The 5% Impermissible-Income Rule: Worked Example on a Mixed-Revenue Company
The "5% rule" is the screen most halal investors get wrong. It says a Shariah-compliant company can earn no more than 5% of its total revenue from impermissible sources — interest, alcohol, gambling and conventional insurance. Stay under 5% and the share passes, but you must still purify the dividend in proportion to that bucket. Cross 5% and the share fails outright — no amount of purification saves it.
Almost every large listed company touches a little bit of haram income. A supermarket parks its cash in an interest-bearing account. An airline sells alcohol on board. A hotel group runs a casino in one resort. The scholars who built the AAOIFI screening standard knew that a zero-tolerance test would leave Muslims with almost nothing to invest in — so they drew a tolerance line at 5%, paired with a duty to give away the contaminated slice. This guide walks through exactly where that line sits, how to read it off a real income statement, and what to do on either side of it, using a worked example you can copy for any share in your ISA or SIPP.
Where the 5% rule comes from
The 5% impermissible-income threshold is the second-stage quantitative screen in AAOIFI Shariah Standard No. 21 (Financial Papers — Shares and Bonds), the standard published by the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions. It is the same benchmark embedded in the major index families — the S&P Shariah Indices methodology and the Dow Jones Islamic Market series — so when a UK halal ETF or a screening app tells you a share is "compliant," this is the test it just passed.
Screening runs in two layers, and order matters:
- Layer 1 — the business-activity screen. If the company's core business is impermissible (a conventional bank, a brewer, a betting operator, a tobacco firm, a conventional insurer), it fails immediately. Nothing about the financial ratios can rescue it, and there is no purification — you simply don't own it.
- Layer 2 — the financial ratio screens. For a company that passes Layer 1, three ratios are tested. The 5% income rule is one of them; the other two cap interest-bearing debt and interest-bearing cash/investments. This article focuses on the income rule.
A company that clears the business-activity screen must also pass these. Thresholds are AAOIFI's; some index providers use a slightly looser 33% on the balance-sheet ratios, so always check the methodology of the specific fund or app you rely on.
| Ratio | What it measures | AAOIFI cap |
|---|---|---|
| Impermissible income | Interest + other prohibited revenue ÷ total revenue | < 5% |
| Interest-bearing debt | Conventional debt ÷ market capitalisation | ≤ ~30% |
| Interest-bearing assets | Cash + interest-bearing securities ÷ market capitalisation | ≤ ~30% |
Sources: AAOIFI Shariah Standard No. 21; S&P Shariah Indices Methodology (2026).
What counts as "impermissible income"
The 5% bucket is not just interest. It is every stream of revenue a scholar would tell you is haram at source. In practice the regularly-seen categories are:
| Category | Typical real-world source | Counts toward 5%? |
|---|---|---|
| Interest (riba) | Interest on bank deposits, money-market holdings, loans extended, interest-bearing bonds held | Yes |
| Alcohol | Bar & minibar sales in a hotel chain; on-board drinks for an airline | Yes |
| Gambling (maysir) | Casino floor or lottery revenue inside a wider leisure group | Yes |
| Conventional insurance | A non-takaful insurance subsidiary's premium income | Yes |
| Pork & non-halal food, tobacco, adult content | Incidental retail lines inside a diversified group | Yes |
| The company's core halal trade | Selling cars, software, groceries, electricity | No |
Two things trip people up. First, interest income is always impermissible income, even for index providers (like S&P) who exclude it from one particular ratio for compliance-flagging — for the purification step it is firmly back in the bucket. Second, the test is on revenue, not profit. A loss-making alcohol division still pushes revenue into the haram bucket.
Reading the income statement to isolate the haram bucket
You don't need the company to do this for you — the numbers are in the annual report. Work top-down:
- Find total revenue. Top line of the consolidated income statement (sometimes "Total revenue" or "Revenue + other operating income"). This is your denominator.
- Scan the segment note. Listed groups break revenue down by division. Flag any segment whose activity is on the list above.
- Add finance/interest income. Look for "Interest income," "Finance income" or "Investment income" — usually a single line just below operating profit. That whole figure is impermissible.
- Sum the flagged lines = your impermissible-income numerator.
- Divide numerator ÷ total revenue. Under 5% it passes; you carry that exact ratio into the purification step. At 5% or above it fails.
Worked example: a company with 4% interest income
Aisha, a higher-rate-taxpaying NHS consultant in Manchester, holds shares in Pennine Logistics plc (a fictional but realistic FTSE 250 haulage and warehousing group) inside her Stocks & Shares ISA. She wants to confirm it passes the 5% rule and work out what she owes in purification.
Step 1 — the income statement. Pennine's latest annual report shows:
| Line item | Amount (£m) | Impermissible? |
|---|---|---|
| Haulage & warehousing revenue | 1,920 | No (core halal trade) |
| Interest income on treasury deposits | 80 | Yes (riba) |
| Total revenue | 2,000 | — |
Step 2 — the ratio.
Impermissible income ÷ total revenue = £80m ÷ £2,000m = 0.04 = 4.0%.
4.0% is below 5%, so on this ratio Pennine passes the screen (assuming it also clears the two balance-sheet ratios). Aisha can keep holding it — but she now owes purification on the 4% slice.
Step 3 — purify the 4%. The purification formula is simply:
Purification = Dividend received × (impermissible revenue ÷ total revenue)
Aisha owns 4,000 shares. Pennine pays a dividend of £0.30 per share, so she receives £0.30 × 4,000 = £1,200 for the year. Applying the 4% ratio:
£1,200 × 0.04 = £48.
Aisha gives £48 to charity to cleanse the dividend, and keeps £1,152 with a clear conscience. She repeats this every year using that year's published ratio — the 4% is not fixed forever; it moves with the company's accounts.
The UK tax wrinkle. Because the £48 is cleansing money rather than a true gift, the mainstream scholarly position is that Aisha should not claim a personal tax benefit on it — so she gives it without ticking Gift Aid and does not enter it on her Self Assessment. Under HMRC's Gift Aid rules, a higher-rate taxpayer can normally reclaim the difference between the 40% they paid and the 20% the charity recovers — but reclaiming that on purification money would mean profiting from the very income you are trying to purge, which defeats the purpose. (Her genuine, separate charitable giving and her zakat are different matters and can use Gift Aid as normal.)
The dividend isn't being paid? Use the per-share method
If Pennine reinvested everything and paid no dividend, Aisha would still purify the unearned-but-attributable haram income. The AAOIFI-aligned per-share method is: total impermissible income ÷ total shares in issue × shares she owns. If Pennine's £80m of interest income is spread over 800m shares, that's £0.10 of haram income per share; on 4,000 shares she purifies £400 — regardless of whether a dividend was paid.
What happens when a company crosses 5%
Now change one number. Suppose Pennine launches a consumer-finance arm and its interest income climbs to £140m on the same £2,000m revenue:
£140m ÷ £2,000m = 7.0%.
At 7% the company fails the screen entirely. This is the single most misunderstood point about the rule: once impermissible income passes 5%, purification is no longer an option. You cannot give away 7% of the dividend and carry on holding — the share itself is now non-compliant, and the correct action is to sell it (any gain attributable to the non-compliant period should itself be purified). Purification only ever cleanses the small, tolerated residue inside a share that passed; it can never rehabilitate one that failed.
The logic is a "tolerance, not a licence" principle. The 5% line exists because total avoidance of incidental interest is practically impossible in a modern listed economy — not because impermissible income is acceptable in larger doses. Below the line you tolerate the residue and donate it away; above the line the contamination is material and the company is simply off-limits.
| Impermissible income | Screen result | What you do |
|---|---|---|
| 0% | Pass | Hold; nothing to purify |
| 4.0% (our example) | Pass | Hold; purify 4% of the dividend (£48) |
| 4.9% | Pass (just) | Hold; purify 4.9% — watch it closely next year |
| 5.0% and above | Fail | Sell; purification cannot rescue it |
How the 5% rule feeds the purification calculation
The two ideas are one continuous process, not two separate tests. The screen produces the exact percentage you then use to cleanse your return:
- The 5% rule gives you a yes/no: is the share investable at all?
- If "yes," the same ratio you just calculated (Aisha's 4%) becomes the multiplier in the purification formula.
- You apply it to the dividend (or, with no dividend, to the per-share method) and donate that amount.
So a single trip through the income statement does double duty — it decides whether you can hold the share, and it tells you precisely how much to give away if you do. Run it once a year when the annual report lands, because both the pass/fail verdict and the purification percentage can shift as the business changes. Most UK halal investing apps (and the published factsheets of halal ETFs) will surface a current purification ratio so you don't have to read the accounts yourself — but understanding the mechanic means you can sanity-check what they tell you.
- The 5% rule is AAOIFI's cap on impermissible income — interest, alcohol, gambling and conventional insurance — as a share of total revenue.
- It only applies after a company clears the business-activity screen; a core-haram business can never be purified.
- Below 5% the share passes, but you must purify the dividend using Dividend × (impermissible revenue ÷ total revenue). Our example: £1,200 × 4% = £48.
- At 5% or above the share fails outright — purification cannot rescue it; the correct action is to sell.
- In the UK, give purification money without Gift Aid — you may not gain a personal tax benefit from cleansing haram income. Your normal charity and zakat can use Gift Aid as usual.
- The screen and the purification calc are one process: the ratio that decides "can I hold this?" is the same ratio that tells you "how much to give away."
Frequently asked questions
Is the 5% threshold the same everywhere?
The core 5% impermissible-income cap is consistent across AAOIFI Shariah Standard No. 21 and the major index providers (S&P Dow Jones, FTSE, MSCI). The balance-sheet ratios differ more — some allow up to 33% rather than 30% for debt and interest-bearing assets — so always check the methodology of the specific fund, ETF or screening app you rely on.
Does interest income count toward the 5% even though some indices exclude it from a "compliance" ratio?
For purification, yes — interest income is impermissible income and goes in the bucket. Some index providers report a separate compliance ratio that excludes interest and a separate purification ratio that includes it. When you are working out what to donate, use the figure that captures all impermissible revenue, interest included.
What if the impermissible income is 4.9% — am I really fine?
On the income ratio, yes, it passes. But 4.9% is a warning light: a single new finance arm or acquisition can tip it over 5% next year, at which point you would have to sell. Companies hovering just under the line deserve an annual recheck rather than a set-and-forget hold.
Can I claim Gift Aid on my purification donation in the UK?
The mainstream scholarly view is no — purification money is cleansing, not genuine charity, so you should not derive a personal tax advantage from it. Give it without a Gift Aid declaration and don't enter it on your Self Assessment. Your separate, sincere charitable giving and your zakat can still use Gift Aid normally under HMRC's rules.
Do I purify if the company didn't pay a dividend?
Yes. Use the per-share method: total impermissible income ÷ total shares in issue × the number of shares you own. That captures the haram income attributable to your holding even when it was retained rather than distributed.
What happens to my capital gain if a share crosses 5% and I have to sell?
You sell the share because it is no longer compliant. The portion of any gain attributable to the period the company was non-compliant should itself be treated cautiously and, on the conservative view, purified. The capital gains tax treatment of the sale is a separate UK tax matter — see HMRC guidance or a qualified adviser.
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