Contemporary issues of form and substance: an Islamic law perspective

Mohamed Hamour (International Centre for Education in Islamic Finance, Kuala Lumpur, Malaysia)
Mohammad Hassan Shakil (Taylor’s Business School, Taylor’s University, Subang Jaya, Malaysia)
Ishaq Mustapha Akinlaso (International Centre for Education in Islamic Finance, Kuala Lumpur, Malaysia)
Mashiyat Tasnia (Institute of Islamic Banking and Finance (IIiBF), International Islamic University Malaysia, Kuala Lumpur, Malaysia)

ISRA International Journal of Islamic Finance

ISSN: 2289-4365

Article publication date: 25 March 2019

Issue publication date: 26 June 2019



This paper aims to analyse the concept of form over substance and introduces the term substance gap to the literature. The substance gap is defined as the difference between the way a concept is expressed and its intended result. Besides, the study investigates the issue from both classical and contemporary viewpoints.


The methodology adopted in this paper is descriptive research.


This paper has depicted the substance gap in contemporary contracts and found that form is equally important as substance in Islamic finance contracts. This paper offers a fresh outlook on form and substance to highlight the importance of the issue and its significance. The findings of the study will help researchers address the issue at its roots and help them to bridge the gap between the form and substance of Islamic finance contracts.


This paper investigates the substance gap in contemporary contracts that exists between the fiqh rules and conditions of an Islamic contract, and their development and construction. Further, the gap could also be attributed to the pressure to cope with a complicated modern finance environment.



Hamour, M., Shakil, M.H., Akinlaso, I.M. and Tasnia, M. (2019), "Contemporary issues of form and substance: an Islamic law perspective", ISRA International Journal of Islamic Finance, Vol. 11 No. 1, pp. 124-136.



Emerald Publishing Limited

Copyright © 2019, Mohamed Hamour, Mohammad Hassan Shakil, Ishaq Mustapha Akinlaso and Mashiyat Tasnia.


Published in ISRA International Journal of Islamic Finance. Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at


Over the past decades, the Islamic financial system has achieved tremendous progress. However, it has also faced criticisms regarding its operations, products and services. A few scholars have argued that it is a replication of the conventional financial system (Chong and Liu, 2009; Khan, 2010; Beck et al., 2013). Critics have referred to it as putting old wine in a new bottle by changing the name and adding a Sharīʿah-compliant tag (Zaher and Hassan, 2001; Hasan, 2015). Ahmed (2011a) further reasoned that Islamic financial transactions are compatible with Sharīʿah (Islamic law) in form, but fail to meet its substance and spirit. Besides, many debates have given attention to the application of “form”, hence circumventing the “economic substance” of Islamic financial transactions. This raises concerns regarding how authentic some Islamic financial transactions are.

The debate of form over substance is triggered by the offer and acceptance of the underlying intention of the contracting parties. The term substance over form refers to the principle of recording a transaction based on its economic substance or financial reality, not necessarily its legal form (Hanif, 2016). Even though no reference is made to the intention (substance) with regard to legitimate contracts in the Malaysian Contracts Act 1950, there is a long-standing debate about it among Muslim jurists. The Shāfiʿī School, for instance, is more inclined towards form over substance in conflicts between internal will and external consent, approving only bi al-kitābah (what is written) as a rule in the courts. However, the Ḥanafī School strictly adheres to substance over form in exchange of offer and acceptance; for instance, regarding bayʿ al-wafāʾ (redemption sale) contract, it considers it a guarantee instead of a sale. The Mālikī School places emphasis on the importance of the substance of contracts when ruling on the permissibility of business activities, as in the case of bayʿ al-muʿāṭāh (sale by conduct). This form of sale is concluded when a buyer and a seller agree on the object of the sale and its price, and exchange the object for the price without explicit verbal offer and acceptance (Al-Zuhailī, 2001). In this respect, Sharīʿah stresses that both form and substance are important, but they shall not contradict each other. Abozaid (2010) stated that Sharīʿah prioritises substance over form in cases where inconsistencies arise between the two.

Previous studies on the issue of economic substance and legal form in Islamic finance have raised various criticisms on the application of certain techniques to validate the contract as Sharīʿah-compliant (Usmani, 2002; Khan, 2010; Rosly, 2010; Maali and Atmeh, 2015). Researchers such as Hanif (2016) investigated the economic substance and legal form in Islamic finance and found that the legal form of selected Islamic finance contracts is in line with the theory, but the economic substance is quite similar to their conventional counterparts. In a recent study, Atmeh and Maali (2017) examined the use of combined contracts and donation (hibah) from an accounting perspective and found mixed results in the application of economic substance and legal form in conventional and Islamic financial contracts. Overall, to quote Rosly (2010, p. 132) on this issue, “Form over substance is a technique that closes the front door of ribā (usury) while opening the back door for ribā at the same time”. Hence, the issue calls for much diligence in the application of form and/or substance when developing Sharīʿah-compliant products and services to ensure compliance of the contracts in line with their objectives.

The issue of mismatch between the form of a text and its intended meaning and outcome is not unique to Islamic finance contracts. It is also encountered in the field of accounting and law, for example. Today’s Islamic contracts, laws and accounting entries are all expressed in texts, and they can all exhibit substance gaps. According to Dusuki and Bouheraoua (2011), substance over form is an accounting concept which means that the economic substance of transactions and events must be recorded in financial statements rather than just their legal form to present an accurate and fair view of the entity’s affairs. The substance over form concept requires evaluation on the part of the preparers of financial statements for them to present transactions in a manner that best reflects the actual business sense of the transactions. However, the legal forms of events are necessary to provide more relevant information to the readers of financial statements.

Law is another area where substance gaps appear. The letter of the law is its literal meaning, while the spirit of the law is its perceived intention. In some cases, one could adhere to the letter of the law but not its intended objectives, resulting in unfairness (McBarnet and Whelan, 1991). As explained, the term substance gap is used to denote the difference between the form of a text and its intended substance measured by its performance.

In this paper, the aim is to assess the issue of form and substance in Islamic financial transactions from an Islamic law perspective. It thus introduces the concept of substance gap. Identifying the substance gap is meant to pinpoint the area of disjoint between the form and its intended substance.

The remainder of the paper is structured as follows. The second section describes the concepts of form and substance from the Sharīʿah perspective, while the third section elaborates the accounting perspective. The fourth section discusses the contemporary issues of form and substance arising in Islamic financial transactions, and the last section concludes the paper.

Form and substance: a Sharīʿah perspective

In principle, Sharīʿah emphasises that every contract must comply with its legal form, i.e. its essential requirements and its nature and implications. This implies that the form and substance of the transaction are both necessary (Ahmed, 2011b). However, most Islamic financial products are designed by using a series of contracts. Debates arise as to whether the effect of each contract in isolation is to be recorded – hence recognising the “form” of each contract – or whether the economic effect of the series of transactions is to be recorded – thus recognising the “economic substance” of the overall operation.

One area where there has been much controversy over the application of substance over form is the issue of ijārah (leases). The discussion can be illustrated with the product known as ijārah muntahiyah bi al-tamlīk (lease ending with ownership). It is a form of finance lease whereby the lessor leases an asset to the lessee for an agreed lease period, and at the end of the lease period, the lessee becomes the legal owner of the asset. During the ijārah tenure, the lessee rents the asset. At the beginning of the lease tenure, there is usually a waʿd (promise) by the lessor to transfer the ownership of the property to the lessee with a promise by the lessee to acquire the property from the lessor at the end of the lease term. The lessor can transfer the ownership of the property by any of the following means: a gift; a sale contract at a token price, a predetermined price or market price; or through the gradual transfer of shareholding (Abdul Rahman, 2010). In the case of transfer of ownership through a sale contract at the end of the lease term, a separate sale and purchase agreement will take place between the lessor (seller) and the lessee (buyer).

If the principle of form over substance is used for the recording of this transaction, the financial statements will recognise two separate transactions:

  1. rental throughout the ijārah (lease) tenure; and

  2. sale, when the ʿaqd (contract) to transfer the ijārah (lease) asset is executed.

However, if the substance over form concept is applied, the financial statements will recognise one transaction, which is to account for the final sale like the case of a conventional hire–purchase agreement, whereby the two contracts of the lease (hire) and sale (purchase) are combined into one.

The substance over form debate also arises under a bayʿ al-ʿīnah (sale and buy-back) contract. Bayʿ al-ʿīnah refers to a sale contract with an immediate repurchase. If the principle of substance over form is applied, the financial reporting will record the overall effects of all contracts involved in the transaction, whereby the profit generated from the contracts will be recorded as the financing cost payable by the customer. In contrast, if the principle of form over substance is adopted, the financial statement will record two separate transactions:

  1. sale of an asset from the financier to the customer; and

  2. sale of the same asset from the customer to the financier.

As such, in cases where Islamic financial products are designed by using a series of contracts, clarification on Sharīʿah opinions about the principle of substance over form is essential. The following section examines the views from the classical literature on the issue.

Views from the classical literature on the principle of form and substance

An investigation into the classical literature reveals differing positions and opinions on the issue of form and substance of classical Islamic contracts, sometimes within the same school. It is better illustrated by exploring the opinions of the four schools of Islamic jurisprudence regarding the issues of bayʿ al-ʿīnah and sham contracts.

In the case of bayʿ al-ʿīnah, the Ḥanafīs, Mālikīs and Ḥanbalīs considered it to be unlawful. On the other hand, the Shāfiʿīs ruled it permissible, but a prominent later scholar from the same school, al-Nawawi, deemed it discouraged (makrūh) (Shaharuddin, 2012). Al-Shāfiʿī did not consider bayʿ al-ʿīnah as a legal trick and he gave priority to the form over its substance because we cannot evaluate people’s hidden intentions. Al-Shāfiʿī treated bayʿ al-ʿīnah as two separate contracts, in which each of them complies with the features of a sale contract. He did not give any weight to the intention of the contracting parties (Al-Zuhailī, 2001). The Mālikī scholar al-Shāṭibī, on the other hand, viewed the application of bayʿ al-ʿīnah as a legal trick to legalise ribā (usury/interest) (Al-Zuhailī, 2001). There is nonetheless no consensus among jurists about the issue of legal stratagem (ḥīlah); it is a matter of debate. Applying a legal trick to an Islamic contract involves separating the substance from the form and creating a substance gap in the contract. Establishing the presence of substance gaps in classical Islamic contracts is dependent on the intentions of the contracting parties. Abozaid (2014) stated that, although the Ḥanafīs were most willing to employ legal stratagems, they did not accept their use in bayʿ al-ʿīnah, supporting the notion that form must match substance. Because the contracting parties intend to lend and borrow money and not to trade, it cannot be permissible.

A sham contract is one where the contracting parties enter two contracts at the same time – a declared one and a hidden one. The openly declared one fulfils all contracts’ conditions but it does not reflect the actual intention of the two parties, while the hidden one does. A contemporary example of sham contracts is sham marriages in Western Europe and North America. It is a frequent practice among hopeful immigrants, where they enter into fake marriage contracts with nationals of these countries to gain nationality and passports in return for financial rewards. Countries like the UK have developed laws, policies and procedures to weed out such contracts and determine what the true intentions of the marrying couples are. It is usually done in court, and if the sham marriage is proven, the participants face judgments ranging from fines to jail sentences.

An example of a sham contract from classical literature could be bayʿ al taljiʾah (pre-emptive sale), where a person is forced into entering a sale contract in fear of the authority confiscating or forcibly buying his asset. The appearance of the contract is a sale while the true purpose is the desire to safeguard his asset. It is done by the consent and knowledge of the two contracting parties. There are two positions in classical jurisprudence regarding this type of contract. The first is adopted by the Shāfiʿīs and some of the Ḥanafīs. In the case of a dispute between the two contracting parties, they consider the declared contract to take precedence over the hidden intention (Al-Mawsūʿah, 2007). The second position is adopted by the Ḥanbalīs and Mālikīs. They consider the hidden contract and its intention to take precedence over the declared one as long as there is evidence to support it (Al-Mawsūʿah, 2007).

Accounting perspective on form and substance

International Financial Reporting Standards (IFRS) provide higher weight to economic substance rather than legal form for recognition and measurement purposes of accounting transactions. For instance, in paragraph 4.6 of the International Accounting Standards Board’s (IASB) Conceptual Framework for Financial Reporting (IASB, 2010, p. 26), the preference for economic substance over legal form is expressly mentioned as follows:

In assessing whether an item meets the definition of an asset, liability or equity, attention needs to be given to its underlying substance and economic reality and not merely its legal form.

It does not, however, mean that the legal form is ignored. The Conceptual Framework acknowledges that to achieve faithful representation, a complete depiction must include all information necessary for a user to understand the phenomenon being depicted (Epstein and Jermakowicz, 2010). In theory, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) provides consideration for substance and form:

If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality as well as the legal form. Financial reporting involves consideration of the substance of an economic phenomenon as well as its legal form (AAOIFI, 2010, p. 31).

Meanwhile the Institute of Chartered Accountants of Pakistan (ICAP) denies the distinction between substance and form (Atmeh and Maali, 2017). It states that in an Islamic finance transaction, substance cannot be different from its legal form (AOSSG, 2011). For example, if two people entered into a transaction where the true intention is to finance the other party, not to trade, then the transaction is not permissible in Islam. This study considers the example of a murābaḥah contract (purchase and sale contracts with deferred payments) and ijārah muntahiyah bi al-tamlīk (finance lease) to provide a brief explanation of substance and form from the Islamic accounting perspective.

In the case of murābaḥah, the profit is allocated proportionately over the period of credit (AAOIFI, 2010). The economic substance of murābaḥah is lending, although sale and purchase transactions are performed (Atmeh and Maali, 2017; Shakil and Mustapha, 2017). Moreover, the accounting treatment depicts the economic substance of the transactions owing to the allocation of profit over the period of time.

Meanwhile, in the case of ijārah muntahiyah bi al-tamlīk, AAOIFI (2010) requires one separate transaction for the operating lease and another for disposal of the asset. It is evident from the accounting treatment that AAOIFI emphasises more on the form of the contract of ijārah muntahiyah bi al-tamlīk, while the conventional accounting framework focuses more on the economic substance.

The principle of substance over form in the reporting of a Sharīʿah-compliant transaction means that the result or substance of the transaction is recorded. The point of contention regarding this approach is that, in applying substance over form, the reporting of the Sharīʿah-compliant transaction may signify it as indistinguishable from a Sharīʿah non-compliant transaction. It is, however, argued that a Sharīʿah-compliant transaction may yield the same returns and cash flows as a Sharīʿah non-compliant transaction. Despite that, the nature of the contract undertaken would make the former ḥalāl (permissible), while the latter would be ḥarām (impermissible). For Muslims, therefore, it is imperative that the contract or series of contracts used in the financing arrangement be clarified and that Sharīʿah-compliant transactions be depicted as distinct from interest-bearing financing. As such, some have advocated the application of alternative principles of recognition and measurement for Sharīʿah-compliant transactions instead of adopting the IFRS approach (Atmeh and Maali, 2017).

Contemporary issues

Abozaid (2012, p. 8) identified three reasons for substance gaps in Islamic finance contracts:

  1. negligence of the contract substance by the deactivation of some contract rules;

  2. negligence of the contract substance by attaching another contract or condition; and

  3. negligence of the contract substance by the misapplication of the contract.

In the following sub-sections, the form over substance issue will be addressed by tackling examples of substance gaps in real Islamic finance practice. The three reasons identified by Abozaid (2012) as the causes of substance gaps will be used as measures of their existence in Islamic finance contracts.

Waʿd (promise)

A waʿd could be written or oral, and it is unilateral from one individual to another. In classical fiqh (Islamic jurisprudence) thought, waʿd is morally binding but not legally binding because it falls under the category of voluntary contracts. There is a different perspective that, if a waʿd depends on a condition or is not performing, it causes the promisor to incur cost or damages and it becomes morally and legally binding. The first position is adopted by the majority: Ḥanbalīs, Ḥanafīs, Shāfiʿīs and a few from the Mālikī School (Ibn Bayyah, 2010). The second position is adopted by Ibn al-ʿArabī of the Mālikī School, who viewed that if the promise results in a specific consequence, its fulfilment is obligatory, but if it is a promise per se, without any significant effect, fulfilling it is not made obligatory (Ibn Bayyah, 2010). The ruling is affirmed by the Ḥanafī School which distinguishes between absolute promise and conditional promise (ISRA, 2012). The latter becomes binding in the contract of exchange in avoidance of gharar (uncertainty) in the subject matter of the promise. This rule is very similar to the concept of guarantee established by the kafālah contract, which is the difference between a legally enforceable promise and all other promises we have been making or breaking in all our lives.

In the classical sense, the form of the waʿd concept is closely matched with its substance, and there is no opportunity for a substance gap to exist. When a person makes a promise and keeps it, there would be no issues, but if they do not keep the promise, they could be held liable for the damages suffered to the promisor, if any. However, a substance gap exists between the classical use of waʿd as a unilateral promise between two individuals, whether binding or not, and its modern-day utilisation by Islamic financial institutions. Modern-day waʿd is a promise between a client and a financial institution in an exchange contract, e.g. forex waʿd, or to facilitate an exchange contract, e.g. murābaḥah to the purchase orderer (MTPO).

The current use of waʿd has moved its substance away from its classical form, creating a substance gap; an example would be the forex waʿd, which is similar to the conventional option. A bank will promise a customer to exchange one type of currency for a different kind of currency at the pre-agreed rate and price on a future date. On the same date, the bank will receive a fee from the customer for its undertaking. The fee payment changes the waʿd from a unilateral agreement to that of an exchange, because without the fee payment, the bank will not agree.

Waʿd is also used to facilitate MTPO to circumvent the illegality of selling something the bank does not own, by making the customer enter into a waʿd to buy. Waʿd should be voluntary and not compulsory, but the MTPO’s customer has no option but to make the waʿd to buy, otherwise the agreement cannot be concluded. Applying Abozaid’s (2012) third rule (misapplication of contract) to test for the existence of substance gap to the current use of waʿd, one can conclude that its current form does not represent its classical substance. This is because the misapplication is evident in the waʿd. The waʿd is between clients and financial institutions and not individuals. It is to execute exchange contracts and facilitate their execution. Having a different substance from what it was initially intended for does not necessarily make the use of waʿd in modern Islamic financial transactions erroneous. However, it must be evaluated based on its new effect in society by using a measure like maqāṣid al-Sharīʿah (objectives of Islamic law).


AAOIFI (2015, p. 468) defines investment ṣukūk as “certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity”. For the ṣukūk’s form to match its substance, the ṣukūk issuance should adhere to Islamic contract conditions and should not exhibit any of Abozaid’s (2014) three identified symptoms of form over substance. The form of the ṣukūk structure should satisfy the underlying Sharīʿah contract conditions and should distinguish it from a conventional bond (Maurer, 2010).

Critical to the debate of form and substance in ṣukūk is the concept of asset-backed and asset-based ṣukūk, where it is agreed that the former is closer to the true substance of ṣukūk than the latter (Tasnia et al., 2017). In asset-based ṣukūk, the asset is present for Sharīʿah fulfilment to serve as a basis for profit and capital payments (ISRA, 2016). In this case, the ṣukūk holders have no exclusive right over the assets. They depend on the originator’s creditworthiness for repayment either from internal sources or from its ability to refinance. In asset-backed ṣukūk, the underlying assets are the only source of profit and capital payments (ISRA, 2016). In the case of default, the ṣukūk holders would be able to recover their exposure by taking control of and ultimately realising the value from the asset (ISRA, 2016). In the case of bankruptcy, the originators’ creditors do not have recourse to the underlying asset because it is owned by the ṣukūk holders (ISRA, 2015).

One can conclude that asset-based ṣukūk are structured and supported by an enhancement to affect their risk and return profile to mimic that of bonds. This is done to appeal to the international investor. On the other hand, the asset-backed ṣukūk is closer to the actual substance of Sharīʿah because the ṣukūk holders experience the risk of ownership of the underlying asset.

Organized tawarruq

The word tawarruq is derived from wariq (silver coins). The Arabs used it to mean seeking silver, and in modern-day financing, it means monetisation. Tawarruq could be defined as buying a commodity by deferred payment and selling it to a person other than the seller for a lower price with immediate payment (Al-Shalhoob, 2007; Soualhi, 2015).

There are three kinds of tawarruq, the basis for the classification being who carries out the tawarruq: done on an individual basis, organised by the seller or organised by the bank. AAOIFI (2015, p. 758) defines individual tawarruq as:

[…] the process of purchasing a commodity for a deferred price determined through musāwamah (bargaining) or murābaḥah (mark-up sale), and selling it to a third party for a spot price so as to obtain cash.

In organised tawarruq, the seller handles the process by which cash is acquired for the mutawarriq (the person/customer who seeks liquidity). The seller does so by selling a commodity to him for delayed payment; he then sells it on his behalf for cash by taking the payment from the buyer and handing it over to the mutawarriq (Abozaid, 2014). Meanwhile, in banking tawarruq, the bank organises the sale of the commodity between a dealer in an international commodity market and the customer seeking monetisation, for a delayed future payment.

The majority of fiqh scholars opine that individual tawarruq is permissible if it satisfies certain conditions to guarantee proper application (Al-Dabū, 2009; ISRA, 2012). As for organised and banking tawarruq, there is no consensus on their permissibility among the scholars. Some consider banking tawarruq allowable as long as it meets certain conditions, while others consider it a trick to circumvent the prohibition of ribā (Iqbal and Mirakhor, 2011; Mohamad and Ab Rahman, 2014).

This paper assesses the question of substance and form for banking tawarruq compared to individual tawarruq. The essential condition for the individual tawarruq to be permissible is that the commodity purchased needs to be sold to a third party other than the seller for a lower price with immediate payment. The process of individual tawarruq creates two separate sale contracts and avoids the charge of ʿīnah (buy-back) sale. For example, in the past two decades in Sudan, a form of individual tawarruq has become widespread and common. The locals term it as kasir, meaning “a break” in Arabic. The process follows this sequence: the person in need of immediate finance will buy a highly demanded product like a wide-screen TV in exchange for some post-dated cheques. Then they will sell it to a consumer or another trader at a price below the market price to speed up the sale and gain cash. The unfortunate consequence of this type of kasir financing is that many people may not get paid their debts, and they may end up in prison as a result of their debts for unlimited sentences.

Those who reject banking tawarruq believe it clashes with the principle, “matters are to be evaluated in light of their objectives”. They perceive the aim of the two sales to be procurement of cash in exchange for a deferred payment of a more substantial amount of cash. This renders both sales not actual sales, and the practice suffers from a substance gap, satisfying Abozaid’s third criterion of misapplication of a contract (Iqbal and Mirakhor, 2011; Abozaid, 2012). For the form of banking tawarruq to match the fiqh tawarruq, the customer and the bank would have to experience the risk of ownership of the commodity, but in practice, this risk is minimised to the degree of non-existence. In practice, this is done by adopting the following procedures:

  • The transactions occur within a short time period between each other.

  • The bank often acts as an agent on behalf of the customer (in the customer’s transaction with the commodities broker).

  • First and second commodity brokers know each other, and have a pre-arrangement to trade the said commodity. Broker A sells the commodity to the bank, the bank then sells the commodity to Broker B who sells it back to Broker A.

  • Commodity price quotes from both brokers are valid for 24 h.

  • There is a purchase undertaking with the first commodity broker (put option).

The above reasons and practices take away the substance of tawarruq from its classical form. The Council of the International Islamic Fiqh Academy, in its 19th Session, which was held in Sharjah, United Arab Emirates, from 26 to 30 April 2009, decided that:

It is not permissible to execute banking tawarruq because simultaneous transactions occur between the bank and the mustawriq [the party who seeks liquidity by entering into the tawarruq], whether it is done explicitly or implicitly or based on common practice, in exchange for a financial obligation. It is considered a deception, i.e. to get the additional quick cash from the contract. Hence, the transaction is considered as containing the element of ribā (ISRA, 2010).

In issuing this resolution, the Fiqh Academy affirmed that tawarruq, as practised by modern financial institutions, suffers from a substance gap between its form and substance. For this reason, they changed their position from permissible to impermissible.


Linguistically, the Arabic term ijārah means to rent or hire, and it could be defined as the transfer of the usufruct of a specific property from one party to another in exchange for rent, or transfer of the labour of one person to another in exchange for fee payments. There are two types of ijārah of usufruct, depending on the type of contractual agreement. The first is an operating lease, and this is used for leasing different assets, for instance, buildings, ships, aeroplanes and heavy-duty equipment. It is characterised by the absence of a purchasing agreement at the end of the lease. The second is a financial lease, which involves the purchasing or gifting of the asset at the end of the lease; this is named al-ijārah thummah al-bayʿ (AITAB) in Arabic.

The rules of ijārah are like those of a sale because in both cases something is transferred to another person in return for a price. The only difference between ijārah and sale is that in the latter, the property is transferred to the purchaser, while in the former, the property remains in the ownership of the transferor; only its usufruct is transferred to the lessee. In its original form, ijārah is not a mode of financing but a normal business activity like a sale. However, due to certain reasons – in particular, tax concessions in Western countries and the retention of ownership by the lessor to enhance credit security – financial institutions started to use leasing for financing. Instead of giving an interest-bearing loan, some financial institutions offered lease financing of assets. The best example is the use of AITAB for the sale of cars in Malaysia.

To arrive at the same result as offering a loan, these institutions will add the total cost they incurred in the purchase of these assets and also add the interest amount they could have claimed on such amounts during the lease period. The total is divided by the number of months of the lease period to fix the monthly rentals. It is already clear that even in a conventional finance lease, the substance is just an interest-bearing loan and this circumvent is done partly for tax purposes. Also, it is practised to reflect the substance of the transaction.

The question of whether leasing can be used as a mode of financing in Sharīʿah depends on the terms and conditions of the contract. The question that follows is: Does ijārah also suffer from a substance gap between the original ijārah concept and its application as a contract in modern-day Islamic finance?

The common mechanism of ijārah as it is applied in Islamic banking contracts follows this sequence. First, the customer identifies and approaches a vendor or supplier of an asset that he needs and collects all the relevant information. Then the customer approaches the bank for ijārah of the asset and promises to obtain the asset on lease from the bank upon the bank’s purchase of it. The bank makes the payment of the price to the vendor; the vendor transfers ownership of the asset to the bank. The bank then leases the asset, transferring its possession and specific right of use to the client. The customer pays ijārah rental over the agreed period. When the ijārah tenure expires, the asset is gifted or sold for a nominal value to the customer (Abozaid, 2014).

Muslim jurists have pointed out contentious areas in this modern application of ijārah that might create a substance gap between its classical form and modern use (ISRA, 2012; Abozaid, 2014). The first falls under Abozaid’s second criterion of combining two contracts in one; here, the customer makes a promise to the bank to rent the identified asset before the bank buys it. Scholars in support of this step claim that the lessor and lessee relationship has not been established yet, and hence, there are no two contracts in one (Zaher and Hassan, 2001; Abozaid, 2014). The same point resurfaces at the end of the ijārah tenure when the bank promises to pass the ownership of the leased asset to the customer by a nominal purchase or gift. Also, the promises are both unilateral and binding only on the promisor; the intention is to enhance the ijārah contract, and in so doing, it mimics a conventional loan.

Another issue in the ijārah contract is that rentals in long-term contracts are sometimes linked to an interest rate benchmark like LIBOR (Zaher and Hassan, 2001). Linking rental payments to an interest benchmark is an attempt to preserve the rental amount’s value of money, but this is a risk that should not be shifted to the lessee from the lessor. If an ijārah contract adopts interest rate benchmarking, this will widen the substance gap between the classical form of ijārah and its substance where the lessor has a certain risk he/she must endure. Adopting a clear benchmark such as a government tax rate or an agreed-upon percentage between the lessor and lessee introduces an element of risk to both sides because the rental payments can go up and down in real terms depending on the rate of inflation.

Another contentious issue in ijārah contracts is who is supposed to endure the risk of ownership during the period of the contract. Usmani (2002, p. 111) summarises the rule thus:

As the corpus of the leased property remains in the ownership of the lessor, all the liabilities emerging from the ownership shall be borne by the lessor, but the liabilities referable to the use of property shall be borne by the lessee.

In contracts where this is observed, the substance gap should narrow down and come closer to the true substance of the classical ijārah contract.

In answering the question of form over substance, one should place greater emphasis on the intention in forming a contract. The Shāfiʿī School adopted the opposite view on the basis that it is not the jurist’s business to ascertain people’s purposes. Thus, evaluation should be limited to the exterior signs to arrive at an opinion. The paper favours the first argument. This is because we do not know the historical context that led the Shāfiʿī School to adopt this position, but in modern times it will be abused and will drive a significant wedge between current Islamic finance contracts and their maqāṣid (objectives).

When it comes to the ijārah financing contract, the intention is clear from the beginning – that of not transferring the usufruct but transferring the ownership. The evidence is in the name which translates into “a lease that leads to purchase”.

In conclusion, the modern-day ijārah contract suffers from the most significant substance gap of all the contracts. That is because it is engineered to such a degree that it no longer resembles its classical form. A better term that would more genuinely reflect its substance would be sale using ijārah.


This study assesses the issue of form and substance from an Islamic law perspective and introduces the new concept of substance gap in the literature. Identifying the substance gap is meant to pinpoint the area of disjoint between the form and its intended substance within the contract process from product development to execution to effects. This study investigated the issue of form and substance from classical and contemporary angles; the issue was also identified in the fields of law and accounting.

The study has shown that the substance gap in contemporary contracts exists between the fiqh rules and conditions of an Islamic contract and their development and construction in the modern practice. It could be attributed to the pressure to cope with a complicated modern finance environment. This identification should help researchers who desire to address the issue at its roots and help bridge the gap between the form and substance in Islamic finance contracts.

Abozaid’s (2014) criteria were used to assess contemporary Islamic finance contracts of waʿd, ṣukūk, tawarruq and ijārah for the presence of substance gaps. All studied contracts were found to suffer from substance gaps with varying degrees of complexity, which demonstrated that form is just as important as substance. This paper offered a fresh outlook on substance and form to highlight the significance of the issue.

Islam was sent to humanity as an agent of change to make a difference in people’s lives; therefore, more research is needed to better understand the social and economic impact of contemporary Islamic finance contracts and not just their substance.


AAOIFI (2010), Accounting, Auditing and Governance Standards, Accounting and Auditing Organization for Islamic Financial Institutions, Manama.

AAOIFI (2015), Shari’ah Standards, Accounting and Auditing Organization for Islamic Financial Institutions, Manama.

Abdul Rahman, A.R. (2010), An Introduction to Islamic Accounting: Theory and Practice, CERT Publications, Kuala Lumpur.

Abozaid, A. (2010), “Contemporary Islamic financing modes between contract technicalities and Shari’ah objectives”, Islamic Economic Studies, Vol. 17 No. 2, pp. 55-75.

Abozaid, A. (2012), “The methodology of product development needed for Islamic banks upholding social responsibility”, paper presented at International Conference on Business Ethics and Corporate Social Responsibility: Ideals and Realities, 12-14th April, Istanbul.

Abozaid, A. (2014), Reforming the Methodology of Product Development in Islamic Finance, LAP Lambert Academic Publishing, Saarbrücken.

Ahmed, H. (2011a), “Maqāṣid al-Sharīʿah and Islamic financial products: a framework for assessment”, ISRA International Journal of Islamic Finance, Vol. 3 No. 1, pp. 149-160.

Ahmed, H. (2011b), Product Development in Islamic Banks, Edinburgh University Press, Edinburgh.

Al-Dabū, I.F. (2009), “Al-Tawarruq: Ḥaqīqatuh, ʿAnwāʿuhu”, 19th Council of International Islamic Fiqh Academy of OIC, UAE.

Al-Mawsūʿah, A.-F. (2007), Wizārat al-Awqāf wa-al-Shu’ūn al-Islāmiyyah, Kuwait.

Al-Shalhoob, S. (2007), “Organized tawarruq in Islamic law: a study of organized tawarruq as practised in the financial institutions in Saudi Arabia”, IIUM International Conference on Islamic Banking and Finance, Kuala Lumpur.

Al-Zuhailī, W. (2001), Financial Transactions in Islamic Jurisprudence, Dār al-Fikr, Damascus, Syria.

AOSSG (2011), Financial Reporting Issues Relating to Islamic Finance, Asian-Oceanian Standard-Setters Group, Kuala Lumpur.

Atmeh, M.A. and Maali, B. (2017), “An accounting perspective on the use of combined contracts and donations in Islamic financial transactions”, Journal of Islamic Accounting and Business Research, Vol. 8 No. 1, pp. 54-69.

Beck, T., Demirgüç-Kunt, A. and Merrouche, O. (2013), “Islamic vs. conventional banking: business model, efficiency and stability”, Journal of Banking and Finance, Vol. 37 No. 2, pp. 433-447.

Chong, B.S. and Liu, M.-H. (2009), “Islamic banking: interest-free or interest-based?”, Pacific-Basin Finance Journal, Vol. 17 No. 1, pp. 125-144.

Dusuki, A.W. and Bouheraoua, S. (2011), “The framework of maqāṣid al-Sharīʿah and its implication for Islamic finance”, Islam and Civilisational Renewal, Vol. 2 No. 2, pp. 316-336.

Epstein, B.J. and Jermakowicz, E.K. (2010), WILEY Interpretation and Application of International Financial Reporting Standards, John Wiley and Sons, Hoboken, NJ.

Hanif, M. (2016), “Economic substance or legal form: an evaluation of Islamic finance practice”, International Journal of Islamic and Middle Eastern Finance and Management , Vol. 9 No. 2, pp. 277-295.

Hasan, Z. (2015), “Risk sharing versus risk transfer in Islamic finance: a critical appraisal”, ISRA International Journal of Islamic Finance, Vol. 7 No. 1, pp. 7-26.

Ibn Bayyah, A.A. (2010), Maqasid al-Muuamalat wa Marasid al-Waqiuat, Al Furqan Islamic Heritage Foundation, London.

International Accounting Standards Board (IASB) (2010), The Conceptual Framework for Financial Reporting, IFRS Foundation, London.

Iqbal, Z. and Mirakhor, A. (2011), An Introduction to Islamic Finance: Theory and Practice, John Wiley and Sons, Singapore.

ISRA (2010), “OIC Fiqh Academy ruled organised tawarruq impermissible in 2009”, available at: (accessed 17 January 2019).

ISRA (2012), Islamic Financial System: Principles and Operations, International Shari’ah Research Academy for Islamic Finance, Kuala Lumpur.

ISRA (2015), Islamic Capital Markets: Principles and Practices, International Shari’ah Research Academy for Islamic Finance, Kuala Lumpur.

ISRA (2016), Islamic Financial System: Principles and Operations, 2nd ed., International Shari’ah Research Academy for Islamic Finance, Kuala Lumpur.

Khan, F. (2010), “How ‘Islamic’ is Islamic banking?”, Journal of Economic Behavior and Organization, Vol. 76 No. 3, pp. 805-820.

Maali, B.M. and Atmeh, M.A. (2015), “Using social welfare concepts to guarantee Islamic banks’ deposits”, International Journal of Islamic and Middle Eastern Finance and Management, Vol. 8 No. 2, pp. 134-149.

Maurer, B. (2010), “Form versus substance: AAOIFI projects and Islamic fundamentals in the case of ṣukūk”, Journal of Islamic Accounting and Business Research, Vol. 1 No. 1, pp. 32-41.

McBarnet, D. and Whelan, C. (1991), “The elusive spirit of the law: formalism and the struggle for legal control”, The Modern Law Review, Vol. 54 No. 6, pp. 848-873.

Mohamad, N. and Ab Rahman, A. (2014), “Tawarruq application in Islamic banking: a review of the literature”, International Journal of Islamic and Middle Eastern Finance and Management, Vol. 7 No. 4, pp. 485-501.

Rosly, S.A. (2010), “Shariah parameters reconsidered”, International Journal of Islamic and Middle Eastern Finance and Management, Vol. 3 No. 2, pp. 132-146.

Shaharuddin, A. (2012), “The bayʿ al-ʿīnah controversy in Malaysian Islamic banking”, Arab Law Quarterly, Vol. 26 No. 4, pp. 499-511.

Shakil, M.H. and Mustapha, I.M. (2017), “Reporting Islamic financial transactions: need for special Islamic accounting standards”? Journal of Islamic Finance Accountancy, Vol. 1 No. 1, pp. 12-17.

Soualhi, Y. (2015), “Application of Sharīʿah contracts in contemporary Islamic finance: a maqāṣid perspective”, Intellectual Discourse, Vol. 23, pp. 333-354.

Tasnia, M., Mustapha, I.M. and Shakil, M.H. (2017), “Critical assessment of the legal recourse for the case of sukuk default for the asset-backed sukuk and asset-based sukuk structures”, European Journal of Islamic Finance, Vol. 4 No. 2, pp. 1-6.

Usmani, M.T. (2002), An Introduction to Islamic Finance, Kluwer Law International.

Zaher, T.S. and Hassan, M.K. (2001), “A comparative literature survey of Islamic finance and banking”, Financial Markets, Institutions and Instruments, Vol. 10 No. 4, pp. 155-199.

Corresponding author

Mohammad Hassan Shakil can be contacted at:

About the authors

Mohamed Hamour is an Independent Researcher of Islamic finance. He is a PhD Candidate in Islamic finance at the International Centre for Education in Islamic Finance (INCEIF), Kuala Lumpur, Malaysia.

Mohammad Hassan Shakil is a PhD Candidate in business as well as a tutor at Taylor’s University, Malaysia. He received MSc in Islamic finance from INCEIF, Malaysia, and was a recipient of a masters scholarship from the Islamic Research and Training Institute (IRTI), a member of Islamic Development Bank Group (IDBG).

Ishaq Mustapha Akinlaso is a PhD Candidate in Islamic finance at INCEIF. He obtained MSc in Islamic finance from the same institution.

Mashiyat Tasnia is a PhD Candidate of Islamic banking and finance at the IIUM Institute of Islamic Banking and Finance (IIiBF) of the International Islamic University Malaysia (IIUM), Kuala Lumpur, Malaysia.