After an initial understanding on the framework of Capital Gains Tax (CGT) between the senior members of the Karachi Stock Exchange (KSE) and the Government, finally the tax exemption on gain on shares investment will come to an end as of June 30, 2010 after 36 years. A press release issued by the KSE on the understanding of the framework of CGT states the following:
· CGT will be applicable on the purchase of shares made on and after July 01,
2010.
· CGT will be charged on short-term investments based on two holding periods;
a) Less than six months. Initial tax rate of 10 percent for two years, which will be increased gradually by 2.5 percent each year (from FY2012 onwards), bringing the final rate to 17.5 percent in FY2015.
b) More than 6 months and less than one year. Initial tax rate of 7.5 percent for two years, which will be increased gradually by 0.5 percent each year (from FY2012 onwards), bringing the final rate of
10 percent in FY2017.
· There will be no CGT for holding period more than 12 months (long-term investments).
Following table shows year wise CGT rates to be applicable as per the understanding between KSE and the Government.
Holding period FY11 FY12 FY13 FY14 FY15 FY16 FY17
< 6 months 10 10 12.5 15 17.5 17.5 17.5
> 6 months < 12 months 7.5 7.5 8 8.5 9 9.5 10
> 12 months 0 0 0 0 0 0 0
Source: KSE press release
Figures in %
Since the modus operandi of CGT still remains largely unclear, we have analyzed the issue in light of the Indian CGT model and local Income Tax Act.
CGT collection
Capital gain on shares investment and other income (business or salary) will be treated separately for the purpose of computation of tax liability. Unlike Capital Value Tax, every investor is required to pay his CGT and submit tax return annually under the self assessment scheme.
Withholding tax adjustment
Currently, following three types of withholding taxes (WHTs) are applicable @ 0.01 percent:
commission under presumptive tax regime (PTR).
On sale value of shares traded from stock brokers in lieu of their commission under PTR.
On sale value of shares traded from members.
Capital loss
According to the Indian tax model, a taxable ‘capital loss’ (i.e. a transaction on which there is a liability to pay tax if result where ‘gain’ instead of ‘loss’) can be set-off only against ‘capital gains’. An exempt capital loss (i.e. a transaction, which is exempt from tax if the result where ‘gains’ instead of ‘loss’) cannot be adjusted against capital gain tax. For example, a long-term capital loss (on securities having holding period of more than 12 months) cannot be adjusted against short-term capital gain (on securities having holding period of less than
12 months).
As per the Income Tax Ordinance, 2001 (Pakistan), a capital loss sustained in any given year shall be set-off against any capital gains sustained over the next six years. We believe that above provisions will be applied for the purpose of CGT.
Non-resident investors
We believe that exemption of CGT will come to an end for the non-resident investors as well. KSE has proposed capital gains and losses for non-residents are to be calculated according to the currency in which, investment is made. In India, same provision is applicable for non-residents; therefore we believe that such provision will be included for the purpose of determining CGT for non- residents.
Implications
We believe that withdrawal of CGT exemption will not have a major negative impact on the market as:
Shares’ trading is expected to remain attractive due to higher tax rates on other businesses i.e. 20% income tax on small companies and 35% income tax on large companies.
The long-term fundamentals of the market will remain intact as CGT will not be applicable on long-term investments.
Adjustment of negative impact has already been incorporated in the market as the decision to withdraw the exemption has been announced in advance.
Fear of market participants being on tax radar after implementation of CGT is overplayed. The tax authorities do not need CGT to track their trading activities as it can be done through existing Universal Identification Number (UIN).
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