Since its imposition, the Capital Gains Tax has failed to be of much benefit for any of the stake holders involved. Infamous amongst the investor community, the levy has hurt capital market development contributing in reality towards its regressive trend seen during this period. The tax was aimed to be an income generating avenue for the revenue strapped government at that time, with GoP estimating an inflow or around Rs5b. However, the actually realised amount versus the consequences that accompanied makes a strong case against this fallacy.
A capital gains tax – or CGT as it is more popularly known – is a charge implied on the gain when an asset is sold at a higher price than what it was bought for. The champions of this tax argue that this is there to discourage ‘non-productive investment’ and ‘speculative transactions’ by making it more expensive to engage in such activity. They reasoned by the notion that the rich of the exchanges should also be contributing their fair share of taxes and so pushed successfully for the passing of SRO 112(1)/2011 issued by FBR in February 2011 which notified the imposition of the tax. While their argument holds weight, the way out is not the wrong type of tax. The capital market, faced with enough difficulty on its own, suffered another set-back it has struggled to recover from.
Now to put this into perspective: along with discouraging speculation, it has discouraged activity altogether. In 2008 and 2009, the average daily volumes of shares traded on the index stood at 161m and 136m respectively. In 2010, this had dropped to 89m shares given that half the year was endured under this new charge. Coming to 2011 the metric witnesses a further decline to 66m daily turnover. Less and less investors are being attracted to the exchange and current investors are also finding their investments ‘lifeless’. Although this decline cannot be attributed solely to the taxation measure, it certainly has had a part to play. It can be argued that such a regime is also present in India for over five years. But at the same time it should be realised that the SENSEX depth, in terms of investor base and product base, along with general investment climate, is far greater than ours. India took the step once its secondary market had achieved a level of maturity ours has still to see. A lesson half learnt beckons chastening in future.
Foreign investment into the local bourse has suffered as well. Net inflows received for the 1.5 years periods prior to and after imposition have been cut to half, precisely declining by 47 per cent. There is also a strong element of deteriorating law and order situation which has warded off foreigners but this gives added importance to the creation of investment friendly incentives rather than their anti. At the time of implementation, members of the exchanges lobbied hard against the imposition anticipating the negative impact it would add to an already problem filled plate. Notwithstanding they tried for several relaxations ranging from exempting foreign investors from the tax, lowering the rates, easing collecting mechanism requirements, removing the tax clearance certificate requirement for brokers, amongst numerous others. Apart from removing the regulation for obtaining tax clearance, none of these pleas were entertained.
What benefit has the government been able to extract from CGT? Under the IMF directed taxation moves, hardly any revenue from this front has been collected so far. This is attributed to the unreasonable computation and collection mechanism which was proposed without giving much thought to how it would unfold in reality. Each investor is expected to file an e-statement of taxes applicable on trades conducted under FIFO basis. For this a record needs to be maintained of each and every share transacted and when it was transacted. Expand this to the millions of shares being traded by investors daily; keeping track is no easy task. Then we have the issue of capital washouts, futures, and margin trades. It is a different scenario if broker systems were advanced enough to account for on-spot deduction, but this requires a detailed accounting setup which hardly a few can afford. CGT may look good on theory but has proved to be a messy affair when applied – or tried to be applied – in reality.
Market development is an important part of overall economic development. It acts as a means to providing liquidity to investments made as well as a source of capital for companies listed. With dried up investor interest, company listings have also been discouraged decreasing in quantum substantially. To revitalise investment in the country, CGT should be removed and possibly replaced with other non-financial measures if the intention of discouraging unproductive speculations is to be kept intact.
The writer is a financial analyst with
Pakistan Credit Rating Agency (PACRA)