CONSOLIDATING STOCK MARKET

PROPOSALS FOR THE FEDERAL BUDGET 2012-13 ARE AIMED AT PROVIDING AN IMPETUS TO CREATE AN INVESTMENT FRIENDLY ENVIRONMENT, WHICH WOULD SPUR INVESTMENT AND INDUSTRIAL ACTIVITY IN THE COUNTRY.

SHABBIR H. KAZMI
(feedback@pgeconomist.com)

Apr 2 - 8, 20
12

The Karachi Stock Exchange (KSE) has suggested to the government to facilitate development and deepening of the capital market by announcing an aggressive, time-bound schedule in the forthcoming budget for listing of significant large state owned enterprises (SoEs) including government-to-government joint ventures such as PARCO, various development finance institutions (DFI's), Pakistan Steel, etc. on the local exchanges. This would enable these enterprises to access long-term capital from the public by offering them new investment opportunities.

1. COMPULSORY DISTRIBUTION OF DIVIDEND BY LISTED COMPANIES

Finance Act, 1999-2000 made it compulsory for listed companies with free reserves of more than 50 per cent of its paid-up capital to distribute at least 40 per cent of its taxed profit as cash dividend. This measure had proved to be very effective resulting in payment of additional cash dividend of Rs553 million by 39 companies listed on the exchange for the year 1998-99, not only to the investors but also generated extra revenue for the government by way of 10 per cent tax on such cash dividend. This compulsory cash distribution was necessary to nullify the oppressive practice of the controlling shareholders who more often chose to ignore the expectations of minority shareholders and the balance 60 per cent retention out of profits is generally sufficient to meet the requirements of the company for expansion and growth.

KSE has urged reintroduction of this policy. This will not only encourage the small investors to invest in the equities through stock exchange but government would also be beneficiary in shape of 10 per cent tax on dividends distributed by such companies.

2. TAX ON DIVIDEND

Tax on dividend is in fact double taxation or multiple taxation particularly in case of inter company dividend. For instance, when a company earns profit it pays tax at 35 per cent before distributing (dividend) to its shareholders at the time of distribution (dividend) to its shareholders. It further withholds tax at 10 per cent on such dividend thereby resulting in double taxation. When a company receives such a dividend it becomes part of its distributable profit, hence when such part of profit is distributed (dividend) to its shareholders, it again attracts withholding tax at 10 per cent, therefore resulting in multiple taxation whenever a dividend is paid by a company to another company.

Therefore, considering the above, this scenario of inter-corporate dividend shows how double/multiple taxation occurs. This scenario of double taxation has in fact become a hindrance and deterrent for offering dividends by the companies. Therefore, it has been suggested that the dividend received by companies be exempted from tax as this results in double taxation of dividend in the hands of the company and then in the hands of the ultimate shareholders.

3. REDUCED RATE OF TAX FOR LISTED COMPANIES

When more companies from a broad array of sectors/industries choose to list on the stock exchange, the stock market performance will become more representative of the national economy. The government often expresses its concern that despite the stock market boom, new listings have not picked up. Although in the past some large public offers took place mainly under privatization program of the government, private industrial units are still shy of getting themselves listed. For instance, a total of 56,548 companies were registered with Securities and Exchange Commission of Pakistan (SECP) as at June 30, 2011, whereas at present only 613 companies are listed on the KSE.

The main reasons for this are as follows: 1) until June 2002 there was a tax differential of 10 per cent for listed companies. Non-listed companies were subject to income tax rate of 45 per cent whereas listed companies 35 per cent. In the budget of 2002-03, the government decided to progressively reduce the tax rates of private limited companies thereby removing the tax difference of 10 per cent between a private company and public company leaving no tax incentive for listed companies. Tax rate on dividend from unlisted companies and listed companies is currently at 10 per cent, which once again highlights that there is no advantage to listed companies. 2) The stock exchanges on directives from SECP have introduced code of corporate governance on the listed companies making them subject to much desired discipline to protect the shareholders of the listed companies. Many of the listed companies consider it a burden on them with no advantages to them vis-a-vis unlisted companies.

In order to attract more companies for listing, the tax rates for the listed companies may be also reduced to 30 per cent. It is also proposed the tax credit under section 65C of the ITO equal to 15 per cent of the tax payable to the companies for opting for enlistment in any registered stock exchange in Pakistan be allowed up-to five year from the tax year in which company is listed.

4. CAPITAL GAINS ON CORPORATIZATION AND DEMUTUALIZATION

Members of the KSE (currently owners of the KSE) agreed to segregate their ownership rights from trading rights, retaining trading rights after the demutualization as per terms and conditions agreed upon through the memorandum of understanding (MoU) signed with the SECP. In this regard, KSE appointed a leading international investment bank to advise and assist KSE to take the demutualization plan forward. In order to facilitate a speedy corporatization and demutualization of the stock exchanges, certain exemptions have been proposed.

5. CALCULATION OF CAPITAL GAINS FOR NON-RESIDENTS

In Pakistan, there is a technical flaw in the manner of calculation of capital gains especially in the case of investment in shares where the investment is made in foreign currency. Such a gain is calculated in historical rupee terms. Due to this reason, a tax liability may arise to a non-resident due to devaluation of Pakistani rupee vis--vis foreign currency even if the shares are sold at the same value in foreign currency or even at a loss. This manner of calculation of capital gain needs to be corrected.

Capital gains and losses for non-residents are to be calculated in terms of the currency in which such investment is made. For example, capital gain for investment in shares by a nonresident may be computed in US Dollars term instead of Pakistani Rupee term. To protect foreign investment from sharp depreciation in Pakistani Rupee and to help attract foreign investment it is proposed that a proviso similar to section 48 of the Indian Income Tax Act 1961 be inserted in Section 76 of the ITO relating to cost of investment for the purpose of determining of capital gains.

6. TAX ON MARGIN TRADING SYSTEM (MTS) TRANSACTION TO BE TREATED AS FULL AND FINAL

A person deriving income from profit on debt is chargeable to tax under section 39 of the ITO i.e. income from other sources. The rate of tax is 10 per cent which is full and final where an individual receives yield on an account deposit or on a certificate under the national savings scheme or post office savings account or on an instrument issued by the banking company, financial institution, federal government, provincial or local government.

There is a tax rate of 10 per cent on transactions of government securities like treasury bills done by individuals. MTS transaction is a stock market financing arrangement whereby interest income is earned on the period of the transaction between the financier and financee. Therefore, it is a lending transaction whereby premium is paid by the borrower to the lender. The settlement of MTS is linked and netted off with the ready market in such a manner that settlement obligation shifts from the financier to the financee as the case may be. Since the nature of premium earned by financier on MTS transaction is that of profit on debt as defined in section 2(46) of the ITO, it is proposed that the premium earned by financier on MTS transaction should be charged to tax at 10 per cent as full and final tax liability.

7. TURNOVER TAX RATE

Presently, under section 113 read with Division 1A of Part I of First Schedule, minimum tax is levied under section 113 of ITO at one per cent on the turnover of the taxpayer where no tax is payable either due to loss during the year or due to brought forward losses of previous years or if the tax payable is less than the minimum tax on the turnover. However, the reduction in tax is available to the following:

1) A company engaged in the business of distribution of cigarettes manufactured in Pakistan is required to pay minimum tax reduced by 80 per cent.

2) Distributors of pharmaceutical products, fertilizers, consumer goods including fast moving consumers goods, are required to pay minimum tax reduced by eight percent.

3) The rate of minimum tax shall be reduced to 0.5 per cent only for the cases where annual turnover exceeds rupees one billion.

4) For cases of flourmills, the rate of minimum tax on the amount representing their annual turnover under section 113 shall be reduced by 80 percent.

5) Minimum tax is also not payable by certain companies and sector.

This regime is effectively negating the provision of section 57 of ITO that allows for losses in tax year to be set off against future profits and is thus forcing the taxpayer to pay more corporate tax that would otherwise have been due. Therefore, in order to maintain a level playing field, it is proposed that other than above companies and sectors to whom the reduced rate or exemption is available, the general rate of minimum tax be reduced to 0.5 per cent on the total turnover of the taxpayer.

8. ALTERNATIVE DISPUTE RESOLUTION COMMITTEE (ADRC) DECISIONS

To provide the taxpayer an easy and efficient dispute resolution mechanism and liquidate arrears of tax, an alternative dispute resolution forum comprising of an officer of inland revenue and two persons from a panel comprising of chartered or cost accountants, advocates, income tax practitioner or reputable tax payers has been introduced in the ITO. The ADRC is an independent body because of the nature of its composition and thus has a very strong element of credibility being trustworthy and totally unbiased. Since it comprises of officer of inland revenue and other experts from public/private sector, they have a thorough understanding of the tax laws and its practicality and therefore the recommendations of the ADRC will have strength and to be considered seriously by the board. Therefore, in order to increase the effectiveness of the ADRC, its recommendatory nature may have to be changed to an authoritative nature having absolute decisions. It is proposed that ADRC decisions be made binding and accepted by the FBR.

9. AMENDING ASSESSMENT ORDER

Under section 122, the commissioner is empowered to amend an assessment order as well as any amended assessment order on the basis of definite information acquired from an audit or otherwise during the period of five years after the end of the financial year in which the original assessment is issued. Accordingly, the tax authorities may open assessment order frequently thereby as a result of which assessment orders of particular tax year may not be finalized.

At times of amendment of tax orders, there may be add-backs, which may be termed disputed by the taxpayer and this creates a wide gap between the taxpayer and the tax authorities leading to greater fear of the taxman and unnecessary litigation. Further, the re-amending of tax orders by the tax authority creates discomfort with the system and the natural cohesiveness that one should have with tax authorities is severely jolted.