Applicability of minimum tax: SECP proposes exemption to private funds

Securities and Exchange Commission of Pakistan (SECP) has proposed exemption to private funds from the applicability of minimum tax under Income Tax Ordinance 2001 in coming budget (2018-19). According to the budget proposals of the SECP for 2018-19, the FBR should exempt private funds from the applicability of minimum tax.
Details of the proposal revealed that income, or classes of income, or persons or classes of persons, enumerated below, shall be exempt from the operation of such provisions of this Ordinance, subject [(11A). The provisions of section 113, regarding minimum tax, shall not apply to a venture capital company, venture capital fund and Private Equity and Venture Capital Fund and Private Fund which is exempt under clause (101) of Part-1 of this Schedule.
The impact of the proposal is to exempt private funds from the applicability of minimum tax as it is a pass through entity, SECP has proposed. The objective is to exempt private funds from the applicability of minimum tax as it is a pass through entity. Exemption from Capital Gains: The second proviso of Section 99A should be deleted and the first proviso should be reworded as follows:
Profit and gains accruing to a person on sale of immovable property to a REIT Scheme." This proviso under Division VIII Part I of the First Schedule should be deleted, SECP has proposed. A REIT involves transfer of property to a Trustee, which is an additional leg not required under a conventional property transaction generating revenues for the government in the form of CVT, Stamp Duty, Registration fee and compliance with other laws. To encourage sellers to deal with REIT schemes, which will lead to discovery of actual market price of real estate.
At present the prices of real estate in the valuation tables are substantially lower than the market value. The government should intervene in order to strike balance of tax incidence on sellers of property to REIT schemes (on actual price) and sellers of property to others (as per valuation table). In the long run, the economy will benefit from discovery and documentation of actual values of properties and consequence capital gains taxes.
The sale of real estate to a REIT scheme is an extra step which is only required so that property is transferred in the name of Trustee. No other form of organization such as a company, partnership or sole-proprietorship has to undertake this transaction. Real estate transactions are generally reported at book value based on "valuation table" or FBR rates. Actual transaction value could be manifold higher as it is based on the market value. Hence the deemed capital gain is significant. The imposition of any taxation on these gains renders the transaction uneconomical and prohibits launch of REITs Exemption from gain tax, which was available till June 2015, is the most critical starting point to promote RE1Ts in the country and limiting the exemption of income tax to "Developmental REITs for Residential purposes" only, excludes all real estate projects as the overwhelming majority of the developments falls in the category of mixed-use developments.
The commercial component of a development generates surplus revenue, which makes the residential component more economical for the buyers. The current limited exemption cripples REITs' potential as many opportunities entail commercial developments such as malls, offices, warehouses, etc., which are ideal avenues for REIT involvement, SECP added.
The SECP has proposed insertion of new definition of Private Funds under section 45A of ITO. Description of proposals: (45A): Private Funds means a fund as defined under Private Funds Regulations 2015. The impact of the proposal revealed that it will bring fair treatment for investor of private funds as this will remove the anomalies of double tax at the investor and fund level both. Currently the taxation is on the investor and fund level. Economic activity will take place as the capital will be injected in unlisted companies by sophisticated investors.
SECP vide S.R.O. NO. 1159/2015 dated November 25, 2015 notified the Private Funds Regulations 2015, which repealed the existing Private Equity and Venture Capital Funds Regulations 2008 and new definition Private Funds is proposed to be included in the ITO 2001.
Geographical source of income: The SECP has proposed that any income derived by a Private Fund, if not less than ninety per Cent of its accounting income of that year, as reduced by unrealized capital gains, is distributed amongst the unit or certificate holders or shareholders as the case may be. Provided that for the purpose of determining distribution of at least 90% of accounting income, the income distributed through bonus shares, units or certificates as the case may be, shall not be taken into account.
The pass through status is given to only one category of private funds that is private equity and venture capital funds up to year 2024. To bring it in line with mutual funds the unlimited pass through status is recommended for all categories of Private funds, SECP proposed.
Foreign tax credits (reference: section 103 of ITO 2001): Any distribution received by a taxpayer from a collective investment scheme registered by the Securities and Exchange Commission of Pakistan under the Non-Banking Finance Companies and Notified Entities Regulations, 2007, including National Investment (Unit) Trust or REIT Scheme or a Private Equity and Venture Capital Fund out of the capital gains of the said Schemes or Trust or Fund. Provided that this exemption shall be available to only such mutual funds, collective investment schemes and Private Funds that are debt or money market funds and these do not invest in shares.
The impact of the proposal is to restrict the benefit of this clause to only those Private funds which do not invest in shares. The objective of this amendment is to restrict the benefit of this clause to only those Private funds which do not invest in shares, SECP added.