Stock Market Taxation

Huzaima Bukhari & Dr. Ikramul Haq

 

 

During the trading session on May 23, 2008, the Karachi Stock Exchange registered the highest single day loss surpassing the earlier figure of -635.80 (recorded on 05.11.2007) amid speculation that the index will fall even further. The Stock Exchange closed at -615 at 4.00pm. The downward trend is being attributed to increase in interest rates permitted by the State Bank of Pakistan and expected imposition of capital gain tax in the forthcoming Budget for the fiscal year 2008-2009. Each year, just before the announcement of the budget by the Finance Minister, a bearish trend is witnessed, but this year, despite there being a people’s elected political set-up, the situation is quite alarming, especially for small investors.

 

If the entire issue is revolving around the statement of Mr. Ishaq Dar reported on 13 May 2008 in Dawn newspaper under the title, “Several new taxes in budget, says Dar”, that there is a need to impose capital gain tax then for the awareness of the general public there already exists such a tax under section 37 of the Income Tax Ordinance, 2001 (hereinafter “the Ordinance”). Besides, section 233A of the Ordinance requires registered stock exchanges to collect advance tax from its members at the rate of 0.01% on sale/purchase of shares and trading of shares; and 10% in respect of financing of carryover trades in share business. Additionally, another tax known as Capital Value Tax which came into existence vide Finance Act 1989 is also in the field and is chargeable as per section 7 of the Act, on the capital value of purchase of modaraba certificates or a registered instrument of redeemable capital as defined in the Companies Ordinance, 1984, or shares of a public company listed on a registered stock exchange in Pakistan. 

 

Section 37 of the Ordinance explicitly speaks about a tax on gain arising on the disposal of capital asset that includes stocks and shares and such movable properties in personal use as a precious work of art, jewellery, rare manuscript, folio or book; a postage stamp or first day cover; a coin or a medallion; or an antique. No doubt, there are certain concessions with respect to assets retained for a period of more than one year and there are some exemptions on the gain of certain stocks and shares but this certainly does not imply that there is no capital gain tax in Pakistan. In fact, collections as reported up to June 2006 and June 2007 are as follows:

 

Head of Payment	June 2006	June 2007
u/s 233A	2,595.8 million	5,920.7 million
CVT on purchase of shares	1,440.3 million	2,238.5 million

 

The figures clearly speak of the amount of tax that is related to trading in stocks and shares. With these taxes already in existence, it is quite surprising that ex-Finance Minister was talking about levying capital gain tax! This clearly speaks of how ill-informed the members of our political parties are.

 

It is very strange that Chairman FBR has not explained the correct position and the prevalent impression that exemption is given to investors in the capital market has not been contradicted by the official quarters till today. On the one hand, stock market investors have contributed substantially towards revenue as evident from the above figures while on the other, they are being accused of enjoying some imaginary tax benefits.

 

The role of capital markets in development of economy like Pakistan needs no emphasis. This avenue provides great opportunities to small investors to earn dividends from scrips of good companies. The companies also strive hard to enhance the value of their scrips. This creates an atmosphere of confidence and a favourable investment environment. The growth and promotion of capital markets depend on political stability and any negative news badly affects its working. Speculators immediately take advantage of such panic. During the last many days due to all kinds of negative and alarming news in the media, the signals reaching the stock market are creating devastation. The main reason behind the crash is political uncertainty and expected clash between the Parliament and the President.

 

In fact Musharraf is singularly responsible for this chaos. He is repeatedly claiming to stick to the post for another five years despite the clear verdict of 18 February 2008. Even Zardari has declared him the main hurdle between the people and democracy. Its about time to save economy, stock markets and democracy in Pakistan by stabilizing the system. Our stock market has tremendous potential to grow provided that political forces give the nation assurance of cohesion, unity, peace and security.  

Federation and distribution of taxes

Huzaima Bukhari & Dr. Ikramul Haq

 

The governments in Pakistan, military and civilian alike, have failed to end injustice in all spheres of life and areas, but more tragically in distribution of taxes between the federation and the federating units. Assignment of taxes is a vital constitutional and political issue that has been blatantly ignored, resulting in there being no judicious distribution of taxes between the centre and the provinces. The imbalances and unjust monopoly of taxes by Islamabad is a perpetual source of disharmony between the Centre and the provinces. Mr. Yousaf Raza Gilani, unanimously-elected Prime Minister, in his maiden speech after winning the “historic” vote of confidence, made a pledge that Concurrent List in the Constitution will be abolished within one year. One wonders why it could not be dispensed with immediately when there has been consensus in both the houses that it denies fair and equitable distribution of taxing powers between the federation and the federating units.

 

It is an undeniable fact that Islamabad has always usurped the right of the provinces by levying sales tax and other duties at federal level on goods and services within their (provincial) territorial jurisdiction. In all major federations, e.g. USA, Canada and India, the federating units have the exclusive right to levy indirect taxes on goods and services generated within their geographical boundaries. In Pakistan, the federal government has vehemently denied this right to all the four provinces. Adding insult to injury the federal government is collecting huge amount of taxes through provincial government departments treating them as withholding tax agents without paying any service charges as envisaged in Article 149 of the Constitution. On the contrary, it charges 2% fee to provinces while collecting sales tax on services on their behalf! This dichotomy has never been contested by any provincial government.

 

Federal highhandedness in tax matters (by using both federal and concurrent lists) has destroyed the financial and economic rights of provinces. The provinces should have the exclusive right to levy taxes on goods and services within their respective physical boundaries, but the Federal Government blatantly encroaches upon their undisputed right by levying tax on goods and services under the garb of presumptive taxes in Income Tax. Such taxes cannot be termed as taxes on income (which the federal government is empowered to levy under item 47 of the Federal List) but tax on goods and services. It is a great tragedy that this argument was not presented in the Supreme Court when the constitutionality of such provisions was challenged in 1991 and the debate merely revolved around academic discussions over the concept of income. If the Federal Government can treat tax on goods and services as tax on income, as held by the apex court per incuriam (a mistaken judgement) in Elahi Cotton case PLD 1997 SC 582, then what will be the sanctity of division of fiscal powers provided in the Constitution of Pakistan between the Federation and the provinces.

 

Our tragedy is that on the one hand we have too many taxes in the country (federal, provincial and local, although the last two only generate negligible national revenue) while on the other, the benefits of revenue collection are not reaching the poor masses of the less privileged provinces. The few rich are the real beneficiaries of every luxury that is available. Fiscal gap is increasing every year despite five-year Tax Administration Reform Programme (TARP) initiated in 2002 with borrowed funds of US$ 100 million.

 

The prime reason for failure to stall ever-increasing fiscal deficit is that provinces have not been empowered to generate their own resources. They have been denied fiscal autonomy of levying taxes on goods and services. Since 1947 our rulers at the Centre have been treating the provinces in the same way as the British imperialists.

 

In fiscal year 2006-2007, total federal tax revenue by Federal Board of Revenue (FBR) was Rs. 843 billion. The Federal government showed total receipts (both tax and non-tax) at Rs. 1087 billion, out of which the provinces received as little as Rs. 437 billion. Interestingly, the federal expenditure under two heads alone i.e. defence and debt-serving was Rs. 515 billion. The over-all deficit suffered by the Federal government was Rs. 373 billion.

  

The Centre might have given away some of the federal taxes to the provinces, most likely sales tax as is the case in India, if the federal taxes collection had increased substantially, but tragically, despite all kinds of oppression, highhandedness, negative tactics, withholding of refunds and what not the FBR took four years —1998-99 to 2001-02— to cross from Rs. 307 billion to Rs. 401 billion — an average increase of Rs. 24 billion a year. From 2002-03 to 2004-05 FBR managed to increase revenue from 460 billion to 590 billion— a poor performance as average annual increase did not even cover inflationary impact.  In 2005-06, the collection was Rs. 710 billion, and the last year it was Rs. 843 billion. This year’s target of Rs 1025 billion already stands reduced to Rs. 950 billion, whereas our real potential is not less than Rs. 1600 to 1800 billon. FBR’s track record shows little possibility of achieving Rs. 2200 to 2700 billion mark in next five years to give a fiscal space both to the Centre and the provinces to come out of the present mess extending some relief to the poor and trade and industry for growth. Thus in the near future, if our federation-provinces taxing impediments continue, the country will remain in debt enslavement and more and more people will be pushed below the poverty line. If we want to come out of this crisis, there is an urgent need in Pakistan to reconsider equitable distribution of fiscal and taxing powers between federation and the provinces. Provincial autonomy is meaningless without fiscal rights and redistribution of income and wealth amongst all the federating units. It is hoped that some concrete measures will be announced in the forthcoming first budget of the new government, for achievement of these goals.

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The writers are tax advider ikram@huzaimaikram.com