In its ongoing efforts to explore more venues for taxation so that Pakistan's tax-to-GDP ratio improves at its targeted rate, the government is considering expanding the scope of section 37 of the Income Tax Ordinance 2001 dealing with Capital Gains, which has thus far excluded levy of this tax on sale-purchase of immovable assets (real estate). FBR is pushing for the imposition of Capital Gains Tax (CGT) on sellers of real estate.
The imposition of the proposed CGT is logical because it will tax the gainer whereas the currently applicable Capital Value Tax (CVT) taxes the asset buyer. Indeed, like all other incomes, gains on sale of property too should be taxed if that activity is undertaken as a business, i.e., quick purchase and sale of real estate for the purpose of making gains, not occupation or appropriate use of that asset.
That said, there are some likely consequences of such a move that too must be kept in mind if this move is to deliver the results it is supposed to, rather than become another venue for tax evasion and related corrupt practices. To begin with, Pakistan's housing sector is far short of the needs of a population that is expanding at over 2 percent per year. Pakistan also has the distinction of having just one specialised housing finance institution. Because of increased migration of the population to big cities, land prices in cities are rising in spite of the economic depression because of speculative tendencies clearly visible in the housing market. This is a scenario that serves only the powerful property developers and the rich, while the middle and lower middle classes don't benefit. In all likelihood, sellers will not pay the CGT; instead they will build it into the sale price of the asset which, besides defeating the purpose of the well-intentioned CGT levy, could make these assets even less affordable by the middle and lower middle classes.
This impact could be compounded if CGT on real estate transactions, is levied at a high rate; it could put the middle and lower middle classes - the vast majority - at a distinct disadvantage. Besides, it will also encourage practices whereby this tax could either be evaded or its impact minimised by misreporting the purchase and sale prices of the assets involved. It is no secret that, at present, malpractices prevent levy of the correct taxes on transfer of property ownership. Authorities have yet to find a way of checking this ongoing malpractice that prevents collection of appropriate transfer levy. Unless the collecting authorities develop a system of fair valuation - whereby they can establish fair purchase and subsequent sales prices of the properties involved, imposition of CGT may not deliver the desired results. To appear fair, taxes should not be levied merely to bridge fiscal deficits, but to ultimately bridge the gap between the rich and the poor.
From the indications available thus far, the FBR (which proposes to include this tax in the Finance Bill 2012) is unclear about the holding period of the immovable asset that will justify taxing its sale proceeds. The holding period being mooted is between one to three years. Taxing the sale proceeds of a property that was occupied by its owner for three years does not convey the impression that it was bought with the intention of making a capital gain, but properties sold within one year or eighteen months of their purchase convey that impression. Finally, it is undeniable that property developers make hefty capital gains, unless they factor in the land value at purchase price. This obviously they do not as purchase transactions are done on notified prices for each area and are well below the actual price paid. How will it be established that besides the profit they earn purely on the basis of a premium over their construction costs (and, hopefully, taxed), how much capital gains did they earn on the price of land? Shouldn't this part of their gain be admissible for recovery of the CGT in addition to the income tax they pay? All these issues need credibly addressing.