Levying tax on capital gains

By Sultan Ahmad

http://www.dawn.com/2007/04/30/ebr13.htm

THERE have been insistent demands from many quarters for the imposition of capital gains tax on the large income from investment on shares of companies. The demand has become very insistent after the Karachi Stock Exchange 100 index shot up to 12,000 and large fortunes began to be made by some individuals through outright speculations in the market.At the same time prices of land shot up and real estate prices became too high, vastly increasing the fortune of some persons even with a small piece of land in a significant area. If by now a new apartment being built in Karachi can cost as much as Rs40 million it shows a new dimension of the real estate business.But the political consensus now is that land is a provincial subject and any tax on land should be a provincial tax, including all kinds of real estate transactions. And that gives rise to the issue whether build up real estate in areas like defence housing authorities all over the country can be treated differently from a simple land transaction which can be in the provincial domain.But while many institutions have urged the imposition of capital gains tax on shares, few have come up with specific rates. Meanwhile, the government has been keeping on extending the exemption from capital gains tax by one to two years.But the Institute of Chartered Accountants, which is a representative body of accountants who audit accounts of all corporate entities, has come up with a new formula. It has suggested a levy of 20 per cent tax on those who hold their assets for less than one year, five per cent tax on sale after one year and before the completion of five years and no tax on sale thereafter.The 20 per cent tax may seem too high to shareholders who are now paying a nominal capital value tax more for documentation than for real taxation and a 10 per cent tax if the share is held long enough to earn a dividend.As a result of boom in stock exchange, the government’s income from companies, including companies earmarked for privatisation, has risen very high.A boom in stock exchange helps the government in many ways. Apart from rising income from dividend, it collects a far larger sum as 10 per cent tax on dividends of others, which the corporate sector describes as double taxation of the corporate income, plus 2.5 per cent zakat from a large number of shareholders other than those who do not furnish sect certificate.For these reasons, as well as the preference to treat the KSE hundred index as the index of economic success of the government, and to attract more foreign direct investment, Prime Minister Shaukat Aziz is disinclined to levy a capital gains tax on share transactions despite the fact it could yield large profits. At a time when the low tax-to- GDP ratio is being deplored by the donors, there is no valid reason why this most obvious remedy is not being applied.The ICAP has also called for a reduction in the rate of corporate tax from its peak of 35 per cent. The ICAP is among the many institutions of tax payers who have called for reduction of the maximum rate of corporate tax from 35 to 30 per cent. Among them are the Federation of Pakistan Chambers of Commerce and Industry, overseas investors’ chamber and the American Chamber of Commerce. The government is inclined to accept this demand, but whether it will be done in the forthcoming budget or later is not known.The chartered accountants, who are alive to the fiscal problem of the country, have also called for a provincial capital gains tax on real estate transactions with a low rate of taxation to be reintroduced on sale of immovable property. They do not want the centre to collect taxes on real estate transactions.The major stockbrokers in stock exchanges and the professional speculators will oppose the 20 per cent levy on share transactions. They certainly are not in the business for holding the shares for a year before disposing them off.The capital gains tax will hurt initially the speculators among whom some buy shares in the morning and sell them in the evening. They are content with even small gains as they don’t pay the brokers fees either when selling or buying. But if the shares are held for more than a year, the five per cent CGT is not too heavy. The capitals gains tax has a two-fold advantage, it checks wild speculation and adds to the revenue of the government and strengthens the real investors.Now those who hold shares as investors or savers lose if they do not declare themselves as belonging to a sect which does not have to pay Zakat. They also lose 10 per cent of the tax on dividend after their companies had paid full corporate tax which is high in the country with multiple taxes.Small investors have moved away from the stock exchange. That happened even before the KSE 100 index rose to around 12,000. It happened when the KSE decided that the minimum number of shares it would trade would be 500. Along with that, the prices of many blue chips have shot up. You need big money now to play the stock exchange unless you have got a number of shares allotted during the initial public offering (IPO). Of course, if you don’t have your own money you can borrow from brokers but then you will run a risk as many have, to come to learn the government has provided for the continuous flow system (CFS) under which borrowing touched the peak of Rs54.5 billion last week. The KSE wanted the limit to be raised but the SECP refused.The small investors now have to be content with the mutual funds led by the NIT whose unit holders are doing very well after losing heavily earlier so more and more mutual funds are coming up sponsored by the top brokers which are proving to be popular.The chartered accountants also want the tax on dividend payments to be exempted on inter-corporate dividend payments so that groups of companies could be found.Present taxation system discourages group formation and it makes Pakistan out of step with the world.The real profit and today’s share prices are not so much from dividends unless you got the shares allotted during the IPO or through bonus shares. The real profit comes from small circulation which is done both intelligently and cautiously. It has become more and more an insiders’ game with knowledge of what will happen to particulars companies and trimming their own sales accordingly.