THE Pakistan Stock Exchange (PSX) is crying itself hoarse over what it considers the harsh aggregate taxation on the country’s corporate sector, resulting from the multiplicity of taxes.
The average rate of tax in the Asian region is 20.05 per cent. Among other major economies, tax rate on corporates in Europe is a low 18.35pc, while the global average works out to 22.96pc. Compare it to the tax regime on companies in Pakistan.
While the normal tax rate on corporate profits is 30pc, due to multiplicity of taxes, the real rate of tax is incredibly high. Amin Tai, one of the most senior brokers at the Exchange asks to add up the following: workers’ participation fund at 5pc, workers welfare fund 2pc, and super tax at 3pc, which makes a tally of 40pc.
But that is not all. The companies must also cough up tax on dividends and they are left with only half of what they earn. “It is disincentive for capital formation and industrialisation that is the key to growth and job creation”, he says, asserting that the reduction in taxation for corporates should be a priority in the upcoming budget.
Arif Habib, the former chairman of the bourse, concurs that the aggregate tax rates for corporates is alarmingly high. He observes that sole proprietors do well for they have to pay a pittance (if at all) in taxation compared to legitimate companies.
If the economy managers expected to generate huge sums in tax, the effect of multiple taxation has been the opposite
Mr Habib also laments the high cost of production which despite higher sales, leaves little that travels to the bottom line, rendering local products uncompetitive against other countries, particularly in the exportable goods segment.
“Electricity costs are 50pc higher in Pakistan and gas prices almost twice the costs in other regional countries”, he adds. In its budget proposals, the PSX asks for long-term taxation policy (applicable for at least 3 years) for the capital markets which it says would provide confidence to the local and foreign investors and help growth of the capital market.
The second major issue after corporate taxation is the Capital Gains Tax (CGT) on disposal of securities, which is another hurdle in capital formation. It is one of the reasons that drove away foreign investors as is represented by net sales of $254 million worth of securities by the foreigners after the drastic changes in CGT in July 2014 (in place to-date) of net inflows of $256m for the year ended June 30, 2014.
“The CGT (on stocks) is not in line with the taxability on other assets class. There is no tax on gains on disposal of immovable property, if the holding period is three years or more”, the Exchange points out. It proposes CGT on four tiers of holding periods, scaling down from 10pc tax where the holding period of security is up to 12 months, and ending at a zero tax rate for holdings beyond 36 months.
Mr Tai recalls that against such a schedule of tax levy in regard to holding period prevalent earlier, the CGT was clamped at flat rate of 15pc. Every single year following the imposition of 5pc tax on value of bonus shares in the Finance Act, 2014, the Exchange has continued to implore that the tax on bonus shares be abolished.
If the economy managers expected to generate huge sums in tax, the effect has been quite the opposite. The generation of tax revenue from these sources declined simply because corporates put a halt to issuance of bonus shares.
In the three and a half years following the levy of tax, in place of 71 companies that announced bonus issues for their shareholders amounting to Rs19 billion during the year June 30, 2014 alone, average annual declaration of bonus shares has dried down to a minimal Rs4bn.
The attractive incentive for the investors receiving blue-chip shares — for free — in large profitable companies is lost. The PSX says: “There is an impression that due to tax on bonus shares, companies are distributing more cash dividend”.
And it argues that in reality, the distribution of cash dividend as percentage of profit-after-tax of companies has not changed significantly. “Prior to July 2014 the average annual payout was about 55pc, whereas from July 1, 2014 to Dec 31, 2017, the average annual payout is 51pc”.
Distribution of bonus shares enabled company boards to put the money to more pressing use, such as reducing debts and ploughing cash back in modernisation and expansions of running business and diversification into other lucrative avenues.
“Every company for the purpose of distribution of at least 40pc of its after tax profits, shall be entitled to issue bonus shares up to 40pc of total distribution of its after tax profit”, the Exchange proposes. The bourse suggests that tax credit of 20pc be allowed for five years from the tax year in which a company is listed on the stock exchange.
It would encourage companies to float Initial Public Offerings as without the proper incentive businesses have no penchant to enter the capital market and are comfortable in mobilising funds from banks and financial institutions.
Published in Dawn, The Business and Finance Weekly, April 16th, 2018