Dividend purification of Shariah compliant equities is the process of purifying the income earned from Shariah compliant equity investments to the extent it had impure income.
What is Dividend Purification?
Companies having less than 5% of their revenues coming from prohibited business activities are said to have passed the Sector-based Screens. But the proportion of dividends attributed to revenue generated from such non-permissible business activities and interest income will have to be purified.
Let’s demonstrate this with an example:
A company sells cars. It also has a finance division which gives car finance. The income break up of this company is as follows:
A. Revenue from sales of cars : $98
B. Revenue from Interest earned from car financing activity: $2
TOTAL REVENUE : $100
Let’s analyse this revenue:
A.Revenue from sales of cars : $98 (98%) – Shariah Compliant.
B.Revenue from Interest earned from car financing activity: $2 (2%) – Shariah NOT Compliant
TOTAL REVENUE : $100
Since the Shariah NOT compliant revenue is less than the 5% threshold, this company will be deemed Shariah compliant (assuming it passes the financial ratios).
When a Shariah sensitive investor invests in this company and gets a dividend from this company, such dividends will have to be purified to the extent of 2% of the dividends received. This is called dividend purification.
So, when Investments in Shariah compliant securities receive dividends, a purification process takes place as demonstrated above.
Any proportion of income received from activities that are non-compliant as per Shariah principles may be paid to Charity and thereby ‘purified’.
What is the need to purify when I am investing in a ‘Shariah compliant’ company?
There are many situations in which corporations will generate, through an activity or activities unrelated to the primary business of the company, revenue that is haram. In such instances, when clearly unlawful revenue is combined with the lawful, the relevance and significance of such revenues must be subjected to examination.
Many companies that promote development through the provision of beneficial and humane services are based in countries where there are no laws that prohibit the giving and taking of Interest. Nearly all companies in such countries routinely place excess corporate funds in interest-bearing deposits, certificates of deposit (CDs), bonds, bills, notes and other interest-bearing instruments. Many companies also invest in the debt of other companies. In these ways, income from interest will also form a part of the total earnings of companies that otherwise conform to Shariah principles.
Many eminent Shariah scholars, including members of the OIC Fiqh Academy in Jeddah, are of the opinion that an Islamic investor may own shares of companies or investment vehicles whose primary business is consistent with Shariah precepts, even when a small part of their revenues include, within certain limits, haram elements including interest income.
Islamic investors must use all available and necessary means to:
1. Estimate the extent of the haram elements
2. Cleanse their holdings.
This view forms the basis of dividend purification. To know more details about Shariah guidelines of halal investing, read the shariah screening criteria used by Islamicly.
So what do I purify? Capital gains or Dividends?
Returns from investments in listed stocks can be classified into two types:
1. Capital gains - need not be purified
This happens once the shares are bought at a price and sold later at a higher price. The positive difference is the capital gain.
As per Shariah rulings by Shariah scholars, any capital gains or trading gains from Shariah compliant equities need not be purified.
2. Dividend received – needs to be purified
A portion of profits earned by the company is distributed among shareholders which is called dividends.
The dividend received by the shareholder needs to be purified as per the guidelines of Shariah principles laid down by the Shariah scholars.
A question in your mind would be arising that why purification on capital gains is not applicable while purification on income received in the form of dividends has to be purified?
The argument by the Shariah Scholars on this point is that the dividends distributed by the company are out of their profits and earned from direct/indirect operations of the company and may include interest income and income from prohibited activities. Hence, a part of dividends distributed to the shareholders comprises of that impure income.
For example, if a company parks some of its surplus cash with conventional banks and earns some interest on these deposits, such interest income also becomes a part of the company’s earnings that is paid out to the shareholders. Such income will eventually be a part of the dividend that you have received from the company and hence needs to be purified.
On the contrary, the income received from capital appreciation during the purchase and sale of shares is not linked to the interest income or any prohibited income that the company is earning through business operations. Thus, the dividend income needs to be purified and the same needs to be given to any charity of the investor’s choice.
How is dividend purification ratio calculated? What goes into the component of dividends to be purified?
The dividend purification ratio is calculated as:
Dividend Purification Ratio = Total Non-Permissible Revenue/Total Revenue
While calculating the Dividend Purification Ratio, the below items are considered:
1. Interest income received from deposit of cash with banks. 2. Interest income received from term deposits. 3. Interest income received from bonds and debentures. 4. Interest Income received from Money Market instruments. 5. Any other Interest income received. 6. Non-permissible income from Investments (Equity, derivatives, mutual funds, etc.) 7. Income coming from Sales of Alcohol, if any. 8. Income coming from Conventional Financial Services, if any. 9. Income coming from Financial Lease. 10. Non-Permissible Income coming from Sales of Pork, if any. 11. Non-Permissible Income coming from Gambling, if any. 12. Non-Permissible Income coming from Pornography, if any. 13. Non-Permissible Income coming from Sales of Tobacco, if any. 14. Any other Non-Permissible Income Identified.
Non-permissible revenue thus includes all forms of revenue or income that is considered non-permissible from a Shariah perspective (e.g. alcohol sales, gambling revenues, etc.…) and includes any income generated from interests and non-compliant investments. Hence, to maintain Shariah compliance of your portfolio, Dividend Purification has to be carried out.
Islamicly app makes this complicated calculation easy for you!
Find out the purification process works on Islamicly:
Step 1: Go to the home page of your Islamicly app and search your stock – let us say “Saudi Arabian Refineries”
Click on the company name and you will find the four options: Flip Back, View, Purify and add to Portfolio
Step 3: You can either click on “purify” or click on “view” to see the stock details page and then click on “check dividend to be purified”. In both the scenarios, you will find a box at the bottom with asking details of “select date” and “Amount of dividends”.
You need to fill the date and the amount earned as dividend in the box.
Step 5: Once you fill the date and amount (dividend amount received) in the box, you will get the purification amount instantly as shown in the below image as SAR 1 for Saudi Arabian Refineries that you need to purify by give it to any charity. The pie chart shows the same information graphically, i.e. the green part is pure income, while the white part has to be purified.
Isn’t Shariah purification of dividends easy with Islamicly?
You can also see the whole process on how to purify your stocks in this video as well. Watch it here
Please follow the below links to Download Islamicly App.