CGT: still in search of balance

Business Recorder had refrained from proffering any comment on the proposal submitted by the Securities & Exchange Commission of Pakistan (SECP) in relation to some proposed changes in the Capital Gain Tax (CGT) regime until the finalisation of the scheme by the Federal Board of Revenue (FBR). The situation has inclined us to present our perspective because an unnecessary controversy has been sought to be created over reports that a money-laundering scheme is being launched to provide a window to those people in power who have earned kickbacks and commissions during the last four years to whiten their ill-gotten wealth. We would be very surprised if such a thing could happen under the watch of incumbent Finance Minister Dr Abdul Hafeez Sheikh. People appear to have forgotten that it was Dr Sheikh, who levied the CGT on shares' trading after a tax-free ride of 36 years. Prime Ministers and Finance Ministers, year after year, gave the listed share transactions exemption from tax, believing that the KSE index had become synonymous with country's improved macroeconomic indicators. What an irony. The last extension of CGT exemption was allowed in 2008 under a directive of co-Chairman PPP Asif Ali Zardari despite some stiff opposition from the then Chairman of Prime Minister's Economic Advisory team, Shaukat Tarin, and the Federal Finance Minister Naveed Qamar. Hafeez Sheikh in his maiden 2010-11 budget speech held out a firm pledge to end it. And, he did. Unfortunately, however, not only did the FBR experts take more than six months to make the necessary rules, the implementation of CGT regime had been found to be notoriously weak. As a result, the entire collection is hardly 25 percent of the envisaged targeted amount. This is a stark reality. The CGT on securities held for a period of less than one year is applicable from July 1, 2010. The rate of 7.5 to 10 percent is applicable on a net income basis, if shares are held from six to 12 months and into 17.5 percent if held for less than six months. Currently, the withholding tax at the rate of 0.01 percent of the trade value is adjustable. At his last visit to the KSE, Finance Minister Sheikh announced that the SECP proposal finalized after discussion with the stakeholders was accepted "in principle". If something can be done in principle, there is no good reason why it should not be done although it has not yet been done and there may be some difficulties. It is stated to be applicable from April 1, 2012. The time sought for actualization was apparently meant to address the valid concerns that the new system should not give birth to an intriguing and small window of opportunity in which to whiten ill-gotten wealth. Chairman SECP Muhammad Ali is cognizant of both the opposition to the scheme and Dr Sheikh's sensitivities to criticism that stems from unsubstantiated reports that Hafeez too has succumbed to the pressure of those who are not in the habit of paying taxes - powerful hereditary elite, whether royal or rich. Tax is levied by them on the citizens and collected by them to spend according to their wishes. The world has moved on. Kingliness and regal dignity hardly have any place in republics. Arguably, sovereign is now the Parliament. It levies taxes and a legitimate elected government is empowered to collect and spend it in accordance with a National Assembly-endorsed budget plan. To make sense, CGT scheme should not be looked at in isolation. It needs to be examined and investigated why collection of CGT failed to materialize at the targeted level. And, how funds that have been withdrawn from the capital market can, once again, be successfully persuaded to come back so that state can benefit, with the right index level and adequate liquidity to offload government held scrips to payoff the public debt. Let us recognize the fact that the CGT imposition has not yielded the desired results. The exchequer has not received the expected revenue whereas the investors have shied away because they are nervous or frightened on account of complications in calculation and growing perception of harassment for their sources of income. It also needs to be recognized that for the last 36 years when securities trading remained exempt from the levy of CGT, no filing was made or asked by the FBR, thereby leading to creation of massive undocumented gains through transactions in the capital market. As such, it is extremely difficult, if not impossible, to fully document past gains accrued through share trading. However, there is a need to document these past gains. This requires a declaration with the annual tax return and the wealth statement filed by the taxpayer. The SECP has underscored the need for creating a Chinese wall between the investors who take a dim view of tax collector, i.e., the National Clearing Company Pakistan Limited (NCCPL) - which is a clearing house for all transactions on the bourses. NCCPL should not only be the collecting agent but it also be entrusted with the task to calculate CGT on transactions and adjustment of losses with a view to minimizing the interaction - or friction - between the tax authorities and the portfolio investors. The NCCPL would undertake calculation and maintain data as well as issue tax deduction certificates to investors who will be required to file these certificates along with their tax returns with the FBR. To most skeptics, an amnesty with a no-question provision for past transactions is acceptable as the documentation needed by the taxpayer as well as tax collector is just not available. The focus of criticism is on the question: why no questions asked for future transactions undertaken between April 1, 2012 upto June 30, 2014? The rationale for this appears to be that the funds that have flown out from the stock exchange after the imposition of CGT are not lying idle. They have been deployed in other assets. Time is needed to liquidate assets such as: real estate; commodities including sugar and gold, and bring them back into the capital market. After all, time-bound concessions have been the norm to attract investment in targeted sectors of the economy. In order to block the use of new CGT mechanism as a money-laundering window certain caveats could be introduced of a holding period ranging from 45 to 120 days for the weighted amount invested to avail the scheme. These transactions must only be on the Ready Board and delivery undertaken. Similarly, a single transaction with a single financing of buying on Ready Board and selling in futures needs to be prohibited. Unique Identification Number (UIN) trail has to be monitored in every transaction of sale and purchase of scrip as a key measure towards achieving the success of this scheme. Filing of tax returns and wealth statements after April 1, needs to be a mandatory prerequisite while all kinds of presumptive taxation on share trading needs to be withdrawn. Applicability of other laws such as Anti-Terrorism Act and Anti-Money-Laundering Act should continue to be in vogue. In the event of any non-compliance by an investor to file statement of investment with NCCPL or return of income and wealth statement for the tax year would render his case to FBR scrutiny. Let us, then, finally wake up to his reality. Let us embrace the truth. The size of non-regulated economy is dangerously huge while the taxation effectiveness is profoundly weak. We cannot correct the situation overnight. A fair price needs to be paid to bring this non-documented wealth into the documented sector. Further, we need to move the tax system on the right course by phasing out the presumptive and final tax regimes and force the citizens to file return of their net income. Let there be the clarity of thought, purpose and vision that the KSE Index has risen and daily volumes improved due to the optics about the impending changes in the CGT scheme provided by brokers. It needs to be nipped in the bud that only those persons will be eligible to trade on the bourses who regularly file their return of incomes and wealth statements. And the FBR will have access to the full record maintained by the NCCPL as well as the CDC. Let us not allow the wholesale investor to take the retail investor for a ride. Copyright Business Recorder, 2012