Low taxation of property

The recent revelation of massive investment in property by Pakistanis in Dubai of over $11 billion has not only raised issues of the exit of capital from Pakistan but also the extent to which these properties are being taxed as per the tax laws of Pakistan.

Also, there is need to focus on the revenue potential of property-related taxes inside Pakistan prior to the presentation of the budgets for 2024-25 by the Federal and Provincial Governments and to identify proposals for generation of significant additional revenues in a very progressive manner.

The objective of this article is first to quantify the size of the real estate sector and the extent to which it is attracting investment at the cost of other more productive sectors.

Second, the wide assortment of property-related taxes at both the Federal and Provincial levels are identified and an estimate made of the current generation of revenues. Third, an attempt is made to quantify the ‘tax gap’ and proposals presented for higher generation of revenues from the property sector.

According to the Pakistan Bureau of Statistics (PBS), the rental value of the real estate sector, including the imputed value of owner-occupied properties, is 3.5% of the GDP in 2023-24, equivalent to Rs 3705 billion.

This sector has shown a faster real growth rate of 3.7% since 2017-18, as compared to the overall GDP growth rate of 2.6% and that of the large-scale manufacturing sector of only 0.6%.

There is evidence that in the presence of the low tax burden in real estate as compared to other sectors, especially large-scale manufacturing, private investment is increasingly being diverted towards property.

For example, in 2022-23, the quantum of private investment in real estate was over two-and-a-half times larger than in the large-scale manufacturing sector. Up to 2018-19, investment had been higher in the latter sector.

Also, while overall private investment has declined in real terms by almost 19% since 2017-18 it has risen in real estate by 20%. Clearly, the favoured tax treatment of properties has to be withdrawn if investment is to be diverted to more productive channels like manufactured exports.

What is the existing incidence of taxes on properties? There is need to identify first the taxes at the Federal and the Provincial levels, respectively. The property-related taxes at the Federal level are the income tax on rental income, capital gains tax and advance taxes on sale/purchase of property.

At the provincial level, there is the urban immoveable property tax and the stamp duty on property transactions. Also, the Provincial governments have been granted the fiscal powers to levy a capital value tax on property in the 18th Amendment to the country’s Constitution.

The detailed break-up of tax revenues is available only up to 2021-22. The overall tax collection from properties through various provisions in the Federal income Tax was Rs 154 billion in 2021-22. This is only 6.7% of the total revenues from the income tax and only 4.5% of the national rental value of properties.

The combined collection from the stamp duty and the urban immoveable property tax at the Provincial level is even below Rs 80 billion.

There is need to recognize the very progressive nature of property-related taxes. The urban share in rents is 63%.

The share of rents of the top two quintiles is 62%. A first estimate of the potential revenue from the urban immoveable property tax is Rs 100 billion. This is over seven times the collection presented by the four Provincial Governments combined.

There is substantial revenue potential also at the Federal level. Currently, the rental income tax yields less than Rs 30 billion. It is levied as a separate bloc of income.

The exemption limit is Rs 300,000 and there are three slabs, with the marginal tax rate rising from 5% to 25%.

Property income should instead be included in other income for tax purposes and steps taken by FBR to check underreporting and tax evasion. This could lead to at least five times jump in tax revenues.

There is need also for development of the capital gains tax on property. The provision of exemption if a property is traded after a holding period of six years must be withdrawn. Also, the tax rate is low.

In India, for example, the long-term capital gains tax rate on property is 20%. Based on these changes, the revenues from the capital gains tax on property and the advance tax on property transactions will be a large multiple of the present collection.

The urban immoveable property tax is grossly underdeveloped. Total revenue collection by the four Provincial governments combined is less than Rs 14 billion. This is not even 1.5% of the rental value of relatively large properties in the urban areas of the country.

There are two basic reasons for this failure. First, the Provincial Excise and Taxation departments have failed to update the assessed rental or capital values of properties. This has drastically reduced the revenue yield.

The urban immoveable property tax must be seen as the principal revenue source for urban local governments.

This has become even more essential following the abolition of the octroi tax. The very poor state of municipal services in cities like Karachi is attributable to an acute shortage of revenues.

The following proposals may be considered for adoption in the Federal budget of 2024-25:

I) Capital gains on properties to be taxable irrespective of the holding period at 10% of the accrued capital gains.

2. Rental income not to be treated as a separate bloc of income but merged with other income for federal income tax purposes.

The Provincial Excise and Taxation department must announce a process of revaluation of rents/ capital values of properties during 2024-25.

Overall, adequate taxation of properties will represent a big move towards a more progressive tax system in Pakistan. This will be in sharp contrast, for example, to the IMF suggested regressive move of raising the sales tax rate on goods from 18% to 19%. The time has come for the luxury property-owning elite to make a requisite contribution to tax revenues.

Copyright Business Recorder, 2024