Taking stock of stock market response

As soon as the news started filtering through that the Securities and Exchange Commission of Pakistan (SECP) and the Federal Board of Revenue (FBR) have come to an understanding that revenue hounds would not question the source of funds used to purchase shares during the last five years until 2014, both the KSE index and volume improved significantly. Not only did the index cross 12,000 mark on Monday, the volume was the highest in one year. Liquidity is like oxygen for the stock market. Imposition of Capital Gains Tax (CGT), at a lower rate, than applicable on other income was the right move but at the wrong time. The CGT should have been imposed in 2001/2002 when the market was unnecessarily shooting up. This newspaper was supportive of the imposition of the CGT and disapproved the repeated extension of this levy by both Zafarullah Jamali and Shaukat Aziz, the then Prime Ministers of Pakistan, under General Musharraf's rule. The decision to give the last extension by President Asif Ali Zardari was even resented by the then Finance Minister, Shaukat Tarin. It goes to the credit of the incumbent Finance Minister Dr Hafeez Sheikh for first imposing and then resisting CGT abolition in the last budget and waiting to see CGT collection until December this year (when the tax year ends). The collection is said to a meagre amount because the listed scrips' values have fallen like nine pins. Market capitalisation has come down to $35 billion from its peak of $75 billion. And, the capital value of listed PSEs has reduced to a modest $12 billion. Capital gains tax on shares was imposed in July 2010 after the disastrous decision to shut the market on account of falling reserves in 2007, disallowing investors from existing. For 33 years, there had been no CGT on shares. Investors had built portfolios that may have been from tax paid savings but were not documented. But in all honesty, most of the volumes generated on the exchanges were based on the input from investors outside the tax net - guys who do not show up on Federal Board of Revenue's radar. With the introduction of a Unique Identification Number (UIN) and the induction of CDC and settlement through NCCL, it is now physically possible to track individual investors. Fearing official harassment, most stock investors have chosen to withdraw from the market and divert their savings into other assets such as: suttar mandi, kapra market, financing sugar and other agri-commodities. As a result currency-in-circulation has shot up from the traditional level of 21/22 percent of money supply to over 34 percent of money supply, ie over a trillion rupees. Some of this is also parked in real estate, gold and forex holdings. SECP has been pleading with the FBR that targeting one asset class for taxation, while others are free from effective taxation as their collection is the responsibility of provinces, is neither fair nor even handed. The recent SECP proposal is to maintain CGT on shares while tinkering with the mechanisms of its collection without compromising on documentation. It is proposed to move away from indirect tax based on turnover and avoid double-taxation of transactions at the Stock Exchange level. It is proposed to keep a single withholding tax on gains of transaction with collection by National Clearing Company Limited where shares are held electronically. At the end of the year, investors will obtain a certificate from the NCCL of tax deduction, just like they obtain from their banks to make them part incorporate in their annual tax returns. The questions raised by critics are: (a) "Why is the caveat of 'no questions asked on source of funds until 2014'," and (b) "Are we going to open another avenue to whiten black money?" Both questions are highly pertinent because the simplest questions are the most profound. If the prime objective is to inject liquidity into the market, then in order to avail this opportunity a holding period of 30 to 90 days needs to be imposed on the investor of a scrip. It also needs to be recognised up-front that for two years no question on source of income is a price to lure people towards documentation of this vital sector. The filip of the proposal side is to get the right benchmark for off-loading of government stakes in the publicly-managed listed companies. At present value it is economical for an investor to buy an existing company than to establish a new one. Policymakers also need to look afresh at the tax policy and correct the tax rates whereby partnership and proprietorship concerns as well as Association of Persons (AoPs) are encouraged to convert their businesses into limited companies. This would help in documentation. The long-awaited demand that dividend distributed after payment of tax from retained earnings need must not be taxed again deserves serious consideration. And, above all else, government borrowing needs to be reduced to stop its onslaught on private credit space. Similarly, corporate sector should be debarred from investing in national-saving schemes and debt market created in real terms to expand the pool of savings. But all this is only possible if the fiscal deficit is successfully reduced to three to four percent of the GDP in reality and not through any gimmick or an innovative strategem or scheme employed especially to promote a project that clearly shows an unusual accounting contrivance. Copyright Business Recorder, 2012