Assalaamu alaykum,
Purifying capital gains remains a debated issue. Some scholars argue that capital gains’ purification is not necessary, since the change in the stock price does not reflect the interest income, while others advocate capital gains purification.
Those who are in favor of capital gains purification argue that it is safe not to utilize or benefit from impure income that might be reflected in the capital gains. This is because, fundamentally, the market price capitalizes the company’s total earnings including those from Sharīʿah non-permissible earning. However, critics of capital gains purification argue that earnings from interest-based activities tend to be insignificant, and, therefore, their impact on capital gains is negligible.
The treatment of capital gains from the cleansing perspective remains under debate. Some scholars such as Sheikh Taqi Usmani suggest that it is a safe approach to cleanse capital gains from selling shares. It is based on the understanding that the market price might reflect an element of interest or impermissible income. On the contrary, ISRA-Bloomberg opines that there is no need to cleanse capital gains. It is argued that the change in the stock price does not directly reflect interest or other income generated from Sharīʿah non-compliant activities of a company. In reality, the changes in stock price in the market comprise a complex phenomenon that is attributed to multifarious factors, including supply and demand. Therefore, capital gain is not direct income from Sharīʿah non-compliant activities. Moreover, the stock price in the market basically reflects the price that the buyer is willing to pay to acquire those shares. It would be far from reality to think that the investors consider interest or impermissible income during trading shares as the principal factor or objective of the transaction, especially when it is in a negligible amount (less than 5 per cent of the total revenue in this case). This opinion is based on the Islamic legal maxim stating:
يغتفر في التابع ما لا يغتفر في المتبوع
Something can be forgiven as the subsidiary which cannot be forgiven as the principal (Al-Zuhayli, 2006, vol. 1, p. 447).
The above maxim proposes that when a factor or element is subsidiary to a principal factor or element, it might be overlooked in issuing the Sharīʿah ruling for the whole case, whereas that element cannot be overlooked otherwise. Putting it in the context of cleansing capital gains, it can be said that the interest or impermissible income is definitely a subsidiary factor. Therefore, it seems more appropriate to exclude capital gains from the income cleansing process.
Due to the differing interpretations of Islamic laws, Shariah scholars inevitably will have diverging views and thoughts about purification in investments. Some have the opinions that only impure dividends received from Shariah-compliant companies need purification, while others argue that capital gains from stocks ought to be purified as well.
Most scholars agree that non-permissible income, such as interests earned, would taint the overall distributed income of an Islamic fund if the dividends received from its underlying stocks aren’t purified. For that reason, many Islamic finance and investment experts do recommend that purification be carried out on dividends received by Shariah equity funds.
On the other hand, capital gain is a resultant of inherent price volatility of a stock due to varied market factors. And that is why some Islamic scholars think it is unnecessary to subject a market-induced element, like capital gain, to purification
Opposing Muslim academics, however, argue that while capital gains are the outcome of a myriad of market dynamics, these returns could also be attributed to circumstances related to cash and debt, including interest income. As such, capital gains should also be purified, they point out.
Ultimately, the Shariah supervisory boards of Islamic equity funds will be the ones ascertaining the type of income and capital gains that ought to be purified. Looking at the Templeton Shariah Global Equity Fund, for instance, its Shariah supervisory board mandated that purification be implemented on tainted dividends as well as net realized non-compliant profits for semi- annual period ended April 30, 2017.