Finance Minister Shaukat Aziz in his budget 2004-05 speech said that the daily turnover of shares on the stock exchange is around Rs 70 billion but the capital gains arising out of such shares are exempt from the levy of income tax until tax year 2007.
In view of extensive tax-free income being generated in this business, it is proposed to levy capital value tax (CVT) on the purchase of shares at the rate of 0.1% of the value of shares transacted.
There was hue and cry from the tycoons of stock exchange members/brokers against this nominal levy which crushed the stock rate and confirmed the fact that the capital market is dominated by a few tycoons in the name of the investors who manipulate it according to their requirement.
It is unfortunate that in this country big fishes, whether in the agriculture or other sectors, are not in a mood to contribute to the exchequer to build the nation strong enough to get rid of the world donors who lend the money at their dictated terms and conditions and thus the sovereignty of the nation is at their mercy.
It appears that the government had not done its homework before framing this proposed levy of CVT, hence it surrendered under the pressure of these wealthy and powerful lobby obviously for the reasons that the rulers, whether in uniform or otherwise, are from the said flock.
However, the final outcome of the said resistance against the levy of Capital Value Tax was that the Central Board of Revenue (CBR) inserted section 233A to the Income Tax Ordinance, 2001 (Ordinance) and issued three circulars on deduction of withholding tax by a registered stock exchange and one circular on collection of Capital Value Tax by a registered stock exchange on the purchase of shares.
The scenario would now be that the circular No 03 of 2004 dated 01-07-2004 requires the stock exchange to collect tax at the rate of 0.005% with effect from July 01, 2004, on the sale trading value of shares transacted through its automated trading system in ready, future, provisional and any other counter. The members of the stock exchange shall collect tax from their clients and shall pay it to the stock exchange.
The tax so collected, states the circular, is an advance tax and is adjustable against final tax liability of the seller of shares.
The circular No 4 of 2004 dated 01-07-2004 requires the stock exchange to collect tax @ 0.005% of the purchase value and 0.005% on the sale value of the shares from its members in lieu of the commission earned on purchase/sales transacted. The members shall pay tax on purchase/sales. The tax will be the final tax liability of the member.
The circular No 5 of 2004 dated 01-07-2004 requires the stock exchange to collect advance tax @ 10% on carryover (Badla) markup transacted. The member shall collect tax from its financers. The taxes collected would be adjustable against the final tax liability of the financers.
The new section inserted in the Ordinance provides that the stock exchange shall collect advance tax from it members (a) on purchase of shares in lieu of the commission earned by such member, (b) on sale of shares in lieu of commission earned by such members, (c) in respect of trading of shares of members and (d) in respect of financing or carryover trade (badla).
There appears some divergent provision between section 233A of the Ordinance and the circulars issued by the CBR. The section 233A(c) provides that the stock exchange shall collect tax from its members of the sale trading of shares in lieu of the commission earned by such members whereas the circular No 3 dated July 01, 2004 states that the members concerned of the stock exchange shall collect tax from its clients.
According to the circular the investors on whose behalf the members sells the shares will have to pay the tax of the sale value of shares transected through the members, though the intention of the statute is not as such.
Similarly circular No 05 of 2004 dated 01-07-04 states a stock exchange shall collect advance tax @ 10% from its members on carryover trades (COT - Badla) markup transacted through its automated system in COT market and the member shall collect this tax from its financier. But there is no such provision in section 233A(d) of the Ordinance to collect the tax from the financier.
Moreover, section 233A(1) provides that the tax collected by the stock exchange (a) on purchase of shares and (b) on sale of shares is advance tax but sub section (2) of section 233A provides that the said tax is final. Such poor drafting confuses the issues and misleads the investors or taxpayers. This provision needs to be reviewed by the CBR and the stock exchange as well. Further the Securities Exchange Commission of Pakistan (SEC) cannot remain aligned to this confused provision in the Ordinance which has very significant impact on the taxability or otherwise of the investors.
The circular No 6 of 2004 dated 01-07-2004 issued by the CBR is relate to the collection of Capital Value Tax (CVT) by a registered stock exchange on the purchase of shares @ 0.01% of the purchase value of any modaraba certificates or any instrument of redeemable capital as defined in the Companies Ordinance, 1984 or shares of a public company listed on the stock exchange in Pakistan.
The circular states that the members shall collect CVT from their clients. The said circular provides that non-resident persons/institutions seeking refund shall file their claims with the taxation officer concerned. The refund application under section 170 of the Ordinance is required to be filed with the Commissioner but the circular requires the non-residents to apply for refund to the taxation officer which is not in confirmity with the statute which overrides it.
The Finance Act, 2004 has introduced a new proviso to section 7(4) of the Finance Act, 1989 whereby the stock exchange will collect CVT from the resident person. It does not provide that the members will collect tax from their client.
It will be observed that the CVT was levied in the Finance Bill 2004-05 on the purchase of shares by the members @ 0.1% of the value of shares transacted.
The government's intention was to bring into tax-net the free income generated by the members, brokers of the stock exchange; but on their resistance the CBR imposed the withholding tax on the small investors who will bear this additional burden of tax because the tax deducted on the sale of shares is the final tax.
They cannot adjust this tax against the income earned through other source. Thus both the said decisions of the CBR are on an unsound footing.
On the one hand the period of exemption to income of capital gain from the sale of shares etc has been extended for another two years in the budget, on the other it levied CVT on such sale of shares. If the government has the intention to generate revenue, it could have not extended the exemption on capital gain in the budget 2004-05 because it was to expire on 30th June, 2005. Moreover, the exemption on the capital gain is allowed without any limit of income of capital gain earned.
In order to encourage the small investors, the exemption on this account should be allowed at a lower limit, exceeding the specified ceiling of such income be brought to tax.
The levy of withholding tax on the purchase and sale of shares will have an adverse impact on the investment, because the trading in shares is mostly done by the National Investment (UNIT) Trust or mutual funds established by the Investment Corporation of Pakistan or collective investment schemes authorised or registered under the Non-Banking Finance Companies Rules, 2003 or a modaraba.
These institutions are exempted under clause (47B) of Part IV of the Second Schedule to the Ordinance from deduction of tax on payment to them on account of dividend under section 150, profit on debt under section 151, and brokerage and commission under section 233. But the new section 233A investor in the Ordinance in respect of collection of tax on sale/purchase of share has not been inserted in the said clause for exemption of such tax.
Consequently these institutions will suffer a tax burden despite income of mutual fund of an investment company registered under the Investment Companies and Investment Advisors Rules, 1971 or unit trust scheme of an assets management company is exempt under clause (99) of Part I of the Second Schedule to the Ordinance from tax if these institutions distribute not less than 90% of their accounting income among their certificate or unit holder. Similarly clause (57) of Part I of the said schedule has exempted the income of NIT, Mutual Funds subject to distribution of 90% of their income.
Further income of EOBI and other funds which are the main investors, their income is also exempt from tax under the said clause. These exemption provisions, thus will be seriously hit by the provision of section 233A.
The government thus in order the protect the interest of a few tycoons has created serious problems for the investors, especially for foreign investors who have to approach the taxation authorities for refund of such tax withhold on their transaction. It is interesting that the Ordinance exempts income under one provision while the other provision (233A) taxes the same income.
Moreover, the members have started to shift the tax so deducted/collected from trading of shares to the investors. The CBR has, therefore, advised the members of KSE not to charge tax from their clients as it is against the norms of income tax law, because the members/brokers pass on the presumptive tax payable by them on the commission to their clients either by enhancing the rate of commission or through collecting service charges. In fact the payment of presumptive tax is the personal and exclusive liability of the members/brokers on their commission income.
The mechanism devised for collection/deduction of tax on purchase/sale or badla transaction is that the members will tax so collected, including proprietary trade, and submit a specified statement to the stock exchange which will deposit tax on 25th of each month into the government treasury.
The copy of the paid challans along with a specified statement shall be forwarded to the CIT concerned holding jurisdiction over the concerned stock exchange.
The stock exchange claims that it has developed a software to collect and process the required data to create the required specified statements etc. It has delivered a cheque of over Rs 73 million to the CBR of tax collected during the period of July 2004.
The system of the said withholding tax is very complicate and the chances of evasion are tremendous. The Managing Director of the Karachi Stock Exchange also has admitted that of out 150 working members 140 have complied with, the rest are defaulters. The CBR has not any means to detect the evasion and thus default in tax culture will grow.
The question is why the investors are made subject to withholding tax on their investments activities just to please a powerful lobby. Section 233A clearly provides that these withholding taxes are levied on the income of the members/brokers in lieu of commission income earned by them. There nowhere is provided that it will be collected from the investors whereas the members/brokers have started to collect these taxes from their clients. The CBR has also warned them against their illegal practice. But there is no provision in the ordinance to check this trend.
It is recommended that
(i) The withholding tax levied under clause (a) and (b) of 233A(1) be withdrawn.
(ii) The capital gain tax be exempted to a certain low, ceiling, exceeding this ceiling be brought to tax
(iii) The words Advance Tax in sub section (1) of section 233A be deleted.
(iv) As a result of withdrawal of tax on the sale/purchase from the investors, the rate of CVT be raised to 0.02% and the members be made liable to pay it.
(v) The non-resident investors be exempted from payment of CVT.
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