Finance bill 2007 has been welcomed by the stock brokers but termed neutral to negative for the stock market by securities analysts.
As is customary, along with the usually budgetary measures, important legal amendments have been proposed in other areas of the capital market. Let’s look at some of its key proposals.
First, as expected, exemption of capital gains tax for the stock market in general has been extended by one more year to June 2008. Since an announcement to this effect had already been made by the Primer Minister in January 2007, the extension in this exemption was a formality. On the other hand, capital gains tax has been imposed on banks which should help reduce short-term trading by banks in the stock market but would not have a significant impact on their profitability.
Second, contrary to expectations, rates of taxes on trading (CVT, withholding tax, presumptive tax) have not been reduced. At the moment when market is feverishly bullish and turnover is on the rise, lack of reduction in trading taxes is unlikely to have a significant impact on trading volumes. However, once market faces a bear run, then the current level of trading taxes could hit the turnover hard as seen earlier.
Third, as expected, incentives demanded by KSE to encourage new listings and discourage delistings (such as a lower corporate income tax rate and dividends tax rate for listed companies, etc) have not been given. The economic case for seeking such fiscal concessions is weak, however, KSE has been consistently demanding these incentives every year and the government has been just as consistent in refusing them. Lack of new listing is frequently used to call in question the economic contribution and social legitimacy of stock exchanges and this situation is unlikely to change in future.
Fourth, in a surprise move, by amending the second schedule to Income Tax Ordinance 2001, tax exemption of income earned by mutual funds through ‘badla’ financing or CFS has been withdrawn. Now this income of funds would be taxed at 10 percent whereas the rest of their income would continue to enjoy tax exemptions subject to distribution of ninety percent of income. The every existence of ‘badla’ financing and role of mutual funds is highly controversial and this amendment is an indirect and ineffective way of reducing ‘badla’ financing by the funds.
Fifth, by amending the Income Tax Ordinance 2001, companies belonging to a business group are allowed to be taxed as one fiscal unit, allowing tax savings on losses incurred by companies within the group subject to a number of conditions. But along with this concession, tax on inter-corporate dividends has been raised from five per cent to 10 per cent. Since this tax is adjustable against final tax liability, subject to certain conditions, it would probably not have a significant adverse impact.
Sixth, by amending the second schedule to the Income Tax Ordinance 2001, tax exemptions have been provided to upcoming private equity and venture capital funds in the same way these are available to existing mutual fund. Similarly, tax exemption has been provided on gains accruing to a person on sale of property to a real estate investment trust (REIT) up to June 30, 2010 to encourage proper disclosure of prices in real estate transactions.
Further, by amending the Companies Ordinance 1984, SECP has been given enhanced powers to make regulations for NBFCs and these new types of funds without needing approval from the law ministry, which would improve the pace at which regulations can be made and amended. All of these are positive development but many of these new funds would be launched by companies associated with large brokers and it would be critical that these are tightly regulated to effectively manage conflicts of interest.
Seventh, tax credit limit for investments in public offers for individual investors has been raised from Rs 200,000 to Rs 300,000. Clearly, it is return prospects and not tax savings that drive the applications in IPO and with so few tax payers, this move can be safely termed insignificant.
Eighth, as demanded by KSE, by amending the second schedule to the Income Tax Ordinance 2001, special tax exemptions have been provided to the stock exchanges and their members for demutualization. Plans for demutualization of exchanges are being made since 2002 but progress has been slow in coming. Over the years, the SECP itself has been deviating further and further from the recommendations of the international committee of experts it had constituted in 2004 to advise on demutualization and merger of exchanges. What demutualization may or may not achieve is entirely a question of how it is structured and much more is needed to see it through.
Ninth, in a surprise and controversial move, by amending the Securities and Exchange Act, 1997, the Finance Minister or, in his absence, the Adviser to Prime Minister on Finance, as the case may be, has been made chairman of the policy board of the SECP. The current economic managers are already facing severe criticism for interfering in the affairs of SECP and not letting the regulator take action against those involved in market abuse. This amendment would be yet another major obstruction to the SECP becoming an independent and effective regulator.
Tenth, as being demanded by SECP, by amending the Securities and Exchange Ordinance, 1969, the maximum penalty that SECP can levy under the Ordinance has been increased from just Rs 100,000 to Rs 50 million. Although the increase in maximum penalty looks impressive on paper, it is unlikely to deter those who are involved in market abuse. That’s because above everything, it is political will that is required to act against abuse, which is conspicuous by its absence. It is probably the small fish which are going to bear the brunt of this amendment.
In sum, finance bill 2007 has given some tax incentives to new segments and initiatives – such as private equity, REITs, demutualization – but no significant concession has been offered in areas which could directly impact stock market such as corporate tax rate, trading taxes etc.
This was the last budget to be presented by the current economic managers who have been very closely associated with the stock market, so close that KSE-100 seems to be nailed to their mast. It is a bit puzzling that they did not give favors to the stock market. One reason that helps explain this phenomenon is that the KSE-100 is already on a record breaking spree and news media is ridiculing the market for “satta bazi” in the middle of an unprecedented political crisis that is threatening to create political instability.
If the political commentators are right about the current political crisis, then it is likely that none of the current economic managers would have anything to do with the future finance bills for a long time to come. So grave is the perception problem of stock market and so widespread is resentment against lack of accountability after March 2005 crisis that any government that comes through free and fair elections would not like to be seen as a friend of market participants. The next finance bill might be made by a different set of people with a different attitude towards the stock market.
Finance bill 2007 has been welcomed by the stock brokers but termed neutral to negative for the stock market by securities analysts.
