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ZAKAT The Islamic Taxation

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1432/ 2011 ZAKAT The Islamic Taxation A Gateway to Reform Global Economy [Type the document subtitle] Cmpaq Muhammad S. Hafez ZAKAT the Islamic Taxation In collaboration with Irish Islamic Chamber of Commerce
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1432/ 2011 ZAKAT The Islamic Taxation A Gateway to Reform Global Economy [Type the document subtitle] Cmpaq Muhammad S. Hafez ZAKAT the Islamic Taxation In collaboration with Irish Islamic Chamber of Commerce Muhammad S. Hafez 1432/2011 2 In the name of ALLAH the most Gracious most Merciful Peace be upon his Messenger Muhammad ZAKAT the Islamic Taxation List of Abbreviations Preface Table of Contents Introduction Introduction History of Taxation Development of Taxation Systems Introduction to ZAKAT Introduction to Fiscal Policy in Modern Economies 3 ZAKAT vs. Taxation ZAKAT and Modern Taxation Scientific Miracle in ZAKAT vs. Taxation ZAKAT Structure Taxation Structure Taxation Deficiencies Comparing to ZAKAT ZAKAT Accountancy & Auditing ZAKAT Accountancy & Auditing Principles Personal ZAKAT Corporation ZAKAT Agricultural ZAKAT ZAKAT on Livestock ZAKAT on Treasures (Rikaz) Practical Examples 4 ZAKAT and Globalization Importance of Global ZAKAT International Taxation Double ZAKAT vs. Double Taxation ZAKAT and Modern Economies Implementing ZAKAT in Modern Economies Implementation Plan Benefits Review State Revenue and ZAKAT (Secondary Sources) Permitted Taxes and Charges in Islam Conclusion 5 List of Abbreviations GDP VAT ROI MCF R&D HR PR SME Gross Domestic Product Value Added Tax Return On Investment Marginal Cost of Funds Research & Development Human Resources Public Relations Small Medium Enterprises 6 About the author Muhammad Hafez is currently the chairman of the Irish Islamic Chamber of Commerce; previously he has been the secretary director of the Ireland Gulf Business Association. He was the educational manager of the Institute of International Trade of Ireland IITI which is the research and educational division of the Irish Exporters Association IEA. He accomplished the export Ireland survey for 2008 which is very important survey for the Irish Economy and adopted by many states departments to set future strategies. Also, he partially contributed to the NATTS (North Atlantic Trade and Transport Study), which focus on feasibility of launching new direct shipping routes between Island of Ireland and North America. Other Accomplishments: The Strategic Review Report for the Gulf Region presented to IDA Ireland. Articles in Irish Muslim Magazine about the Islamic Economy & Globalization Muhammad Hafez holds Master of Science (MSc) in International Business Management awarded by NTU (Nottingham Trent University, United Kingdom) and HETAC (Higher Education Training Award Council, Ireland). 7 Preface Presenting the first edition of this book, ZAKAT the Islamic Taxation to be the first academic and learning book presented to understand the Islamic Taxation. Despite the importance of tax in economies, no doubt it seems to be unjust and unfair in many of its aspects mainly in the collection and deduction methodology and basis of assessment. However the importance of new ideologies and system to reform capitalism has emerged in the recent financial crises, obviously the legislations of Islam in the economic field tend to be an ideal alternative to reform some of the typical capitalism rules and codes. Hence presenting ZAKAT the Islamic Taxation to modern societies and economies it may not be an easy and simple step but considering the fact that liberty and practicality of modern economies may gives a significant advantage to any beneficial and useful legislations and applications if the feasibility of such legislations is proved. In the first chapter, this book gives an introduction to concept of taxation and the early development and implementation of tax in different civilization and how the modern taxation systems applied and adopted in the modern economies have developed overtime. In contrast this chapter also introduce the concept of ZAKAT in simple and understandable way with its importance in the Islamic economy. Finally in this chapter the fiscal policies and its overlap with taxation system are demonstrated to create clear view about the states sources of fund. Moving to the second chapter to demonstrate the major aspects of both ZAKAT and current taxation systems with an in depth analysis of the structure and methodology of both ZAKAT and tax. Also; detailed demonstration of ZAKAT advantages over the predominant taxation system in different features such as: fairness, revenue generation, simplicity and the feasibility of implementation. 8 The third chapter presents ZAKAT to accountant and auditing parties with clear structure that conforms to current and the contemporary accountancy standards and criteria. However different diversified practical examples have been used in this chapter to demonstrate the accurate accountancy of ZAKAT with using professional structure that is already accountants and auditors can understand, perceive and deal with. The impact of globalization and its implications on international taxation process reviewed in chapter four, the importance of this chapter that it nindicates to possible issues may arise when ZAKAT implemented on global scale and the overlap with current taxation. Finally the fifth chapter is bearing significant value as it gives proper and practical methodology to assist modern economies to adopt and implement ZAKAT without causing clash or conflict with current taxation system and in realistic and practical strategies to guarantee flow of revenue to state exchequer to meet current and future expenditures. These strategies designed to accommodate different cases and different circumstances while the chapter also reviews the forecasted benefits of ZAKAT system comparing to tax. The aim of this book is to introduce ZAKAT as a methodology to reform global economy, and to encourage governments, universities, auditing and accounting firms to adopt the Islamic Taxation system in order to gain maximum benefits and prevent the distortionary cost caused by conventional Taxation system. Muhammad S. Hafez 9 Introduction Introduction History of Taxation Development of Taxation Systems Introduction to ZAKAT Introduction to Fiscal Policies in Modern Economies Introduction The continuing financial crises which hit the entire global economy especially in North America and Western Europe forcing the governments to adopt variety of solutions to get out of the recession and long term deficit. Public debts growth is critical dilemma to western countries and threatening the future of economic stability and even the sovereignty of those economies, the public debts crises became a phenomenon as governments cross worlds in general fail to securer revenue to meet expenditures, hence governments involved in borrowing which subsequently increased public debts, and then created financial crisis and absolute fiasco. However governments attempting to reduce expenditures and increase taxes in order to generate more money and reduce the current and fixed expenditures in the budget, but the dilemma with such options that tax increment and expenditure reduction are another causative of economic shrink which will lower government revenue and lead to a vicious circle associated with extra pressure on the budget such as jobs cuts, low consumer spending, low saving, less investments,...etc. Therefore these elements will affect the level of tax collected, and increase public expenditures on recovery plans; furthermore this can be beginning of a another new recession. 10 Unfortunately none of the economists has indicated to role of the predominant taxation system in these crises due to many reasons, first one that until today there is no clear and practical alternative for governments to replace the current taxation system to generate constant revenue and to be perceived as a fair new tax system, the second reason that most of changes and modifications occurred in the current taxation systems in the modern economies are applied on rate of taxes rather than in the core structure and methodology. Therefore it is the time to bring the concept of ZAKAT in a structure that scientifically proved its merit and to be adopted as a new taxation methodology to reform current fiscal systems and present ZAKAT out of it religious framework which emphasized on the spiritual dimension and its role as a pillar among other five pillars of Islam. History of Taxation The concept of tax is very old, simply and to protect themselves ancient societies used to bear the burdens and charges of security, ruler imposed levy on citizen to fund the army to deter foreign enemies, hence different classes where subject to different levies mainly farmers and other classes like workers and other professionals. However these charges used to be assessed on arbitrary bases and even in different scales based on the need of ruler or the circumstances of the society. Until today the taxation system has never been in one fixed rate and structure and it always subject to constant adaptation to accommodate the fiscal policy requirements, except Islam which introduced one fare, fixed, simple and feasible taxation system called ZAKAT. In the Middle East, where the concept of taxation developed for first time, rulers collected the money from taxation to pay for the cost needed in building public artifacts like monuments and temples. Some of the money was used to finance warfare. Taxation originated there and was spread around the world. Taxation usually stopped during peaceful times. When another war breaks out, tax usually brought back again to fund war. 11 Ancient Taxation Policies: Tax history for more than 2,500 years has focused on two significant issues: who pays and what is taxed. For most of human history, taxes were paid by the poor peasants, slaves, or conquered peoples to support the government and the wealthy classes, the keeping of accounts was the main purpose for developing a system of writing and organizing tax payment. The law codes of Hammurabi, made famous in the Old Testament, one of these codes deals with the penalties for dodging to avoid paying taxes as well as the punishments of citizens trying to avoid the obligatory government service. This form of tax could take the form of hard labor on civil projects such as digging a canal or, at worst, military service. Emerging of taxation played role for creation of perhaps one of the oldest professions, making getting out of paying your tax which is world s third oldest profession. Tax shelters have been documented as early as the fourth dynasty in the Old Kingdom of Egypt ( B.C.E). The staff of temples, appeared to have been successful in gaining an exemption from paying taxes or compulsory labor. Egypt: During the various reins of the Egyptian Pharaohs tax collectors were known as scribes. The auditing function took place when tax imposed on cooking oil. To insure that citizens were not avoiding the cooking oil tax scribes would audit households to insure that appropriate amounts of cooking oil were consumed. Greece: In times of war the Athenians imposed a tax referred to as eisphora. No one was exempt from the taxes, which levied only in extraordinary cases to pay for special wartime expenditures. The Greeks are one of the few societies that were able to rescind the tax once the emergency status is over. When additional resources were gained by the war effort the resources were used to refund the tax. Roman Empire: The earliest forms of taxes imposed in Rome were tariffs and customs duties imposed on importations. Caesar Augustus was considered by many to be the most brilliant tax strategist of the Roman Empire. During his reign as First Citizen the publicani were virtually eliminated as tax collectors for the central government. During this period cities were given the responsibility for collecting taxes. Caesar Augustus instituted an inheritance tax to provide retirement funds for the 12 military. The tax was 5 percent on all inheritances except gifts to children and spouses. The English and Dutch referred to the inheritance tax of Augustus in developing their own inheritance taxes. Development of Taxation Systems In England, an attempt was made in 1404 to collect real taxes based on the people's wages. However, the public refused the proposal and the method was repealed. The first development of modern income tax occurred on 1719 in England. This tax was used to finance warfare against France during the Napoleonic Wars. This helped Britain and its other European allies win in After the war, the people again demanded its repeal and so it was in The tax records were again burned for the second time Other European countries like Germany, the Netherlands, Sweden, Switzerland and others adopted the method and thus it was spread. Therefore the adoption of the conventional tax system in the modern countries was mainly inherited system, and this taxation methodology was not initially developed through economic researches to fund the governments. In the U.S. a direct tax was placed on citizens after drafting the Constitution in The Supreme Court supported the government's first income tax during the Civil War in The Union government found financial burdens for warfare, just by using taxes based on tariffs so the government used income tax for emergency reasons. It was then renewed in 1864 and was achieving a good rate since it imposed heavier tax burdens on people with a larger income than most. After the war it was repealed in Under the earliest taxing schemes an income tax was imposed on the wealthy, office holders, and the clergy. A tax on movable property was imposed on merchants. The poor paid little or no taxes. In 1798 Congress enacted the Federal Property Tax to pay for the expansion of the Army and Navy in the event of possible war with France. The first income tax suggested in the United States was during the War of The tax was based on the British Tax Act of 1798 and applied progressive rates to income. The rates were 8% on income above 60 and 10 percent on income above 200. The tax was developed in 1814 The Tax Act of 1861 proposed that there shall be levied, collected, and paid, upon annual income of every person residing in the U.S. whether derived from any kind of property, or from any professional trade, employment, or vocation carried on in the United States or elsewhere, or from any source whatever. The 1861 Tax Act was passed but never put in force. Rates under the Act were 3% on income above $800 and 5% on income of individuals living outside the U.S. The Tax Act of 1862 was passed and signed by President Lincoln July The rates were 3% on income above $600 and 5% on income above $10,000. The rent or rental value of home could be deducted from income in determining the tax liability. Although the people cheerfully accepted the tax, compliance was not high. Figures released after the Civil War in USA indicated that 276,661 people actually filed tax returns in 1870 (the year of the highest returns filed) when the country's population was approximately 38 million. Taxes rates for the Tax Act of 1864 were 5% for income between $600 and $5000; 7.5% for income between $5001 and $10,000; 10% on income above $10,000. The deduction for rent or rental value was limited to $200. A deduction for repairs was allowed. 14 In more modern times, as governments became more adept at collecting taxes, the revenue accrued increased dramatically. Unfortunately for the taxpayer, so did expenditure. As wars became more common and more expensive, the tax burden increased. Studies have confirmed that the tax burden of the eighteenth and early nineteenth centuries increased by 85% in England. No surprise then that this period gave rise to the first calls for what we know as Progressive Taxation. Adam Smith, in Wealth of Nations, wrote It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion. Introduction to ZAKAT Not only introducing a unique and solid tax system but even prohibit any other kinds or methodologies of tax, this prohibition seem to be an emphasis on the importance and solidity of Islamic taxation system ZAKAT. One of the most important principles of Islam is that all things belong to ALLAH, and that wealth is therefore held by human beings in trust. Imposing taxes other than ZAKAT are extremely prohibited in Islam, unless if these taxes are generated in a voluntary basis such donations (Alms). ZAKAT is the amount of money that every adult, and financially able Muslim, male and female, has to pay to support specific categories people, and one of the five pillars in Islam. The breakthrough and the unprecedented advantage presented in ZAKAT that the rate and structure is fixed, any modifications on ZAKAT is totally unlawful. This feature gives an indication that such system must be unique and adequate for government fiscal policies. All of earned incomes or profits are exempted from any levy in ZAKAT unless if such income and profit converted from income or profit into net worth, and this happened if this money held for approximately one year. 15 However detailed demonstrations are presented in chapter two and three regarding ZAKAT accountancy. The other important feature of ZAKAT that it is really considered as a distribution of wealth in the society because real rich or wealthy people pay or at least they pay more. In European history, the Muslim administrations of Spain (Al Andalus) collected ZAKAT from large land owners in the form of land, and redistributed this land directly amongst the poor farmers. This helped greatly to reduce rural poverty and increase agriculture. It resulted in a rapid growth of the population and it made Islam the faith of choice for many of Spain's poor. Likely, this social and economic success of ZAKAT was perceived as a threat to Europe's feudal and papal economy, which was heavily based on exploiting land monopolies, and much less successful in creating wealth. Also in Persia's early Islamic history, ZAKAT on land property helped to achieve great social and economic progress. As a mandatory requirement in Islamic faith, every year 2.5% of one's wealth (Net Worth) is given away to Islamic state if available, except for Agricultural and Livestock ZAKAT rates and collection are different. ZAKAT is different from sadaqah (plural, sadaqat). Where ZAKAT is mandatory, sadaqat (Alms) are voluntary. In case of war where the expenditures of the Islamic state rise significantly, state is not allowed to increase ZAKAT rate, but state can encourage people to pay more sadaqat (alms) to support the Islamic state. 16 Introduction to Fiscal Policies in Modern Economies In economic science, the fiscal policy is the government policies on expenditure and revenue collection to influence the economy. These policies affect tax rates, interest rates and government spending, in an effort to control the economy. The prime two main instruments of fiscal policy are government expenditure and taxation. Fiscal policy describes two governmental actions by the government, the first is taxation. By levying taxes the government receives revenue from the people. The second action is government spending. This may take the form of wages to government employees, social security benefits, infrastructure, or defense. Obviously both actions are interlinked together. The government has control over both taxes and government spending. When the governments use fiscal policy to increase the amount of money available to the populace, governments lower taxes and increase government spending. When the governments use fiscal policy to decrease the amount of money available to the populace, governments increase taxes and lower government spending. In modern economies, borrowing is an another important aspect of fiscal policy, simply government that wants to provide goods and services to its people while not having the immediate tax revenue to fund that expenditure can turn to the capi
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