Zakat funds, SORP and trust law

The purpose of this guide is help you understand and manage Zakat funds. Charities are increasingly operating in a rapidly changing and competitive environment, with increasing calls for accountability from their stakeholders, sound zakat policies, procedures and protocols will provide trustees and management in your organisation the key areas to address.

https://www.charitysorp.org

Accounting for Charitable funds

Zakat funds are given to a charity for a specific purpose and can only be used for Zakat eligible purposes for the eight categories defined. The accounting records of charities should distinguish the income and spend between Zakat funds and other funds.

The first consideration on the categorisation of Zakat funds for charities is to refer to their governing document and charitable objects. Charities generally appeal for Zakat funds through the use of the Zakat theological references illustrating the eight categories.

Funds generally provided to charities fall into either of the following categories:

• Restricted funds
• Unrestricted funds

The consideration is whether Zakat funds are restricted or unrestricted funds and if unrestricted whether they should be designated funds.

Restricted funds are subject to conditions either specified by the funder or restrictions imposed by the donor or the charity itself during its marketing campaigns thereby restrictions can be created under trust law.

Thus, those charities raising Zakat funds by a specific country 'ask' have restricted these further by country, as such are held in trust only to be spent in those particular countries under trust law. As such, should be disclosed in the restricted funds note to the financial statements.

Unrestricted funds are spent or applied at the discretion of the trustees to further any of the charity's purposes. Unrestricted funds can be used to supplement expenditure made from restricted funds. (SORP 2.6).

Funds held on specific trusts under charity law are classed as restricted funds. The specific trusts may be declared by the donor when making the gift or may result from the terms of an appeal for funds. The specific trusts establish the purpose for which a charity can lawfully use the restricted funds. It is possible that a charity may have several individual restricted funds, each for a particular purpose of the charity. (SORP 2.8).

From a SORP perspective where Zakat funds are aligned to the charitable objects they can be classified as unrestricted funds to “further any of the charity's purposes”.

In regard to fulfilling the stewardship of Zakat funds from a Islamic jurisprudence perspective requires reporting publicly to donors, the amount of Zakat raised and how it was utilised. Zakat funds are 'ring-fenced' from a religious obligation upon the trustees of Islamic faith-based charities as such the charities policies, procedures and systems should ensure that Zakat funds are allocated and spent in accordance with the organisation's Zakat policies, procedures and principles.

Thus, Zakat is for specific activities (designated) and as part of the funds reporting charities should designate the Zakat funds and track the appropriate application.

Trustees may choose during the reporting period to set aside a part of the unrestricted funds to be used for a particular future project or commitment. By earmarking funds in this way, the trustees set up a designated fund that remains part of the unrestricted funds of the charity. This is because the designation has an administrative purpose only and does not legally restrict the trustees' discretion in how to apply the unrestricted funds that they have earmarked. Identifying designated funds may be helpful when explaining the charity's reserve policy and the level of reserves it holds. (SORP 2.7).

Fuber (2017) in relation to UNHCR Zakat Collection and Distribution states:

“Zakat funds should be placed in their own account in an Islamic bank or an interest-free account. If this is not possible, care must be taken to ensure that no interest is distributed as Zakat. Rather, any accrued interest should be spent on general infrastructure and operational costs that are not related directly to Muslims.”

Free Reserves

The Charities Governance Code and Charity Commission guidance on reserves emphasis “should maintain some level of reserves to ensure long-term financial sustainability, the charity should disclose its reserves policy in the annual report.” 

The term "Reserves" is used to describe that part of a charity's income funds that is freely available for its operating purposes not subject to commitments, planned expenditure and spending limits. Reserves do not include endowment funds, restricted funds and designated funds.

The SORP allows charities to calculate reserves based on their specific circumstances as such funds held for specific purposes can be excluded such as programme-related investments or tangible fixed assets for charity use.

Zakat funds held have a direct impact on calculating free reserves.

Zakat funds are only available to spend on the eight categories

[1] the poor, [2] the needy, [3] administrators of Zakat, [4] for bring hearts together [5] to free those in bondage, [6] for those in debt, [7] for God's cause and [8] the stranded traveller.

In regard to [3] administrators of Zakat there is an Islamic jurisprudence limitation of 12.5% (1/8^th) of the funds collected to the charity to cover direct and indirect support costs. Unless the charity has a specific written theological opinion provided by recognised Islamic scholars to exceed the 12.5%.

Thus, Zakat funds (less the 12.5% of total funds) should be excluded in calculating the charity's free reserves position.

Impact

Charities should ensure that clarity of communication exists with their stakeholders on how they will fundraise, allocate, distribute Zakat and report on that.

Each charity exists to make a difference and it's the “difference you make is often called impact”. NVCO.

Reporting by charities whilst need to demonstrate that Zakat funds are being utilised, distributed and monitored; should also demonstrate the impact of social-economic value Zakat has had to enhance societies.

The Trustees Annual Report should provide stakeholders with key information

• How much Zakat was raised annually and eligible projects the Zakat was applied to
• The difference, the impact that the charity achieved.

References:

1. Fuber, M (2017) UNHCR Zakat collection and distribution
2. Charities SORP https://www.charitysorp.org
3. Charity Governance Code https://www.charitygovernancecode.org/en/front-page