Sources told Business Recorder here on Saturday that SECP Chairman Muhammad Ali has written a letter to Minister of Finance Dr Abdul Hafeez Sheikh, FBR Chairman Salman Siddique and all the three stock exchanges to submit a workable solution on the issue of the CGT on securities'' trading. The SECP Chairman has given viable suggestions which would not only ensure collection of the CGT from stock exchanges, but also confirm documentation in a systematic manner without disturbing FBR revenue collection.
According to SECP proposals to the Finance Ministry, continuation of withholding tax after CGT is double taxation ie taxing both turnover and net income. Equity demands that with the imposition of CGT, withholding tax (WHT) on turnover should be done away with. The SECP has also proposed comprehensive amendments in the Income Tax Ordinance 2001 to revise collection mechanism of the CGT from stock exchanges.
The SECP has further proposed that National Clearing Company of Pakistan (NCCPL) shall act as a withholding agent to deduct and deposit the CGT from investors'' transactions. The NCCPL shall also provide investor-wise monthly report of CGT deducted and deposited for each investor to FBR and issue a certificate to the investor of the amount deducted. The investor will file tax return, including the CGT deposited, based on the certificate provided by NCCPL and would be exempt from CGT record maintenance requirements under CGT Rules of the FBR.
The SECP has categorically conveyed to the Federal Board of Revenue (FBR) that a general consensus has been developed, saying that maintaining status quo on the CGT is not in the interest of the economy as it has adversely impacted tax collection, investors'' sentiment, capital formation and overall functioning of the capital markets.
The SECP has written a letter to the FBR Chairman Salman Siddiquei and all three stock exchanges on the issue of the CGT on securities trading. According to the SECP letter, during deliberations between the SECP and the FBR there was a general consensus that maintaining status quo on capital gain tax (CGT) is not in the interest of the economy as it has adversely impacted tax revenue collection as well as trading volume at capital markets (CM). Besides these, CGT has adversely affected investors'' sentiment, capital formation and overall functioning of the capital markets.
The SECP has objectively analysed the situation by looking at the global trends, impact of CGT on the capital market, and issues with present CGT regime and is placed to share its proposal to revamp CGT regime in a manner which not only addresses issues highlighted above but also meets overall objectives of FBR, SECP and capital market.
The CGT regime is in place in many developed jurisdictions, like Australia, Canada, Brazil, China, France, and Germany. However, it encompasses all asset classes such as securities, immovable properties, collectibles, and other personal assets. While in developing jurisdictions CGT applicability varies from jurisdiction to jurisdiction.
The CGT regimes across the globe have evolved differently as per each country''s political, fiscal and economic environment. Securities are usually brought under CGT regime after a country has achieved certain level of capital market depth, investor outreach, and adequate capital formation and documentation.
In Pakistan, securities'' trading remained exempt from CGT for 36 years (since 1974) till June 30, 2010. Imposition of CGT on securities trading from July 1, 2010 has not only impacted the tax revenue (less than 10 percent of figure three years ago) but has also reduced average traded value to the lowest level during the last ten years, the SECP said.
Tax collection data depicted that value traded at stock exchange has direct bearing on the tax collection, and vice versa. This is evidence of market''s willingness to pay taxes as capital market and WHT imposed in 2004 and rate of tax doubled in 2006, were well absorbed by the market since then there is ease in transaction; economic viability and minimum interaction with tax authorities.
In the absence of above three factors, apart from decline in trading volume and revenue, existing CGT regime has also impacted capital market in following manner:
1. Price Discovery: Dwindling trading volume post-CGT imposition has raised question marks on the effectiveness of price discovery at the stock exchanges and ha increased impact cost. This raises issue of sustainability of the quoted prices and has ramifications as Pakistan is excluded from various world indices.
2. Withdrawal of investors: Number of active investors in capital market has dramatically reduced, in particular retail investors. The situation becomes even more complex as investors exited the market and moved funds to other business avenues, which are either exempt or under presumptive tax regime.
3. Business viability: Revenue of exchanges and market intermediaries is directly linked with trading volume; decline of volume has raised viability concerns of these entities as reflected in Chart-II. A number of intermediaries have either closed or are facing closure due to financial difficulties.
4. Capital formation and resource allocation: A number of companies have deferred plans of fund raising from the capital market due to lack of investors'' appetite. In recent past, IPO of two major business houses remained under-subscribed. Trend is alarming for overall economic activity and GOP privatisation program through capital market.
The SECP has further informed the Finance Ministry that it is pertinent to mention that Global Financial Crisis in 2008 impacted capital markets across the globe. However, majority of capital markets, except Pakistan, recovered from its adverse effects and gradually stabilised or grew.
Highlighting the issue in CGT implementation and objectives of stakeholders, sources referred to the SECP letter and said that the capital market remained exempt from CGT for past 36 years. This created an anomaly in shape of undocumented gains accrued through transactions in the capital market during this period. Even though the requirement of filing of tax returns was there, it was neither followed by capital market nor implemented by FBR. This led to a situation where capital market investors ended up with legitimate but undocumented gains. Abrupt change from exempt regime without factoring this anomaly has forced investors to withdraw funds from capital market.
Another issue is cumbersome calculation and documentation requirements embedded in CGT regime. Prior to CGT imposition, capital market remained under the presumptive tax regime under which tax was deducted and deposited by the exchange. Lastly, continuation of withholding tax after CGT is double taxation ie taxing both turnover and net income. Equity demands that with imposition of CGT, withholding tax (WHT) on turnover should be done away with, sources said.
Key stakeholders in Pakistan''s CGT regime are FBR, SECP and capital market including exchanges, intermediaries and investors. Key objectives of these stakeholders are:-
The SECP has proposed that taking into consideration above highlighted issues and stakeholders'' objectives, SECP recommends implementation of following measures in CGT regime that will address the issue and achieve objectives of all stakeholders.
The SECP has also explained the anomaly of undocumented gains during exempt period and double taxation. As the documentation is not available to substantiate the gains made from capital markets transactions during the exempt period, it is proposed that applicability of Section 111 of Income Tax Ordinance, 2001 (ITO) requiring unexplained income or assets may be deferred for funds invested in capital markets till June 30, 2014. Post-June 2014, highest or peak value of an investor''s portfolio between now till then should be treated as income generated from the capital market and part of investor''s wealth.
It is further proposed to abolish the WHT under section 233A to rectify double taxation anomaly and to freeze the CGT rate at the current rate applicable for the year 2011-12.
Following amendments in Second Schedule, Part-IV are proposed to address the issue:
Suspension of applicability of section-111: Applicability of sec-111 shall be suspended from April, 2012 till 30th June, 2014 by inserting clauses 80 and 81 in Part -IV of 2nd Schedule as:
---- "(80) the provisions of section 111, part X and part XI of Chapter X shall not apply in respect of any amount of income of any income year or years ended on or before June 30, 2014, inserted by individuals in the stock exchange registered in Pakistan."
---- Provided that no tax shall be deducted under section 233A(1) till June 30, 2014.
---- "(81) No assessment orders for an individual will be made under section 121, 122, 122A, 122B, 122C or 123 for any amounts declared in the returns as inserted under clause 80 Part-IV of Second Schedule on or after April 1, 2012 till June 30, 2014".
---- It has been further proposed that no audit proceedings under section 177 will be undertaken for the declared amount. Freezing Existing CGT rate: To simplify calculation and achieve smooth implementation of CGT, it is proposed to freeze the CGT rate at existing levels and a new clause 27 be introduced in Part-II of the 2nd Schedule:
---- "(27) The rate of tax specified in Division VII of Part-I of the First Schedule shall be 10 percent on capital gains arising on securities held for a period up to six months and 8 percent on capital gain arising on securities held for a period above six months to one year, for any person for any amount inserted in the stock markets in Pakistan on of after April 1, 2012 till June 30, 2014".
As far as calculation and documentation requirements are concerned, the SECP stated that to simplify and ensure timely deposit of tax revenue, centralised collection mechanism at National Cleaning Company of Pakistan (NCCPL) is recommended. The NCCPL, shall act as a withholding agent to deduct and deposit the CGT from investors transactions. At the end of every month, NCCPI, shall deposit the amount deducted from investors making capital gains after adjusting for the investors suffering capital losses (ie on net aggregate basis) with FBR. The NCCPL, shall also provide investor wise monthly report of CGT deducted and deposited for each investor to FBR and issue a certificate to the investor (at year end) of the amount deducted.
Sources said that the investor will file tax return, including the CGT deposited, based on the certificate provided by NCCPL and would be exempt from CGT record maintenance requirements under CGT Rules. The FBR will benefit with immediate CGT revenue stream from the capital market while for investors this would entail no tax avoidance and no interface with FBR. Following amendments are acceded in Part III of Income Tax Rules of 2002.
---- Rule 131 "payment of tax on capital gain" clause (3) shall accordingly be amended and Rule 131 : "liability of broker" shall be declared.
---- Rule 131 of CGT Rules shall therefore not be applicable for individual investors.
The SECP stated that the proposed amendments in CGT regime bear advantages including documentary trail of undocumented income; no presumptive regime - example for other sectors; correction of anomaly where exempted gains in past were not documented; higher revenue for the government; broadening of tax base; depth in trading volume; efficient price discovery; efficient capital formation and resource allocation; higher possibility for privatisation and attraction of foreign portfolio investment, SECP maintained.
Sources further said that an argument against the proposals can be that gains made outside capital market would also be documented and scheme of payment of investment tax involving declaration and upfront onetime charge may be suggested. In our view, even today there are options available in the country through which income could be documented incurring onetime upfront cost without any benefit to the exchequer. Therefore, any upfront payment of tax before making an investment would be counterproductive in achieving the overall objective of the proposal, as well as objectives of various stakeholders highlighted above ie documentation of income and economy broadening of tax base, higher tax revenue, revival of capital market, etc. Furthermore, the tax collection by the government from CGT and other income, for all times to come once an investment is made and documented, will be far greater than onetime upfront charge, the SECP explained.
As per SECP, the proposal is the best way forward, not only to retain the overall spirit of CGT regime but also to achieve various stakeholders'' objectives and revive capital market. It is believed that its implementation will, apart from generating additional revenue for the government, attain sustainable economic growth for all sectors of the economy, in particular the capital markets. The SECP may meet to discuss the proposal in detail, and once broad contours of the proposed amendments in CGT regime are agreed, officers from FBR and SECP can work out the modalities for its early implementation, sources added.