From poor to the rich

Published December 13, 2021

The ‘mini-budget’ coming up soon before the parliament envisaging around Rs550 billion in fiscal adjustments would carry two critical highlights among other things — taxing the poor and facilitating the rich. This is in the shape of withdrawal of tax exemptions on items of common use and substantial further relaxations to the real estate.

In the broader narrative, the Chairman Federal Board of Revenue (FBR) crafts the Finance (Supplementary) Bill, 2021 as an amendment in tax laws that “are warranted in order to achieve efficiency and equity in the tax system through removal of aberrations, broaden the tax base, and document the economy”.

As they say, however, the devil is in the details. The proposals in effect promote further inequity in the country’s taxation system as the summary of tax proposals seeks to make it difficult for the people to have access to medicines and extends further tax breaks and concessions to certain vested interests.

An analysis of just two tax proposals contained in the summary is a case in point to uncover the direction of these proposals. For example, amendment in the Sales Tax Act, 1990, demands that “exemption regime under the Sixth Schedule is proposed to be curtailed including pharmaceutical sector and restricted to import and local supply of essential commodities only”.

It has been proposed to the government that the Sixth Schedule to the Sales Tax Act, 1990, enlisting items exempt from sales tax on import may be curtailed to only essential commodities and that the pharmaceutical industry may be excluded from the Sixth Schedule and therefore exempt from sales tax.

The tax proposals show that the FBR could have been carried away by the demands of rent-seeking business groups as often bemoaned by PM’s adviser on finance Shaukat Tarin

The FBR does not seem to have considered the implications of this proposal viewed in the context of already too expensive medicines, rising manifold over the last three years. The FBR apparently wants to maintain sales tax exemption on essential commodities needed in good health but withdraw such exemption on essential items needed by patients.

The prices of medicines have already risen beyond the reach of middle and lower-income segments of society. Many people have learned to live with diseases because they cannot afford the cost of treatment. The FBR’s proposal to take the pharmaceutical industry out of the Sixth Schedule carries implications for the health of the multitude.

Another amendment from the FBR through supplementary finance bill seeks that “Special Purpose Vehicle (SPV) under the Real Estate Investment Trust (REIT) regulations, 2015, is proposed to be extended”. The tax proposals in the summary show that the FBR could have been carried away by the demands of certain business groups that keep on lobbying for rent-seeking as often bemoaned by the prime minister’s adviser on finance Shaukat Tarin.

This is based on a joint demand from seven REIT sponsors — AKD Reit Management, Arif Habib Dolmen Reit Management, ISE Reit Management, Magnus Investment Advisors, SB Global Reit, TPL Reit and Veritas REIT.

The Securities and Exchange Commission of Pakistan (SECP) apparently have supported this as it amended the Real Estate Investment Trust Regulations, 2015, allowing such trusts to create SPVs. The management of the seven such REITs has not been content with the tax benefits already extended by law to the REITs under their management and control.

Therefore, they jointly wrote to the FBR asking for tax benefits for their SPVs similar to those already being enjoyed by their REITs. Without going into the merits of the move, some precautions are genuinely required when dealing with private SPVs that would involve citizens’ money.

The SPVs are business entities that have been used in the past to commit the greatest accounting frauds in American corporate history. The theoretical justification for any parent company to create an SPV is to get a credit rating better than its own and thus to cut down the cost of its capital. However, an SPV also affords the parent company a novel opportunity to commit accounting fraud or to defraud its investors.

Enron, the well-known energy giant in corporate America capitalised on this opportunity, used its SPVs to conceal huge debt from its investors and finally became bankrupt bringing financial demise to its millions of investors.

While seeking exemption of corporate income tax, the REITs proposed that any income derived by a collective investment scheme, a REIT Scheme including the income of an SPV structured under 2015 REIT Regulations, if not less than 90 per cent of its accounting income of that year as reduced by capital gains whether realised or unrealised is distributed among the unit or certificate holders or shareholders as the case may be.

Secondly, it has also been proposed that dividends received by REITs from SPV should not be taxed. Similarly, capital gains accruing to a seller of shares of SPV to a REIT scheme should not be taxed until June 30, 2023.

Interestingly tax benefits for an SPV are something which even Enron did not seem to have demanded from its regulators in America where SPVs had been repeatedly used to plunder the investors. In Pakistan too, the FBR and SECP would hopefully put in place safety nets that ensure that SPVs allowed by the Securities & Exchange Commission and to be nurtured through tax exemptions by FBR will not follow that route.

On the positive side, the supplementary bill also seeks, on the demands of international lending agencies and Organisation for Eco­nomic Cooperation and Development to fight corruption across borders, to have mandatory “disclosure of information in respect of high-level public officials” regarding assets and investments in line with the requirements of the development partners, rule of law and integrity.

Published in Dawn, The Business and Finance Weekly, December 13th, 2021

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