Section 68 is a general section of the Income Tax Ordinance, 2001 that deals with the subject of determination of the fair value of assets. Under this section, taxation officers whilst determining the tax incidence of any transaction are entitled to determine the 'consideration' at the fair value. Officers, in all circumstances, are not bound to accept the transaction value as declared by the taxpayer. There is an inherent power of substitution of the declared value. For tax purposes, transaction is to be taken at the fair value.
This provision has a special significance in the case of transactions relating to disposal of immovable property. In that case 'valuation' has another dimension also as there is another value for the purposes of levy of stamp duty and registration, under the provincial legislations. That value in generic terms is called DC rates. As explained in the following paragraphs both are different subjects which have been unnecessarily inter-linked for the sake of convenience.
It is a commonly known fact, that despite several increases DC values are substantially less than the fair value of immovable properties. In almost all the cases, actual transaction is made at the fair value whereas documentation, for all official purposes, is made at the DC value. This leads to effective non-documentation of a documented transaction. It is considered that this 'gulf' has now widened to 1:10 level in some cases. This means that 90 percent of the value remains out of the system. In practice, two payments are made. One representing DC value of the transaction and other being 'non-trailed' 'undocumented value of the transaction'.
There is no estimate of the amount that lies, undocumented in the system due this lacuna. Nevertheless if it is considered the actual GDP of the country is around US $390 billion as against US $290 billion officially recorded then around US $100 billion is created undocumented each year in Pakistan. If it is further considered that out of the same 25 percent lands in property then it means around US $25 billion is being parked in property sector each year. So an estimated sum of US $250 to 300 billion is already parked in this sector. There has to be a system to bring the existing assets into record and stop further accumulation/ parking of untaxed money in that sector. This parking lot has effectively brought the prices to a level where it has become unmanageable for people with taxed money to own a reasonable property. It is an economic issue not restricted to tax.
Capital gains on disposal of immovable property, other than trading transactions, constitute a subject that falls within the ambit of taxation of the provincial governments. There are controversies regardless of the question whether or not amendment in the Federal Legislative List by the 18th Amendment to the Constitution has changed that status. Nevertheless, it is author's firm opinion that gain on disposal of immovable property, other than those being adventure in the nature of trade, are taxable by the provincial governments not the federal government.
This division of taxing right is a different subject not under discussion in this article.
Through the Finance Act, 2016 three major amendments have been made in the laws which will directly affect the tax on disposal of immovable properties. These are:
1. Gains on properties sold within 5 year of acquisition can now be taxed by the federal government under the Income Tax Ordinance, 2001. Previously the said period was two (2) years. Any gain on sale of property held for a period more than 5 years is not taxable under the Income Tax Ordinance, 2001;
2. A new sub-section has been added to the Section 68 of the Ordinance whereby 'fair value' in the case of immovable property shall be determined by a panel of approved valuers of the State Bank of Pakistan;
3. A special flat fixed tax scheme has been introduced for builders and developers whereby tax on sale of property by such builders and developers will be a fixed sumnot related to actual gain or loss on such sale.
All the three amendments if properly implemented have changed the whole paradigm of taxation of income on disposal of immovable property. Nevertheless this article is restricted to the subject of fair valuation.
The first amendment is the enforcement of Federal Government's right of taxation. In another sense it also means that any disposal within 5 years is effectively taken as being in the nature of trade. This would in practical sense means that volume of transaction that can now be taxed has increased substantially.
The second amendment is a major paradigm change in the existing system. Notwithstanding the fact that there is no expressed restriction on the right of a taxation officer to determine the fair value to ascertain the gain on disposal of assets, there had always been an 'implied' restriction which is the main cause of dual transaction system as referred above. This implied restriction has been placed over a long period of time which has specifically been reiterated by Federal Board of Revenue's circular dated June 29, 1993 which in paragraph 2 states that:
"I, am in view of the foregoing , directed to say that in cases where assessing officers have to value the immovable properties for one reason or other the value fixed by the Provincial Authorities, if available for the area in which the property is situated should be made the basis of valuation".
Under Section 206 read with 214 of the Income Tax Ordinance, 2001 instructions of Federal Board of Revenue are binding on the assessing officers therefore, in practical sense, Section 68 became inoperative by the aforesaid instructions and assessing officers were barred to value immovable properties at a sum higher than the values determined by Provincial Authorities. This leads to a double accounts system.
On the other side, there had always been a very strong and valid argument that arbitrary powers to assessing officers lead to discrimination and abuse of discretionary rights.
Through the amendment made in Section 68 of the Ordinance as referred above, the aforesaid circular has become 'redundant'. Now in case of immovable properties the assessing officers are not restricted to limit the transaction value to the DC. In case there is a difference of view on the value declared, or recorded in the sale document, though registered by the Provincial Government, the taxation officers are entitled to amend the declared position. Nevertheless such amendment is subject to a condition that amended value shall be the one undertaken by a valuer from amongst the panel approved by the State Bank of Pakistan. This amendment looks simple; however, it has very far-reaching consequences for the culture, market and incidence of tax on transactions relating to properties.
At the outset, one primary principle of taxation is to be understood. Tax is levied on an individual transaction and tax incidence 'has' to be determined on the basis of 'that' transaction value. Whenever the incidence is moved away from transaction value to any other value, low or high, other than the actual value, then it means that there is deviation, aberration and discarding of actual record. That is the starting point of all ills in the taxation system being non-documentation. Accordingly, restricting the value of transaction to DC value, irrespective of actual transaction is fundamentally a wrong concept. It is for this reason this aberration never became the part of law. It was always used as a guidance for the taxation officer. It is effectively used as a doctrine of necessity. It should therefore be clearly understood that if there is a desire to tax actual income/gain then DC value restriction is fundamentally a wrong concept. Nowhere in the world woes there exist its application.
Secondly, an implausible argument is placed that DC value should be increased to bridge the gap between the actual transaction and the real value. This argument is fundamentally flawed. Let us analyse that analogy on facts of the matter. There are two houses on the same street one being west open, made with excellent materials, fitted with imported accessories, etc. Whereas on the same street there is an ordinarily built east open house. The value and price of both the houses can never be the same, and accordingly the transaction price for sale would never be the same. An apartment facing a park has a different value than the value of the flat on the rear side. Property is not a homogenous commodity, therefore a standard pricing is essentially a wrong idea. This approach was adopted for facilitating the taxpayers which over the time has become a menace in the tax system. If the Provincial Government revises the DC value that would be an additional good step but that is a different subject.
Stamp duty incidence and withholding at the time of execution of transaction have no relation with the tax incidence of a particular transaction. Even after the amendment in the law, such incidence will remain the same and the amount of withholding will be adjustable against the actual liability so calculated. There will be no change in the value for withholding tax purposes which will continue to be undertaken on DC value.
Now, let us see the other side of the picture. In the Circular of 1993 where this restriction of DC value was placed in the system has a preamble. That preamble rightly identified the possibility and recurrence of abuse of discretionary powers by the taxation officers that led to this facilitating measure. Abuse of discretionary powers is a fact especially in our culture where overall governance is weak. Accordingly, there has to be a balance between the two forces. Now that balance has been created by taking away the overarching right of valuation from the taxation officer and requiring the taxation officers to use the services of a specified class of valuers. This caveat is theoretically right however its practical effectiveness will emerge over the time. There is always a natural system of evolution and over the time a sensible close of real valuation basis will emerge. Nevertheless, in the meantime these measures will have to be enforced to the effect that discretionary powers are not abused.
If the third amendment is read with the amendment in the valuation process then that could lead to a positive dimension. In principle, fixed tax scheme for the builders and developers is essentially a departure from the taxation system as identified earlier where taxation is to be made on actual transactions on net income basis. This has not been done in the case of builders and developers. Accordingly another 'island' in the system has been created. Without prejudice to the same, if the amendment relating to valuation is seen in an overall context then now it may be commercially viable for builders and developers to force the buyer to record the transaction at the fair value as it is through them that the tax incidence is fixed. In this manner, there are reasons to believe that in commercial sense the value of property will effectively be inclined to be recorded at the fair value. For builders and developers it is better to receive white money as their incidence of tax is fixed.
The aforesaid commercial sense is correct; however, the fundamental problem is the availability of 'white' money with the buyers. A substantial number of purchasers of property are the persons who do not have white money to be used for such transactions. In the overall context, genuine 'reform' will emerge when all such leakages are plugged over a short period of time. Property remains to be an easiest and most liquid market for parking such funds; therefore, ways and means will have to be identified to deal with this channel.
Notwithstanding the implementation process and the difficulties that may arise on the matter including the forces which will strongly resist the change there is no doubt that the step undertaken in the Finance Act 2016 with respect to valuation of property is a move in right direction. It, at least, identifies and indicates that this biggest parking lot for untaxed/undocumented money is on 'radar' which itself is the first step towards any corrective measure.