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Article information:
To cite this document: Fahad Zafar, (2012),"Ijarah contract: a practical dilemma", Journal of Islamic Accounting and Business
Research, Vol. 3 Iss: 1 pp. 67 - 69
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http://dx.doi.org/10.1108/17590811211216078
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PRACTITIONERS NOTE
Ijarah contract:
a dilemma
67
Introduction
The word ijarah is derived from the Arabic word ajara ujeru meaning renting.
It involves one party (the lessor) allowing another (the lessee) to utilise the benefits on a
tangible asset for a rental consideration. Two fundamental requirements for ijarah to be
recognized as an acceptable mode of business financing under Shariah are that:
(1) the profit must be generated from selling or offering the use of something
having intrinsic value, i.e. based on real assets; and
(2) the risk element is assumed by the lessor.
There are five steps in the flow of ijarah transaction:
(1) Customer identifies the asset and asks the bank to acquire it and promise to the
bank that it will lease the asset after the bank acquires it.
(2) The bank acquires the asset from the supplier at cost price.
(3) The bank makes payment to the supplier and receives title of the asset.
JIABR
3,1
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(4) The bank leases the asset to the customer for a fixed rental consideration and
depending on the objective of the contract, the customer probably also makes a
promise to purchase the asset in the future at a potential price. It should be
noted that the promise is not a contractual obligation as there could not be a sale
contract executed on an asset which is being leased.
(5) The customer makes rental payment according to the agreed upon repayment
schedule.
It is a widely used trade mode of financing by Islamic Financial Institutions. In this
article, I would like to demonstrate a particular dilemma faced by bankers related to
vehicle ijarah contract and the resolution offered by the Shariah scholar.
Vehicle ijarah contract: the dilemma
Vehicle leasing or vehicle ijarah contract represents a transaction in which benefit
(usufruct) associated with the vehicle is sold for a payment. In the course of this sale of
usufruct, ownership of the vehicle is not automatically transferred to lessee and the bank
(lessor) maintains the ownership. In other words, the ijarah contract is designed to return
the vehicle to the lessor at the end of the term, thus taking on the features of an operating
lease whereby the bank takes title of the asset at the end of the lease term. The other
mechanism available is to allow the lessee to agree at the outset, to buy the assets in
question at the end of the lease period which basically takes on the nature of a hire
purchase known as Ijara wa Iqtina or Ijarah Muntahia Biittamleeek IMB) (i.e. lease
& ownership). FAS 8 (para 4) lists four possible conclusions of IMB: as gift (hibah),
i.e. transfer of legal title for no consideration; through a token consideration, i.e. transfer
of legal title (sale) at the end of a lease term; through price that is equivalent to the
remaining ijarah installments, i.e. transfer of legal title (sale) before the end of the lease
term; and through gradual transfer of legal title (sale) of the leased asset.
A customer approached the Islamic bank for a vehicle lease and was informed of the
total cost of the vehicle (above the market price), Rs 1,000,000 and that 20 per cent is
required as down payment/security with the remaining 80 per cent adjusted against
36 monthly rental payments. The customer was also told that the contract will be a ijarah
Muntahia bittamleek through gift (hibah) whereby the bank will transfer ownership of
the vehicle to the customer at the end of the lease term without further consideration and
that the bank will also be responsible for any damage to the vehicle.
The customer told the banker that he would like to pay 80 per cent as down payment
instead of 20 per cent which the banker eagerly accepted as this helps in achieving the
branch sales target. The contract was signed and the customer paid the monthly rentals
as expected. After paying 35 months rental payment, the customer decided that he does
not need the vehicle anymore and demand his 80 per cent down payment back.
The banker sought the advice of the Shariah scholar as such case has never been
encountered by the bank before.
Outcome
The Shariah scholar advised the bank to return the 80 per cent down payment back to
the customer since the contract was a ijarah muntahia bittamleek. The bank should not
have taken more than 40 per cent as down payment or security in the case of ijarah
contract and if the customer insists upon giving more than that percentage, the bank
should have entered into a diminishing musharakah contract. This contract will allow
the bank to transfer a percentage of ownership to the client upon payment of rentals. If
such contract, i.e. diminishing musharakah had been entered by the two parties, then the
customer would have attained almost 97 per cent ownership of the vehicle at the end of
the 35th month.
Ijarah contract:
a dilemma
Lesson learnt
Before entering into contract based on ijarah muntahia bittamleek, it is equally
important for bankers to take into account the amount of down payment requested
besides the fulfillment of other criteria. Ijarah contract is only appropriate when the
amount of deposits or down payment requested is below 40 per cent (the threshold) and
above that, the contract should be diminishing musharakah as risk will be shared
between both parties.
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