Purification of income and dividends
Learn why and how investors purify income from small non-compliant revenues, using the dividend method and the per-share method with full calculations.
What you will learn
- What purification (tathir) is and why it is needed even after screening
- The dividend-based method and the per-share income method
- How to purify interest credited on cash balances and fund distributions
- How purification differs from zakat and what to record each year
Explanation
Lesson 3 showed that Sharia screens allow companies with a small share of non-compliant income, often up to 5% of revenue. That tolerance is the reason purification exists.
What purification is
Purification (Arabic: tathir) means giving away the part of your investment income that comes from non-permissible activities, such as interest income or a small non-compliant business line. The investor does not keep the benefit of that part. It is not a penalty and not a fee; it removes income that should not be kept.
Purification is separate from zakat. Most scholars say purification money cannot be counted as zakat, because it was never really yours. It is usually given to general charity, without expecting any benefit. Whether you may claim a German tax deduction for it is a sensitive question: some scholars say the donor should not benefit at all. Ask your scholar, and for tax questions check with a Steuerberater.
Method 1: dividend-based
This is the simplest and most common method for private investors:
Purification = dividend received × (non-permissible income ÷ total income of the company)
You need the company's ratio of non-permissible income, which index providers or screening apps often publish. Many calculate it on the gross dividend, before withholding tax. Choose gross or net and stay consistent.
Method 2: per-share income
AAOIFI's standard on shares links purification to the company's non-permissible income, whether or not a dividend is paid. You calculate:
Purification = (non-permissible income ÷ shares outstanding) × your shares × (days held ÷ days in the period)
This method is more complete, because a company that pays no dividend still earns some non-compliant income on your behalf. It needs more data.
Other sources to purify
- Interest on cash balances: if your broker or bank credits interest, purify 100% of it. Better: choose an account that does not pay interest, or keep less cash there.
- Islamic funds and ETFs: some providers publish a purification ratio for distributions, or purify inside the fund. Read the fund documents to avoid purifying twice or not at all.
- Capital gains: scholars differ. Some require purification of gains with the same ratio; many do not. Decide your approach and record it.
Practical routine
- Keep a purification column next to each dividend in your records.
- Use the latest available ratio and note its source and date.
- Pay once per quarter or once per year, and keep the receipt separate from zakat receipts.
Worked example
Hypothetical example: Omar receives these gross dividends during one year. Assumptions: ratios are hypothetical figures from a screening source; he uses Method 1 on gross dividends; his broker also credited interest on cash. Taxes and fees are excluded.
| Item | Gross amount | Non-permissible ratio | Purification |
|---|---|---|---|
| Company A dividend | €200.00 | 3.0% | €200 × 3.0% = €6.00 |
| Company B dividend | €150.00 | 0.5% | €150 × 0.5% = €0.75 |
| Company C dividend | €100.00 | 4.5% | €100 × 4.5% = €4.50 |
| Interest on broker cash | €18.00 | 100% | €18.00 |
Total purification = €6.00 + €0.75 + €4.50 + €18.00 = €29.25.
Method 2 check for Company A: Company A had a hypothetical €30 million of non-permissible income and 100 million shares, so €0.30 per share. Omar held 200 shares for half the year: 200 × €0.30 × 0.5 = €30.00. That is five times the €6.00 from Method 1, because the company paid out only part of its profit as dividends. The method you choose matters.
Common mistake
Practice activity
Using Method 1, calculate purification for: ETF distribution €320 with a provider-stated purification ratio of 1.25%; Company X dividend €90 with a ratio of 2%; Company Y dividend €60 with a ratio of 0%; interest on a savings account €12. Then state whether the total may be counted as zakat according to most scholars.
Show solution
ETF: €320 × 1.25% = €4.00. Company X: €90 × 2% = €1.80. Company Y: €0. Interest: €12.00.
Total = €4.00 + €1.80 + €0 + €12.00 = €17.80.
According to most scholars it may not be counted as zakat; it is given to charity separately.
Limitations: ratios change every reporting period, and scholars differ on gross versus net dividends and on capital gains.
Key takeaways
- Purification removes the small non-compliant share of income that screening tolerates.
- Method 1 multiplies each dividend by the company's non-permissible income ratio; Method 2 uses non-permissible income per share and holding period.
- Interest credited on cash must be purified in full.
- Purification is not zakat; record and pay it separately, with source and date of the ratios used.
Next step
The final lesson brings screening, zakat, purification and product choice together into one written Sharia-compliant investment plan.
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