Amnesty is justified!

The Karachi Stock Exchange (KSE) performance during the year ending December 31, 2011 remained fairly disappointing. The total annual turnover of shares at KSE fell from 30313 million shares to only 19610 million during this period. Similarly, the KSE 100 Index dropped from 12022 to 11374 resulting in a net drop of 675 points.
The entire year passed without any meaningful progress on efforts to improve its performance. It remained a rudderless ship. Foreign investors remained unwilling to invest in local capital markets, which resulted in a net outflow of USD 123 million from selling by foreign investors. Local investors almost abandoned the capital markets on various fears.
Prior to the imposition of CGT on stock exchange transactions, the Federal Board of Revenue (FBR) used to collect on average Rs 4.5 billion tax annually from the stock market but after the imposition of the CGT, the collection fell drastically to about 500 million rupees last year. In view of this sluggish performance of the capital markets, the Chairman Securities and Exchange Commission of Pakistan (SECP) convinced various stakeholders of the federal government to rehabilitate the capital markets by taking appropriate measures.
Thus, the Minister announced some major policy measures for stock exchanges investors. This included revised procedure on collection of capital gains tax (CGT), and the past investment in stocks and shares would not be probed under section 111 of the Income Tax Ordinance 2001. In addition, the government promised to impose a bar on the officials of the FBR from probing investments made in the stocks and shares during the last five years. He further announced that the government intends to freeze the existing rate of CGT of 2011-2012 for another two years. As the SECP was of the view that due to lack of satisfactory documentation that could substantiate the previous gains made from the capital market transactions during the exempt period, investors would be unwilling to invest in stock market trading due to the fear that the investors would not be able to satisfy the FBR staff regarding their source of income. To address this concern, it was announced that the applicability of Section 111 requiring unexplained income or assets may be deferred for funds invested in capital markets till June 30th 2014. Post-June 2014, highest or peak value of an investor's portfolio between now and then would be treated as income generated from the capital market and will become part of investor's wealth. In order to remove a double taxation anomaly, it was also decided to abolish the Withholding Tax that is being deducted from investor's transaction under section 233A of the Income Tax Ordinance 2001.
The imposition of CGT and its mode of collection remained a major concern for the market players and it seems that it was the major reason for drastic decline in the daily trade at the KSE. To address this issue, the SECP advised the collection of the capital gains tax (CGT) at the National Clearing Company (NCCPL) level that would ensure deduction of CGT at source for each investor/trader and deposit it with the Federal Board of Revenue. This change, if implemented should almost reduce the interaction of taxpayers with the FBR staff and hopefully, the collection would be done without harassment and corrupt practices.
The Chairman of SECP took personal initiative to convince the officials of the Ministry of Finance and the FBR that the proposed amendments in the CGT regime bear advantages, including a documentary trail of undocumented income; no presumptive regime, correction of double taxation anomaly, higher revenue for the government, and broadening the tax base. It would further assist in creating depth in trading volumes, efficient price discovery, efficient capital formation and resource allocation. Its resulting impact would be higher possibility of privatisation, encouraging higher inflow of foreign exchange and direct investment in portfolio management.
There is another school of thought that objected to these proposals and argued that these measures amounts to amnesty for tax dodgers and money launderers. In support of their argument, It was stated "Suppose an individual invests Rs 500 million in stocks at the KSE and the very next day asks his broker to sell all the stocks and give him a cheque for the sale proceeds, he will have legal funds of half a billion rupees, laundered without any hassle or cost." This conclusion is flawed because of the following reasons.
Firstly, brokerage houses do not accept cash to buy shares as KSE regulations prohibits cash deposits of any sort and if it accepts a cash deposit then it desires that it must be disclosed to the KSE by the receiving bank on the same day with a declaration from the brokerage house as to its purpose, name of the payee and the reason for accepting cash. The only way to pay a stock brokerage house is through banking channel. If payment is made through proper banking channel, then it is not laundered money and the bank should be able to justify the source of those funds. Therefore, the premise of critic's argument is ill founded and is not based upon the ground-realities.
Some critics also argue that investors and traders at the Stock Exchanges do not pay their share of taxes; their entire wealth is dubious as the sources of their wealth are not known. If amnesty is to be given than why not give it to other sectors also where there are more opportunities for job creation. This perception is also ill founded as this is the only sector that is fully documented if compared with others and that is reflected as hereunder:
Firstly, the functioning of stock exchanges is highly regulated. In order to trade at these places, one has to fill in a lengthy form that provides information relating to the applicant's full name, address, I.D. number, bank account number, his verified signatures by the bank manager, verification by NADRA that it is one's true identity, that he is not a terrorist and that he is not a reported money launderer. Is it not enough information for a person who wishes to invest in the shares of national institutions? This situation should be compared with alternative investments such as National Saving Schemes (NSS) where If someone wishes to invest he just walks into the centre, pays cash amount and buys investments of whatever nature just within five minutes. You can buy billions of rupees prize bonds without any question asked. Unofficial remittances through "hawala" and other methods in the UAE or UK are as easy as one can imagine and no questions asked for the source of these deposits. The only restriction in the UK is to answer questions if one is withdrawing cash money beyond a certain limit. One has to disclose the purpose of the withdrawal and not the source of deposit.
Secondly, it is not an amnesty at all. Amnesty is defined as condoning criminal acts. Here, since long, income or gains generated through stock exchange trading remained tax exempt by law. So everyone rightly or wrongly was under the impression that as the income was exempt, there was no need to file a tax return showing exempt income, as is the case with agriculture income. There was also no effort from the Federal Board of Revenue to advertise or highlight this omission that even if the income is tax exempt, individuals have to file tax returns. So if an individual is to be blamed for this omission then the FBR is equally liable for this omission. In this case, the income remained tax exempt but was not declared. So if this is an amnesty, it is for not filing tax return and not for hiding exempt income. Even if it would have been reported, there was nothing the FBR could do to make it taxable income. We have so many examples where several developed western economies gave amnesties to all illegal immigrants as the benefits to provide amnesty to illegal workers outweighed the disadvantages of not providing amnesty. The list includes UK and USA.
Thirdly, the omission is justified on the grounds that its future benefits would outweigh the current sluggishness in our capital markets resulting in loss of revenue to the exchequer through lower revenue collection. There is also strong possibility that if this remains an unacceptable wealth, it might become the basis of capital flight to places where no questions are asked about the source of capital. Is it acceptable to us? We must encourage wealth to come out from hidden places and be productive within the national economy.
(The writer is a Fellow of Chartered Management Accountant and has done his Masters in Commercial Law from United Kingdom)