taxation is classified into so many sub-taxes. In general, all income of companies and individuals is subject to income tax. Other taxes include real property gains tax, sales tax and service tax.

Sales tax and service tax apply to goods and services selected by the Minister of Finance. Now we will talk about primary types of taxation first which is income tax and it consists of individual income tax and corporation income tax. Tax can be categorized into two major types either it is direct or indirect. This split depends upon the current practices of assessment and collection of taxes. If the taxes is actually assessed on and collected from the individuals who are intended to bear it., it is known as direct tax namely personal income tax, corporate income tax, capital gains tax, inheritance tax and any future wealth tax.

A feature of direct taxes is that the amount of tax can be related to individual circumstances, for example, the taxpayer’s commitment or family size. All individuals are liable to tax on income accrued in, derived from or remitted to Malaysia. The rate of tax depends on the resident status of the individual which is determined by the duration of his stay in the country (as stipulated under Section 7 in the Income Tax Act 1967). However, indirect taxes include value added tax and excise duties. Sources of income which are liable to income tax are as follows: • Gains and profits from trade, profession and business • Salaries, remunerations, gains and profits from an employment • Dividends, interests or discounts • Rents, royalties or premiums • Pensions, annuities or other periodic payments • Other gains or profits of an income nature not mentioned above.

CORPORATE INCOME TAX A company, whether resident or not, is assessable on income accrued in or derived from Malaysia. Income derived from sources outside Malaysia and remitted by a resident company is not subject to tax, except in the case of banking and insurance business and sea and air transport undertakings. A company is considered a resident in Malaysia if the control and management of its affairs are exercised in Malaysia. Places of control and management are considered on the basis of where meetings of the Board of Directors are held.

A tax rate of 28% is applicable to both resident and non-resident companies. In the case of a company carrying on petroleum production, the applicable tax rate is 38%. Employment income- Gross income from employment includes wages, salary, and remuneration; leave pay, fees, commissions, bonuses, gratuities, perquisites or allowances arising from employment. An individual employed in Malaysia is subject to tax on income arising from Malaysia regardless of where the employment contract is signed or the remuneration is paid.

Self-employment and business income- All profits accruing in Malaysia and foreign source income received in Malaysia are subject to tax. Income from any business source is subject to tax. A business includes a profession, a vocation or trade, as well as any associated manufacture, venture or concern. Contract payments to non-resident contractors are subject to a total withholding tax of 20% (15% for tax payable by the non-resident contractor and 5% for tax payable by the contractor’s employees. Income derived in Malaysia by a non-resident public entertainer is subject to a final withholding tax at a rate of 15%.

Investment income- Interest paid by banks to resident individuals on deposits in excess of RM 100,000 is subject to a 5% final withholding tax. Other interest, dividends, royalties and rental income are aggregated with other income and taxed at the rates set forth in the tax rate schedule. Real property gains tax. Real property gains tax is levied on gains derived from the disposal of either real property situated in Malaysia or shares in closely controlled companies with substantial real property interests.

Properties held for two years or less are subject to a 30% gains tax. Properties held over 4 years are subject to a 5% tax. OTHER TAXES Social Security- Corporations with one or more employees earning up to RM 2,000 per month are required to insure their employees under an employment injuries scheme managed by the government Social Security Organization. Social security provides for medical and other benefits to be paid to workers and their dependents for job related injuries. Contributions to the Employment Injury Insurance Scheme are payable by employers only, at approximately 1.25% of wages.

Contributions to the Invalidity Pension Scheme amount to approximately 1% of wages and are shared equally by employer and employee. Sales Tax - Sales tax in Malaysia is a single-stage ad valorem imposed on all goods except those classified as exempt. Depending on the goods, they are taxed at 5%, 10% or 15%. All exports are exempt from sales tax. Service Tax Service tax- Service tax is a consumption tax levied on a prescribed value of goods or services provided. The rate of service tax is 5%. Prescribed establishments from which this tax is levied are: I) Hotels, nightclubs, health centers, public pubs.

II) Insurance companies and firms providing telecommunications or parking services. III) Restaurants, private clubs and advertising firms with a turnover of RM 500,000 and above. IV) Accounting, architectural, legal, surveying firms; private hospitals, estate agent firms, consulting firms, dentists and veterinary doctors with annual turnover of RM 300,000 and above. V) Forwarding agents, motor vehicle services and repair centers, security guards with annual turnover of RM 150,000 and above. Excise tax- Excise tax is imposed on a selected range of goods manufactured in Malaysia.

The rate of excise tax depends on the goods involved and varies from RM 0.02 per liter on soft drinks to 65% on automobiles. Other goods such as tobacco, sugar, and sugar confectionaries, beer and stout, toys and games are also subject to excise tax. Real estate tax- Real estate tax is payable by property owners. Taxes are imposed by state governments and local authorities and vary from state to state. The tax is levied as a percentage of either the capital value or the taxable value of the property.

DIFFERENCES BETWEEN ISLAMIC TAXATION AND MODERN TAXATION As zakat relates directly with the pillar of Islam, there exist some differences between the Zakat system and the modern practices. Some of the main comparisons are that Islamic taxation is a religious duty an act of worship, which is only applicable to Muslims.[10] Zakat is an obligatory duty that must be adhered to under all circumstances. Fundamentally, zakat is received from the rich and distributed to the poor for the purpose of wealth distribution while the modern taxation is a method of transferring resources from private to the public sector.

When man pays a worldly tax he considers it a burden. When a Muslim pays his religious tax he feels gratified that he fulfilled an obligation to Allah, exactly as he offers his salat, except that in this ibadat the society at large also benefits from the ibadat. The state is committed to support the poor and needy, who will remain through zakat. And if it is not enough, the contribution from the rich are required from the taxation to meet the subsistence from their wealth. Defining the tax base in derive the issues concerning the assesment and measurement of the taxable property and Islamic scholars placed considerable emphasis on that matter.

Abu Yusuf for example, stressed the need for proper surveying of the land and avoiding mixing up between barren and cultivated lands and in addition to that by Qudama is availabilitiy of water irrigation on land, quantity of produce and even, cost of transportation of produces.[11] Defining the tax rate need the proper survey to avoid unjust rates of taxation. In the Western literature, setting a proper schedule of tax rates is the second most important step in taxation. Furthermore, Abu Yusuf suggested that the ruler could reduce or increase the tax according to what the tax payers could bear.

Abu Yusuf and Qudama agreed with the need of differential taxation to reflect that efforts are duly rewarded. Thus, the relatively low rates of taxation on the land and its produce seem to have encouraged agricultural progress. Zakat is better than taxes in avoiding the evasion from payment, the zakat is better than taxes because the administrative measures of estimating and calculating the zakat value and evasion penalty are not different from those who followed on tax systems. However, zakat is more favorable than tax because it is accompanied with a fear of Allah which makes it more abundant.

Zakat is taken on the net wealth which can be more easily and accurately estimated then incomes which are probably can undergo various type of fraud especially in accountancy. Concerning fairness, zakat’s channels, nisab and percentage are unchangeable since they are according to Quran and Sunnah. Thus, this state gives the feeling of stability in religious duties. In turn, it is refraining from abuse or exploitation through other ways. Moreover, zakat fulfill the right of the poor in the state.

Under these conditions, society will be relieved from the centralization of taxes which are paid on those close to authority. Separating the zakat budget from that of the government will put an end to the problem of nonsegreration between rich and poor. Separation ensures that assistance reaches those who deserve it. The zakat method, taking from the rich and giving to the poor, will surely lead to just income distribution as contrary to what happens in the West.[12] Thus, it is observable that zakat is opposite to tax.

It realizes justice in taking and kindness in giving. As a result, political stability, economic growth and social solidarity are accomplished. ----------------------- [1] Chaudary, M.S. (1992), Taxation in Islam and Modern Taxes, Chapter 1, page 25.

[2] www.zpub.com [3] www.understanding-islam.com [4]Yousuf Kamal Muhammad, The Principles of the Islamic Economic System, Islamic Inc. Publishing & Distribution. [5] www.zpub.com [6] www.al-islam.org [7] Yousuf Kamal Muhammad, The Principles of Islamic Economic System. [8] Leypalan Kassipillai & Bala Shanmugam, Malaysian Taxation. [9] Dora Hancock, Taxation Policy & Practices, 1995/1996, Chaman Hall. [10]Zulkarnain bin Yusof, Penerokaan Negara Islam- Perbandingan Percukaian Moden dengan Islam, 1994, DBP.

[11] Ahamed Kameel Mydin Meera & Syed Nazmul Ahsan, Readings in Islamic Economic Thought, 1992, Longman Malaysia. [12] Yousuf Kamal Muhammad, The Principles of Islamic Economic Thought