In principle, trading in corporate shares is lawful. A person who purchases shares in a company is merely purchasing a part of a company. When that person sells his shares, he is selling a part of the company. The purpose of trade – whether it be in retail goods or in corporate shares – is to make a profit. This requires selling at a price higher than the purchase price, which is what the purchaser of the shares hopes to do.
A shareholder may also receive a share of the corporate profits commensurate with his ownership of the company in the form of dividends. All of this is lawful provided that the company’s essential business is lawful. A Muslim should not purchase shares in a brewery, for instance, or in an interest-based bank.
The Problem of Unlawful Corporate Earnings
The problem arises in the fact that the vast majority of companies in the world do not adhere to Islamic Law in their financial transactions. Some of a company’s investment portfolio may be in bonds or in other Islamically unlawful financial instruments. Some interest will be earned by the company unintentionally through its necessary banking transactions. Unless the company is Islamic (and certainly, Muslim investors should go out of their way to support and develop Islamic companies) these earnings will not be disposed of by the company itself. What this means for the Muslim investor is that for virtually every public company, a small percentage of corporate earnings will inevitably derive from unlawful sources, regardless of the company’s actual line of business.
What must a Muslim shareholder do about these earnings? The answer is that when the Muslim investor receives dividends, he must dispose of the percentage that equals the percentage of the company’s income which is unlawful.
Determining what this percentage is quite simple for the investor. It can easily be known from the company’s income statement.
For example, if the company has interest earnings equaling 5% of its total earnings and you receive an annual dividend from those earnings of $100,000, then you should give away $5000 to the poor or to public works.
This money must be given away with the express intention of ridding yourself of your share of the company’s unlawful earnings. The money must not be paid with the intention of giving in charity.
This is because the Prophet (peace be upon him) said: “Allah is pure and accepts nothing but what is pure.” [Sahîh Muslim
A Muslim who rids himself of unlawful wealth can still look forward to a reward from Allah for doing so, since he is doing so out of obedience to Allah. However, it will not be for charitable spending.
Interest Paid by the Company is Not Corporate Income
The Prophet (peace be upon him) said: “Allah curses the one who consumes interest, the one who pays it, the one who draws up the contract, and the witnesses to the contract, then he said they are same (in sinfulness) ” [Sahîh Muslim
This hadîth shows us that it is unlawful in Islamic Law to receive interest and to pay it.
However, there is an extremely important distinction between paying interest and receiving it. This distinction is that unlawful wealth is only acquired by the party that receives interest. The one who pays the interest shares equally in the sin of the transaction, but he is not stuck with unlawful wealth as a consequence of it.
When a company borrows money on interest, it is not receiving
unlawful income, though it is engaging in an unlawful transaction.
The borrower who takes out an interest loan does not receive any unlawful money, since receiving a loan in and of itself is lawful. What is unlawful and sinful is his agreeing to the unlawful condition of paying back the loan with interest.
When the company pays the interest, the recipient of the interest receives unlawful money. The parties who pay the interest (the decision-makers in the company in this case) share in the sin for it, but they do not bring unlawful income to the company as a consequence of their decision.
This means that a Muslim shareholder does not have anything to deduct from his dividends due to the company borrowing money on interest. He only needs to make deductions from his dividends based on the company’s interest earnings.
[Of course, if a Muslim shareholder owns enough shares in a company to get him onto the company’s board of directors, he will be responsible to vote in matters of corporate policy in accordance with Islamic teachings. If he votes contrary to Islamic teachings, he shares in the sin for adopting that unlawful decision. If he promotes lawful policies and votes according to Islamic teachings but is overridden by the other directors, then the sin is on them and not on him.]
These Earnings Do Not Affect Profits from the Sale of the Shares
The requirement of deducting the percentage of the company’s unlawful earnings applies only to dividends earned by the shareholder. It does not apply to the profits received from the shareholder selling his shares on the stock market.
The increase in the price of the shares is directly related to the market value of the company. It is not directly related to the company’s income. Many factors come into play regarding the company’s value, even some things like market volatility that are entirely independent of the company’s performance.
Your ownership in the company is represented by the shares that you bought and that you would hope to resell at a higher price. This is no different than buying an item and reselling it later. You therefore have nothing to deduct from your profits.
Dividends, by contrast, are paid from the company’s income and your share of the company’s income is based on the dividends per share that you receive. Therefore, you should cleanse your share of the company’s income of its percentage of any of the company’s unlawful earnings. You do this by giving away that percentage in charity with the intention of ridding yourself of unlawful wealth.
And Allah knows best.