ISLAMABAD: The Securities and Exchange Commission of Pakistan (SECP) has released a diagnostic review of Pakistan’s Private Funds industry, providing a holistic synopsis and recommendations for key fiscal and regulatory reforms required for a vibrant PF industry that can spur economic activity, catalyze job creation and increase government revenues.
The report provides an overall assessment of the country’s Private Funds (PF) sector, which collectively refer to both Private Equity and Venture Capital Funds (PE&VC Funds) and Alternative Funds.
To enable a vibrant and galvanised PF sector, the report also provides policy recommendations for a multifaceted reform agenda. Apart from properly defining private funds in the tax laws and enabling all private fund categories to avail pass-through status and capital gains tax exemptions, the report provides some basic steps that can augment the investor pool and unify government initiatives for the sector.
The report states the total size of Private Equity and Venture Capital Funds as on June 30, 2022 reached PKR 10.99 billion as compared to PKR 6.69 billion on June 30, 2021, registering a year on year growth of 64 percent. However, the number of PE&VC funds remained the same at five.
The SECP Chairman Aamir Khan, in his statement attached to the report said that considering more than 60 percent of population comprises of youth in Pakistan and to encourage innovation and knowledge-based ideas into commercial production, the potential of PF industry requires to be practically tapped and fully explored.
The report said that most of the local VCs operating in the start-up space do not have any license from the SECP and only a few are incorporated as private limited companies, with object clause enabling investments in other companies. Such VCs tend to invest from their own resources or from funds raised in other jurisdictions and do not actively solicit investors in Pakistan. The investments they make are categorised as personal investments given that the funds have been pooled offshore to be brought into Pakistan.
On the operational side, the study answers pertinent questions enabling launch of private funds in the alternate legal structure of Limited Liability Partnership as compared to the long prevailing trust structure. It also recommends a relook into the role of trustee and custodian, considering that these funds target only sophisticated investors and institutions.
The Federal Board of Revenue (FBR) through the Finance Act 2021 has discontinued all fiscal incentives available to the PF sector that provide it a level playing field with other pooled investment asset classes; like mutual funds and the Real Estate Investment Trusts. 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. 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. 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.
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 the 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 to the above, 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 PF sector, in line with similar fiscal measures adopted by various other jurisdictions. The 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. 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.
Copyright Business Recorder, 2022
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