Discouraging corporatization?

The cabinet has approved amendments in the finance bill. It must be passed by parliament before it comes in effect from 1st July 2021. A few changes may lead to anti-corporatization in Pakistan – such as ending exemption on taxation on dividend income by a company eligible for group relief, income from corporate agriculture enterprise, and income on sale of immovable property under REIT structure.

Barring intercorporate dividend, there will be no visible impact as corporatization in real estate and agriculture is too low; and with this change, anyone who was thinking to corporatize will now refrain. The revenue impact of removal of inter-corporate dividend is however estimated at Rs8-10 billion.

The removal of relief on inter-corporate divided is made in haste. First a clarification is warranted on the concept. Inter corporate dividend relief is not an exemption. It is a necessary condition for corporatization in the country. It is a pre-requisite. The dividend taxation is a pass-through item and eventual shareholder pays the dividend tax invariably. This is double or triple taxation depending upon the layers of companies in a corporate structure.

If this amendment is passed, companies will go in court and obtain a stay. If they are able to make government understand the disadvantages, the change will be rolled back. In case of no legal or lobbying resource working, these groups will have to dismantle the corporate structure which they have carefully created in the past decade or so. How unfortunate this could be for a country where policymakers are always screaming in favor of documentation and corporatization.

The concept of group companies is to consolidate fragmented corporate ownership under a centralized structure. There are multiple advantages of such structures including gaining international competitiveness. The groups can access wider range of capital sources for diversified businesses. Centralized operations create synergies across different lines of business. It is a no brainer to promote such structures and is in line with global best practices.

In 2007, a taskforce was formed with members from private sector, government, and accounting institutions to remove hurdles in forming holding company structure. One of the main roadblocks was inter-corporate dividend tax. After detailed deliberation, a comprehensive taxation framework was developed for group taxation inline with the best international practices. The task force back then analyzed tax regimes of various jurisdictions – such as India, Japan, Korea, Germany, US, Thailand, Malaysia, and others before coming up with its recommendations.

Later in 2016, some exemptions were withdrawn under Dar, and then in PTI’s first year (2019), these were reinstated. The PTI government from the day one was in favour of corporatization and was doing changes in accordance. Now suddenly, in response to the IMF conditions, the reverse changes are sought and processed in haste.

This could sabotage the progress of corporate sector. It will be regressive in nature. Some business groups in Pakistan have spent good chuck of resources to move away from complex and fragmented corporate structure to holding company structure. Many others are thinking to move in the same direction –one textile group is planning to demerge and listing of its retail business, now the group may revisit the drawing board.

This group and a few others who were thinking to form and strengthen the corporate holding structure, will not do it. There is no shortage of informal and fragmented businesses in Pakistan. These people like to operate in shadows and master in tax evasion and avoidance. The government should have worked on incentivizing them to corporatize.

But it seems that the actions are promoting informal and fragmented economy further. If the PTI core team thinks that corporatization is essential for companies to become global by doing partnerships with international players and have access to global capital market, then it should take notice of these changes, and not allow this killing of corporate culture.