The writer is an international development professional based in Islamabad.
The writer is an international development professional based in Islamabad.

THE recently introduced measures in budget 2016-17 relating to the real estate sector have dampened the enthusiasm of investors and punters alike, and transactions have thinned out significantly in the marketplace.

With the government’s willingness to do away with State Bank-appointed ‘valuers’, coupled with enhanced valuation of properties in 10 metropolitans, it seems a mutually agreeable solution would be reached soon, given ongoing negotiations between Federal Board of Revenue (FBR) and realty stakeholders.

However, stakeholders fear that a ‘wrong’ precedent has been set for the industry, tending towards greater documentation and higher taxation, leading to reduced attractiveness in the sector. Amidst this uncertainty, there is a need to take a careful look at the newly introduced steps as well as proposed revisions and assess how they are expected to affect real estate dynamics.

The most significant changes introduced as part of the Finance Act 2016 include the imposition of capital gains tax (CGT) of 10pc on the sale of properties sold within five years of their purchase. Moreover, the government has scaled up some existing taxes, such as withholding tax on the sale of property — increased from 0.5pc to 1pc for filers and from 1pc to 2pc for non-filers.

Similarly, withholding tax on the purchase of property has been increased from 1pc to 2pc for filers and 2pc to 4pc for non-filers. Perhaps the most controversial proposal introduced, now expected to be annulled, is the amendment in Section 68 of the Income Tax Ordinance 2001, prescribing the use of State Bank-appointed ‘valuers’ to assess the fair market price of properties.


The new proposals should bring stability to the market in the long run and reward long-term investors.


However, even with new proposals for enhanced property valuations under discussion, these increased taxes would dilute investors’ expected margins. Furthermore, it is expected that FBR would revise these valuations every year, bringing them closer to fair market prices. The existing valuation is based on the age-old DC-valuation system, with pre-notified prices in specific areas, which are generally at a deep discount to the prevailing market rates. This situation is especially precarious for those involved in frequent trading of property.

These changes, if looked at closely, are not all doom and gloom. While the increase in withholding taxes would definitely add to the transaction cost, the quantum of these taxes ranges from 1pc to 4pc depending on the tax filer status as well as whether it is imposed on a seller or buyer.

The provision of 10pc tax on capital gains within five years however, is expected to hit the market the worst and would cost the sellers significantly. But the measure is not likely to increase other applicable taxes and duties such as CVT and Stamp Duty, which would continue to be based on DC value. The retrospective applicability would mean payment of CGT on capital gains realised after July 1, 2016, if the respective property was acquired in the last five years. This provision was especially aimed at investors with unclear sources of income, who had parked their money in properties declared at significantly lower values.

However, on the one hand, the recently discussed proposal of giving a one-time amnesty, if approved, would give blanket cover to all such transactions at a much lower tax rate, and on the other, the CGT, by definition, would only be imposed on tax filers. Consequently, a large number of investors who remain outside the tax net would continue to enjoy their gains without any such tax for the time being, paying a marginally high cost in the shape of withholding tax.

The new regulations also raise some important policy questions for the government, as they seem like an easy way out to raise revenues through further burdening the people in the tax net, resulting in a handful of taxpayers subsidising the majority of people who refuse to file tax returns. While the withholding taxes are lower for tax filers, they provide little incentive for non-filers, since they fear that once they come in the tax net, they can be pushed to any extent.

Indeed, predictability of tax policy remains a serious challenge, where government continues making ad hoc changes in response to ambitious tax collection targets. While tightening the tax regime is a legitimate requirement, there is a need to gradually calibrate such measures through a balance between taxing the already taxed and those who are outside the tax net. Furthermore, due time should be given for such changes to take effect so that investors can make appropriate and informed choices.

The difference in CGT regime on real estate sector vis-à-vis shares and securities also inadvertently creates preferences between different asset classes. While CGT is higher on securities in the first year, they gradually come down in subsequent years, with no CGT on securities sold after four years. Such scaling down incentivises investors for longer holding periods.

Conversely, a flat structure for real estate — that too lasting five years — poses a serious disadvantage to this sector, which has historically fared well as compared to securities and shares. Without any forecasting and estimation of expected impact, such changes can impact the sector severely and also adversely affect remittances translating into investment in the area.

Long-term genuine real estate investors need not worry much. While these increases will enhance transaction costs and dilute the margins, the nature of the local real-estate market generally offers much higher returns, far exceeding the additional tax imposed. For instance, if a property increases in value by 100pc within five years, this will result in CGT of 5pc of the final value of the property. Additionally, such measures are expected to bring stability to the market in long run, whereby investors will be rewarded for making longer term investments and avoiding speculative behaviour.

But with the direction of the real estate sector set towards higher taxation and greater documentation, this is bad news for punters and speculative investors and also likely to create a serious dent in the earnings of real estate agents. Even with the proposed revisions on the cards, investors are likely to be cautious for a few months, possibly resulting in fewer transactions and some correction in prices, especially in more hyped localities with poor fundamentals. The dust from these changes will have to settle before investment activity resumes on more stable grounds.

The writer is an international development professional based in Islamabad.

hasaankhawar@gmail.com

Published in Dawn, July 26th, 2016

Opinion

Editorial

Afghan turbulence
Updated 19 Mar, 2024

Afghan turbulence

RELATIONS between the newly formed government and Afghanistan’s de facto Taliban rulers have begun on an...
In disarray
19 Mar, 2024

In disarray

IT is clear that there is some bad blood within the PTI’s ranks. Ever since the PTI lost a key battle over ...
Festering wound
19 Mar, 2024

Festering wound

PROTESTS unfolded once more in Gwadar, this time against the alleged enforced disappearances of two young men, who...
Defining extremism
Updated 18 Mar, 2024

Defining extremism

Redefining extremism may well be the first step to clamping down on advocacy for Palestine.
Climate in focus
18 Mar, 2024

Climate in focus

IN a welcome order by the Supreme Court, the new government has been tasked with providing a report on actions taken...
Growing rabies concern
18 Mar, 2024

Growing rabies concern

DOG-BITE is an old problem in Pakistan. Amid a surfeit of public health challenges, rabies now seems poised to ...