CGT: devil is in the detail

KSE-100s rebound on the first trading day after the budget is partially attributed to the continuation of technical rebound.
Monday also saw market participants rejoicing the noise that any purchase of stocks prior to July 1, 2010 will remain exempted from the capital gain tax. This has been confirmed by Asrar Rauf, Member (Policy) Direct Taxes FBR and as well by a leading tax expert.
However, when it comes to the modalities of advance tax payment on a quarterly basis, the expectations of market players and the wisdom of tax authorities are at different tangents.
Individuals lack the administrative wherewithal to file quarterly tax return unlike companies and institutions.
It is understandable that tight fiscal situation is compelling the authorities to collect taxes earlier, but the government also needs to be sympathetic. Instead of demanding the advance payment of CGT every quarter, the government should allow the individuals to pay every six months.
A related worry is that of mutual funds.
Mutual funds and insurance companies, who were exempted from capital gain tax on securities, will no more enjoy this tax holiday and treated at par with proprietary trading of shares.
In other words, according to Rauf, they will pay capital gain tax on shares trading as prescribed in the latest finance bill. Interestingly, however, a leading mutual fund executive, citing Asrar Rauf, informed BR Research that mutual funds will remain exempted from all kind of taxes.
Though, only time will make things clearer, in case the mutual funds are taxed, it could be detrimental for the nascent asset management industry in Pakistan.
This is because if an investor buys the shares of a closed end mutual fund, he will pay CGT on selling it within a years time, while that very fund will also be paying CGT on securities it transacted within the CGT applicable period.
In addition, the fund will be paying 10 percent tax on any dividend income earned on its holding - something which was previously exempted. This implies a double taxation for mutual fund unit holders, according to industry experts, and investors might soon lose interest in mutual fund investing.
However, the wisdom of tax authorities behind this move is to encourage mutual funds to make long-term investments, which are still exempted from CGT. This argument makes sense.
Policy makers have long been critical of the objectionable practices employed by big players in capital markets, who are running brokerage, mutual fund and banking businesses under one umbrella. But whats done is done; taxing mutual funds on short-term capital gains can discourage them from expropriation and day trading.
This step, along with tax incentives on new listing and capital expenditure will help corporatization and capital market development in Pakistan.

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CAPITAL GAIN TAX

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Tax years  Holding period   Holding period

             <6 months         6-12 months

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2011             10.0%                7.5%

2012             10.0%                8.0%

2013             12.5%                8.5%

2014             15.0%                9.0%

2015             17.5%                9.5%

2016             17.5%               10.0%

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Source: Finance Bill 2010