Tuesday, July 10, 2007

Taxing the bourses

By Usman Hayat

http://www.dawn.com/2007/05/14/ebr15.htm


There are four major taxes that have a relatively direct and strong impact on the stock market.These are: (i) capital gains tax, (ii) transaction taxes, including capital value tax (CVT) (iii) tax on dividends and, (iv) income tax for listed companies.Share trading is exempt from capital gains tax till June 2007. This exemption is in place since 1974 and it has been consistently renewed by different governments. Since a lot of money is made and lost (usually not by the same set of people!) in short -term trading, many argue in favour of imposition of capital gains tax to raise revenue for development expenditure. This tax is in force in a number of developed and developing countries such as UK and India.Due to the UIN system, measuring and collecting capital gains tax with reasonable degree of accuracy has now become possible. However, while addressing the KSE Top Companies Award ceremony in January 2007, prime minister announced that exemption from capital gains tax would be extended by one more year to end June 2008.He is also reported to have shown his willingness to consider reduction in transaction taxes. Perhaps this also explains why KSE’s tax proposal for the financial year 2007-08 is silent on the issue of capital gains tax and wants elimination of transaction taxes.Capital Value Tax (CVT) and other withholding taxes on transactions were introduced in 2004-05. Under pressure from stock brokers, government reduced the rate of CVT from an unrealistic rate of 0.1 to 0.01 per cent. In 2005-06, rates of transaction taxes were left unchanged probably due to the fear of renewed controversies but in 2006-07 these were doubled.It is widely held that these taxes are the main reason that turnover at bourses is falling. However, the revenue collected by the government has consistently increased because while rates of taxes have doubled, traded value has not halved. KSE’s budget proposal also says that KSE has collected over Rs1.7 billion on account of transaction taxes, up 31 per cent compared to Rs1.3 billion during July-Dec 2005,Transaction taxes have indeed increased the cost of trading stocks. For instance, when in a day-trade a broker at KSE first purchases and then sells shares worth Rs1 hundred thousand in regular segment, KSE collects from him Rs58 out of which Rs50 are passed to the government on account of transaction taxes, whereas rest of the Rs8 go to the KSE, SECP, and NCCPL.These taxes on trading are widely criticised. Market participants argue that taxes should be on profits and not on trading activity. The argument clearly has weight. If the idea is to reduce “satta” in the stock market, then that is best done through measures which fall in the domain of SECP, such as eliminating ‘badla’ financing (or CFS), changing margining and settlement systems, and educating investors. If the idea is to generate revenue, then it should be generated from those who are making gains and not from everyone buying or selling securities.Next important tax for the stock market is withholding tax on dividends of listed companies. Market participants would like to see it eliminated. They argue that dividends are paid by companies out of post-tax profits therefore taxing shareholders for dividends is double-taxation. Successive governments, including this one, have continued to ignore the economic rationale against double taxation of dividends. At present dividends are being taxed at different rates for different types of investors. For instance, dividends for individuals are taxed at 10 compared to five per cent for public and insurance companies.The fourth is income tax for listed companies. Till 2002, unlisted public companies were taxed at 45 compared to 35 per cent for listed public companies. Since 2003-04, the government has been narrowing this differential at two percentage points per annum so that now both listed and unlisted companies would be taxed at 35 per cent. KSE has proposed a 25 per cent income tax rate for listed companies to encourage new listings and to compensate listed companies for the cost incurred in complying with the Code of Corporate Governance. Not every one is convinced. Others argue that whether or not a company decides to list or de-list should be based on its capital requirements rather than tax advantages and to be rewarded for better governance companies should look towards market forces and not to the government.In principle, taxes for the stock market should be levied under a clear and pre-defined framework which should be developed through a transparent and consultative process and taxes, as a policy tool, should fit in with broader policy objectives of turning the capital market into a fair, efficient, and transparency economic agent.Economic managers should have the right to exercise their best judgment in setting taxes and how the tax money would be spent but then they should also be accountable for the same. Ground realities, however are quite different. Changes in taxes are often a surprise and these changes are made on the basis of short term political pragmatism of a few. Worse, people remain unconvinced that government can put their tax money to good use and the moral cause of taxation is becoming weaker.The current economic managers are perceived to be quite friendly towards the stock market. In the wake of March 2005 stock market crisis, their soft corner for large market players has led to widespread criticism and suspicion. It is quite debatable if an average Pakistani looks at the KSE-100 to gauge what is happening to Pakistan but the desire of this government to see the index at politically correct levels has not abated. In fact, it seems to have hit a new high in the background of ongoing judicial crisis, worsening law and order situation, and upcoming elections.In view of these dominating political realities, it seems likely that finance bill for 2007-08 would probably offer more good news than bad news for the stock market, perhaps as a parting gift from the current economic managers who would later like to remind others how great the stock market used to perform when they were in office.

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