Real estate tax

Everyone in Pakistan be a businessperson or employed, politician or cleric, military officer or bureaucrat, resident or expat; park their savings in real estate, whether the money is black or white. It is one of the most thrived sectors in the country in the last two decades with trillions of rupees transactions taking place every year; yet the real estate business has not generated adequate employment, and its contribution to taxes is peanuts.
The undocumented nature of the transactions is based on ridiculously low DC valuation, attracting more black money to the market and leaving little room for affordable housing projects to spur. The sectors contribution to informal economy is huge with easy return and inadequate taxes; this has discouraged entrepreneurs to reinvest in their businesses.
Real estate income taxation is a provincial subject, and lack of capacity and provinces has kept tax collection potential at bay. Lately, the federal government under the influence of multilateral lending agencies has been attempting to bring the sector into the tax net. And in the process, the center is trespassing into the federating units domain.
This year the government has actually pushed the agenda of taxing and documenting real estate. While the policy direction is right, the decision seems to be taken in haste, might need to be revisited, and should take provincial governments on board.
The capital gain tax (CGT) is now at flat 10 percent on sale of immovable properties within five years of purchase. The withholding tax on both sale and purchase of real estate has been doubled. The tax variation has been maintained for filers and non filers. Apart from increasing rates and enhancing duration, the government has also decided to have an independent property evaluation process under State Bank of Pakistan.
The step of evaluating properties close to the real value was much awaited but is politically a tough decision. All the praise to finance ministry for principally deciding to implement it. However, its not a smart move to increase the rates and revamp the re-evaluation process simultaneously. Here, one can sense an element of greed within FBR to meet the highly optimistic revenue targets.
There is no reason for having WHT for filers at higher rates on actual valuation. It would discourage real estate transactions - certainly not a cherished outcome. Then there are stamp duties collected by provinces at DC rates, resulting in duplication of taxation. And regardless of the lack of interest exhibited by the provinces compelling the center to step in, CGT at real value is essentially capitalizing provincial subject of taxing real estate income. The catch in the new proposal is how accurate would be the independent evaluation of property prices ranging from a commercial plot in DHA Karachi, to an agriculture land in Layyah, or a house in Charsadda. What parameters are the evaluators going to deploy? Are they going to use machinery of district government? How would the capital gain tax be applied for already purchased properties, registered at DC value? How would it be ensured that SBPs evaluators do not indulge in corruption and under value the transactions?
There are numerous procedural hiccups, and these can potentially jeopardize the cause of documenting the real estate transactions. Yes, there are teething problems and recently proposals from experts are raised to deal with it. The government might come up with amnesty scheme in a way that would somehow whiten the black money already parked in real estate.
Amnesty scheme might well be the only sane solution to the issue as all the white and black money is mixed in the real estate and its next to impossible to bifurcate, retrospectively. Even when an honest tax payer buys real estate, the transaction is usually registered at DC value. The reason is simple, the provincial taxation rates are too high as compared to those in other economies; and to avert excessive taxation its norm for everyone to undervalue. Hence, its all grey and the only way to deal is to refresh it white spray and not let the black spots to make it shady again.
An optimal solution would be to revise the DC value close to the real value. The SBP evaluators ideally should be using district management office to revalue the immovable properties. This cannot be done without taking provinces on board. Hence, its imperative for provinces and federal government to be on the same page. Alas, that is not the case today; and its a serious challenge.
If the finance ministry be able to resolve the issue amicably and design a system of fair evaluation; the black money would find it hard to be parked anywhere. This may entice entrepreneurs to reinvest in their businesses or to start new ventures. This would generate more employment and let the economy to grow.
With no big money pouring in real estate; the prices may correct and this would leave the market mainly for builders. There has to have incentive for those who are in construction business as if someone sell the property after building; it should be taxed based on the income the venture generates rather than relying on capital gain tax. However, in the absence of mechanism to tax income, an indirect way may be chosen. This is similar to many other sectors and today most of direct taxes are even in indirect form.
Nonetheless, a right evaluation of property would leave less choice for investing black money - one way, for it to be parked in real estate, could be by sending money aboard illegally and get it back legally with no questions asked. After paying the laundry cost, the shiny white money would be ready to come in real estate.
If that leg is being taken care of, the money which has flown out of the system will eventually come back through some real businesses. Its easier said than done. Best of luck Dar and team!