The stock market crash on Monday the 14th of June saw Rs 44 billion wiped off market capitalisation, as investors demonstrated their resentment against the Capital Value Tax announced by the Finance Minister in his budget speech.
This reflected the fall on the Karachi Stock Exchange (KSE) of 166.91 points or 3.1 percent in share trade.
The market recovered the next day but still the loss incurred is estimated to be around Rs 300 million.
The Budget for 2004-05 proposed the Capital Value Tax (CVT) of 0.1 percent on all share purchases, which the Central Bureau of Revenue (CBR) estimated would net it Rs 7.2 billion a year based on the pre-CVT level of transactions.
The proposal was ill-advised for two basic reasons, and likely to cause the market crash and a violent protest.
First, it came as a complete shock for brokers and investors alike. Some of the latter, and perhaps some of the former too, voiced their anger at losses incurred because of the markets' crash by trashing the KSE's offices and mounting strident protests outside the Lahore and Islamabad Stock Exchanges.
Such behaviour does not behove brokers and investors, groups not normally associated with militancy.
But it has become a sad fact of life in Pakistan that most people believe the government does not listen until and unless an aggrieved group is able to create some nuisance value for itself.
Second, CVT is essentially a tax on investment, which hardly makes sense when the government is claimed to be encouraging investment of all types, including stock market portfolios.
Given that CVT of 0.1 percent on share purchases would raise the transaction costs, the market reacted with panic selling and many brokers and investors had their fingers burnt.
What the geniuses of the CBR failed to realise was that when transaction costs rise, the volume of trading would inevitably decline, making the target of Rs 7.2 billion revenue unattainable.
In response to the protest, the government has now set up a committee composed of the chiefs of the three stock exchanges, the Securities and Exchange Commission (SECP) chairman and Member (Taxes) CBR.
It will report back within a week with alternative proposals to the CVT. Finance Minister Shaukat Aziz, who has come in for a lot of stick for the proposed measure, has promised he will take a decision in one day after the committee reports.
Let us face the ground realities. The economy is not fully documented as yet. Therefore, CBR has opted to take the CVT route as it is felt that the actual realisation from capital gains tax on shares would be difficult to assess in a country where the practice of benami ownership is prevalent to evade tax liability.
As such, the CBR felt the need for resorting to indirect taxation mode for collecting a direct tax.
This is half-way house. Indirect taxes are regarded as being regressive in nature while direct taxes are considered to be progressive.
The other ground reality is the fear of audit of submitted accounts by the business class.
This is due to the heavy-handedness of the tax collectors and the treatment meted out to the assessee by them.
The businessmen are more than willing to have their taxes collected as a transaction tax, ie as withholding tax upon receipt of payments.
However, they all want this to be accepted as the final settlement tax liability. It is in this context that the brokers class will agree to any taxation proposal which shuts out the audit mechanism for them.
But the Government has good reason to be firm that the principles governing the tax regime of selective random audit are not compromised.
Interestingly, the government had sought to sweeten the bitter pill of CVT by extending the concession of not imposing capital gains tax for another two years, thereby stretching the moratorium on capital gains tax to the year 2007.
But in the hullabaloo over CVT, this sweetener has got drowned out. Capital gains tax is a far more rational levy on the particular form of profit accruing from trading in stocks and shares.
A more feasible way to distinguish between the investor (to be encouraged) and the mere speculator (to be discouraged) would be to impose a minimum period that shares have to be held, say 90 or more days, to avoid or minimise capital gains tax.
In any case, if alternatives are being discussed to the virtually dead in the water CVT, it may be advisable to leave the original period of moratorium on capital gains tax, ie till 2005, intact, but with a holding period, and then impose this tax after that date with no holding period.
That would be a more reasonable measure since it does not discourage investment and only taxes profits made out of trading on the bourses. However, as reports indicate, this is not to be.
The bourses and the CBR are in negotiations on three counts, namely: doubling the present rate of withholding tax of 5 percent on brokerage, taxing the intra-day trade between brokers and getting a slice from the volume of carry-over transactions (COT) or 'Badla' in common parlance.
The COT in due course is likely to be replaced by margin financing and would thus be in the documented domain and subject to tax.
Increasing the withholding tax on brokerage would be unjust and to make it the final tax liability militates against the principle of taxing income and not revenue.
Whatever the outcome of the current negotiations, and an outcome there will be shortly because the government is already showing signs of beating a hasty retreat to extricate itself from the mess that it has landed in, it must be said to the credit of the Karachi Stock Exchange management who did not suspend trading under pressure despite hooliganism by none other than the staff of the brokerage houses who are members of the exchange.
These members confined themselves to their offices and did nothing to rein in their employees. Such inaction is indeed most unbecoming of their community, to say the least.