FBR discontinues all fiscal incentives available to PF sector

ISLAMABAD: The Federal Board of Revenue (FBR) has discontinued all fiscal incentives available to the Private Funds (PF) sector that provided it a level playing field with other pooled investment asset classes like mutual funds and the Real Estate Investment Trust.

According to a latest report of the Securities and Exchange Commission of Pakistan (SECP) on the private funds industry, the SECP has termed taxation of the PFs industry as “fiscal dilemma” for the country.

The SECP report recommended that there is a pressing need to remove the fiscal impediments created through the Finance Act 2021 to restore investor confidence in the sector.

In addition to advocacy for the specific tax proposals, it is essential to create an understanding that consistency in fiscal policies is vital for maintaining confidence of foreign investors. Fiscal measures for the sector therefore need to be considered on a perpetual basis as in other jurisdictions and not as an interim make shift arrangement that may be withdrawn in case of pressure to reduce the number of exemptions.

The report highlighted that the pass-through status earlier available to PFs has been withdrawn through deletion of clause 101 of Part I of 2nd Schedule of Income Tax Ordinance (ITO). The deletion also triggered minimum tax on PFs in terms of sub-clause (xii) of clause 11A of Part IV of 2nd Schedule.

The Clause 103 of Part I of 2nd schedule which extended to distribution received by a taxpayer from capital gains of a PF has also been done away with. 37. Similarly, amendments proposed to section 47B have resulted in applicability of withholding tax on PFs, even though such tax is non-applicable for other categories of funds which have pass through status as per tax law. As a result, the following taxation layers become applicable on a PF.

The investment through PFs now stands at an inherent disadvantage due to multiple layers of taxation. This unfavourable taxation environment has severely hampered growth of locally domiciled PFs. It needs to be considered that the first fund under the revamped Private Funds Regulations, 2015 was launched in 2017.

While, the earlier pass-through status with built-in sunset clause granted by FBR till 2024 was a cause for concern for new entrants of the industry contemplating a 5-7 years’ fund life. The uncertainty surrounding the fiscal environment for the sector has been further augmented due to the recent withdrawals which also strengthened views of many of the foreign investors who cite lack of consistent policies as a key reason for not investing directly in locally domiciled funds.

The PF industry has, however, obtained some clarifications from leading audit firms that clause (57) of Part I of the Second Schedule of ITO provides exemption on total income of a PE&VC Fund, other than specified capital gains, provided that the fund distributes 90% of its income of that year amongst its unit holders.

In addition, insertion of clause (103D), Part I of the Second Schedule to the ITO has granted exemption on dividend income and long-term capital gains derived by a PE&VC Fund that invests in enterprises setup under the Special Technology Zones (as defined under Special Technology Zones Authority Ordinance, 2020) for a period of 10 years from the date of issuance of license by STZA authority to the enterprise.

It needs to be noted that the SECP has been pursuing fiscal reforms for the PFs sector, in line with similar fiscal measures adopted by various other jurisdictions.

Majority jurisdictions such as UK, USA, China, Malaysia, India, Italy, France, South Korea, Turkey, Bangladesh etc. provide pass-through status for private equity and venture capital funds (practices in other jurisdictions for fund level tax on PE&VC Funds.

Interestingly, in some jurisdictions such as Israel, which has emerged as a venture capital investment destination, in addition to pass-through status, the investee companies in which a venture capital fund makes an investment was also granted a ten-years tax holiday.

Such measures adopted in other jurisdictions have not only ensured tax neutrality but further incentivised investments through PE&VC funds.

In addition to actively pursuing fiscal reforms with the FBR, the SECP has also been advocating the same at various forums, including with the Asian Development Bank, as part of its recommendations for implementation of Capital Market Development Plan and Road Map 2020-2027, the SECP report added.

Copyright Business Recorder, 2022