IN its efforts to modernise the tax system, the Federal Board of Revenue (FBR) has introduced various reforms in tax policy and administration over the last three years. Some of the main reforms include broadening of the tax base resulting in the number of tax filers increasing from around 748,500 to more than 1.1 million; eliminating distortive tax concessions and exemptions (granted via SROs) to the amount of Rs290 billion; introducing differential taxation for filers and non-filers; and automating procedures to minimise incidences of malpractice.
These revenue mobilisation efforts have resulted in an increase in tax revenue from Rs1,946bn in FY2013 to Rs3,112bn in FY2016, thus raising the tax-to-GDP ratio from 9.9pc to 12pc for the period. However, the percentage of revenues collected from direct taxes leaves much to be desired as it is significantly lower at 38pc compared to indirect taxes at 62pc in FY2016.
One of the main reasons for this sharp disparity can be attributed to the ease of raising revenues through indirect taxes ie GST, excise and duties. Nonetheless, indirect taxes are at variance with the principles of good governance which demand social equity born of a progressive and fair tax system. FBR has made efforts — risk-based auditing, access to third-party information ie bank accounts and transactions, and integration of the national tax number with the CNIC database — to address this discrepancy and increase the share of direct taxes vis-à-vis broadening of the tax base. It has also introduced reform entailing rationalisation of tax payable on immovable property. According to IMF’s working paper on Taxing Immovable Property, the real-estate sector has the potential to raise tax revenue by more than 2pc of GDP (in Canada land tax-to-GDP ratio alone is 2.4pc). In view of these studies and the bonanza of investment witnessed by the sector over the last decade and a half, tapping into the real estate sector’s tax potential was much needed.
The real-estate sector has the potential to raise tax revenue by more than 2pc of GDP.
The attempt to record values of real-estate transactions at close to fair values is important since transactions at less than that act as a continuous source of addition in the volume of the undocumented sector with the seller understating his funds. Moreover, the erstwhile calculation of taxes on land value prescribed by the district collector (DC rates) had largely become redundant and needed to be addressed.
Amendments to Income Tax Ordinance, 2001 authorised the board to determine fair values of immovable properties in cities around the country. These cities were divided into three broad categories — A, B and C — with residential and commercial immovable properties being charged tax at different per square rates. Where no revaluation was carried out, tax is to be calculated on existing DC rates.
This rationalisation of tax has considerable potential to positively affect collections and activities in the real-estate sector in several ways. One, the amount of capital gain tax (CGT) calculated on the difference between the purchase price and the new value determined by FBR or ‘recorded’ sale price (whichever is higher) will increase marginally since the previous prices determined at DC rates were much lower than the fair market value. Moreover, CGT which was previously charged at 10pc and 5pc on properties sold within one and two years, respectively, will now be subjected to varying slabs. Hereafter, properties sold within the first, second and third year of purchase will be charged CGT at 10pc, 7.5pc and 5pc, respectively with zero per cent thereafter; helping curtail speculation and protecting real investors from negative spillovers.
Two, advance tax to purchasers and sellers of property will be charged at enhanced differential rates for filers and non-filers. This tax which will be chargeable against the total income tax payable for the year may, in the coming years, encourage more people to file returns, consequently increasing both the revenue and the tax base.
Three, Section 111 of the ordinance will help restrict unexplained ‘additions to income’ or highlight understated incomes being invested in immovable property since prices cannot be stated below the new value determined by the board; thereby helping contain the scourge of black money being parked in the sector.
Four, the amnesty scheme, under negotiations, will allow the filers and non-filers the opportunity to revise their return positions to a period limited to five and 10 years, respectively, hence raising revenue by accounting for lost or understated taxes on previous land transactions and also giving a boost to the tax base.
The initiative should control speculation in the real estate sector which has led to artificially inflated land prices similar to those of share prices prior to the stock market crash of 2008. Also, similar efforts to rein in speculation, redirect investment to other productive sectors and tap into the revenue potential of the real estate sector have been undertaken in a number of countries in Eastern Europe, Africa and Southeast Asia.
Yet, there has been quite a backlash from the real estate sector in the wake of the Finance Act, 2016, which promulgated the amendments to the ordinance. The barrage of criticism created pressure for allowing a one-time tax amnesty across the board. Whereas the matter is still under consideration in parliament, the government should ensure that the amnesty is neither seen as a recurrent opportunity for whitening black money or unaccounted for wealth nor puts compliant taxpayers at a disadvantage.
Moving forward, FBR should be encouraged to continue with complementary reforms under process such as establishing a centralised electronic cadastre to better record transactions and assess real estate tax based on periodically updated market valuation of each property, in order to enhance revenues and effectively contain the fiscal deficit and debt burden.
The writer is a civil servant and has worked on economic reforms under the IMF programme in Finance Division.
Published in Dawn, December 26th, 2016