Real estate taxation — a blessing or a curse?
Real estate taxation — a blessing or a curse?
The Finance Bill 2016 caught everyone by surprise in the real estate sector especially persons with black money and short term speculators. For them it is a nightmare that FBR can value the properties at fair market value which have taxation repercussions regarding source of investment and thereafter can levy Capital Gain Tax (CGT) if the asset is held for less than five years. The whole real estate market is in shock and statedly it has been learnt that in some major housing entities the business is almost at halt. There are visible signs for arranging strikes in some major cities in Pakistan but so far no defined agenda in terms of demand has been made public especially by real estate dealers association.
Interestingly, the here-say is that the two major amendments would discourage foreign remittance to Pakistan, which apparently is totally misplaced. The overseas Pakistanis, if they remit their money through normal banking channels per income tax ordinance 2001, are exempt from tax and the remitted money is treated purely “white”. In fact, previously when an overseas Pakistani with “white” money used to buy as asset and get it registered at Deputy Commission (DC) value he was willingly or unwillingly converting part of his “white” into “black” money.
As an example, an asset bought for PKR 10 Million and registered at a DC value of PKR 2.5 Million would transform an overseas person’s major chunk of money i.e. PKR 7.5 Million into “black”. This was totally undesirable but he had to follow the market practice by getting the sale purchase agreement registered at the DC value. The beneficiary was other party who in most of the cases did not have enough “white” money to complete the transaction. Therefore, the worry should be for people who have untaxed money but not the overseas Pakistanis who have, in fact, only “white” money.
Secondly, the capital gains tax has been levied @10% of the gain between sale and purchase price if the property is sold within five years of its purchase. This amendment is also geared towards curbing speculative trading which majority of the overseas Pakistanis do not intend to undertake due to their remoteness and investment strategy. Hence, practically it will not impact the overseas Pakistanis and even in case a 10% tax is paid on the gain, it should be acceptable considering the high tax rates on capital gains which they are bound to pay in most of the foreign countries of their residence, except for middle east.
The 10% tax slab is rational considering that on other business incomes, the applicable rate is around 35%. Hence the applicable rate is very well lower than the tax rate levied on normal business income. Conclusively, the overseas Pakistanis should consider these aforesaid changes in the tax statute as a blessing in disguise as it will allow them to properly make their declaration and let their “white” money remain “white” instead of being forced to convert it in to “black” money, under the older system. However, a piece of advice for overseas Pakistanis would be to at least stick to the below:
1) Use normal banking channels to remit their money into their bank accounts from overseas. Keep the relevant documents in their record for future purposes. The documents in order of precedence would proceed realization certificate issued by their Pakistani bank, bank statement from Pakistani bank and remittance receipt of overseas bank.
2) If you intend to purchase the property it should be with “white” money. The sale-purchase agreement should be on the fair market value of the property and not the DC vale. The agreement has to be signed by both parties and should not be left blank. If you are a filer, you can declare it, else keep it in safe record for future use.
3) In case you intend to sell a property, hold on till the dust is settled and the issue of capital gain is cleared. Else, the maximum you have to pay is 10% of the gain between fair market value and purchase price.
Federal Board of Revenue (FBR) remained helpless especially during last five years and was made to accept DC values owing to FBR’s own circulars wherein the aforesaid were binding. FBR tried to suggest changes in the statutes which included desperate measures including proposing to the government that FBR could acquire the property at 25% additional price compared to the registered price. But government rightly struck down these proposals as it could have created panic in the market. However, the recent amendment regarding fair market valuation and levying of capital gain if an asset exchanges hand within five years of its purchase merited consideration which the government approved through legislature. The implications of these two amendments are far reaching:
Fair Market Value: If the transactions would be registered at Fair Market Value, the seller would have to pay CGT (within five years of its purchase) and purchaser would have to produce “white” money to complete the transaction which will be an uphill task. Else, the tax implications, including levy of evasion penalties and additional tax, could eat up major portion of the market value of the asset under transaction. The measure would definitely discourage “black” money holders who were hiding their wealth in real assets.
Capital Gain Tax (CGT): The levy of CGT withholding period less than five years is an attempt to discourage speculative trading. Currently, speculative trading had resulted in creating artificial hike in
prices, leaving it to be a mere dream for ordinary Pakistanis to build a house of their own.
Surprisingly, the real estate dealer associations have not yet come up with their official demand of charter. I even wonder what a rationale set of demand could be; do away with fair market value or abolishing the holding period of capital gains tax. Both of these do not hold merit for serious consideration in view of the fact that the provisions have been included to check “black” money and speculative trading. Hence, what could be the options at hand and what could be the possible outcomes:
1) Stay from Higher Courts: Apparently, there is no cogent reason as the bill has been passed by the National Assembly and the intention of legislature is clear – discourage black money holders and curtail speculative trading
2) Street Protests and Hold Off: Unless there is a genuine and rationale agenda, it will be difficult to muster supporters from ordinary citizens apart from the stakeholders which will be represented by real estate agents. The government may not be pressed for revenue loss due to halt in business considering their long term goal. Per daily Express clipping by Shahabaz Rana dated July 14, 2016 Naveed Zafar Ashfaq Jaffery & Co, a chartered accountancy firm has revealed that there is PKR 7,000 Billion of “black money” in the real estate sector. If taxed properly, there could be one time wind fall tax collection and recurring thereafter.
3) Negotiation with the Government: Apparently, this will be the desirable and best route forward. FBR is in a strong position and it is expected it will not budge with undue demands. There could be number of suggestion but I would suggest the following:
a) Tax Amnesty: Government has announced tax amnesty schemes a number of times in the past with the recent one for traders just few months back but the response has always been lukewarm. However, here the situation is different wherein noose is around the neck of tax evaders and it will primarily be at their request with only available and acceptable solution. It is expected that FBR will take advantage of the situation and will not offer amnesty at any rate lower than 10% of the amount to be made white. The aforesaid is the rate which FBR has normally used as a benchmark rate for amnesties declared during last few days. The impact of this would be enormous for the economy wherein huge amount of tax will be collected one time and then perennial collection based on the market value. In case we agree with the number quoted by Express Tribune then 10% of PKR 7,000 Billion would translate into PKR 700 Billion tax collection. It is important to mention that the current year collection of FBR was 3,104 Billion and hence it would translate into 22.6% of the tax collection for current year and even FBR would not have any issue in meeting Fiscal Year 2016-17 target, which is fixed at RS 3,621 Billion.
b) Capital Gain: Reducing the holding period from five to three years would be reasonable and acceptable to all the parties. Earlier, it was two years wherein after this period there would not be any liability under capital gains tax.
c) Giving Powers to FBR to Inquire the source of Foreign Remittance: The Protection of Economic Reforms Act 1992 debars FBR to request foreign exchange remitter to disclose the source i.e. who remitted the money and whether that person had the financial health to remit that money. The lack of these powers has in fact caused more damage to the FBR than any other restriction as it has robbed Pakistan of trillion of rupees in terms of tax collection ever since the act came into force. Practically, all sophisticated investors who are fully conversant with legal implication send their untaxed money through ”hawala” abroad and get it remitted to Pakistan statedly at less than 5%. This is a big loop hole in the system and has to be plugged immediately. It is odd to understand that if the remitter is genuine then he should not have any issue if his financial health is probed. But apparently, due to known reasons to everyone in terms of beneficiaries, none of the political government has ever shown willingness to give this power to FBR. In the instant case, if this power is not granted, even if amnesty scheme is declared and implemented, it will not meet set objectives. Just consider, if the rate for amnesty is 10% all sophisticated investors will be inclined to whiten their money at much reduced rate and hence exchequer will be robbed of the requisite revenue.
Conclusively, the changes in tax statute regarding real estate taxation is a blessing in disguise for the overseas Pakistanis who can do transactions with their “white” money freely and without any hassle. However, these measures are a nightmare for “black” money holders and speculative traders who had become used to having unprecedented gains in short time frames. The government and FBR has got a golden opportunity to set things right, and with the assistance of stakeholders, they can come up with a viable solution wherein a tax amnesty can be one of those. However, equally important is to make amendment in Protection of Economic Reforms Act 1992 by giving powers to FBR to probe the source of remittance to distinguish between genuine and “hawala” transactions.
A very well written article by LRE WhatsApp group member Aamir Ali sahib ( Abdal® here). Was shared by him in LRE Gulf group no 53 today. Please share in all groups you are a member .