THE recent decision to keep income tax non-filers out of property transactions of more than Rs5 million is ill-conceived and does not bode well for the economy.
The real-estate sector in Pakistan has been in the experimental laboratory of lawmakers for the last many years, especially with regard to tax reforms. The initiative to document the economy is a step in the right direction; however, it should not be at the expense of inflows to the national exchequer.
The behaviour of the public towards tax compliance cannot be changed overnight by the introduction of new legislation. The non-filers, by and large, will instead prefer to stay away from property transactions and the government would lose the tax that they were otherwise receiving from them.
Government functionaries themselves are not conditioned to take long-term steps for sustaining growth or increasing the tax net; constrained by political exigencies, the government needs an immediate visible impact of any of their reforms.
The problem therefore, is not of tax payment or its avoidance; it is a conflict between the conditioning of government officials and the behaviour of the public. This becomes a paradoxical situation.
The introduction of capital gain tax (CGT) on the sale of property and the Federal Board of Revenue’s (FBR) rates for registering a real estate transaction were the two tax reforms that the government introduced with the intention to increase the tax base.
FBR rates were introduced to replace the earlier prevailing Deputy Commissioner (DC) rate. However, the government had to revise said FBR rates subsequently in major cities earlier this year, which was reflective of poor homework before implementing the law.
The move did not increase the tax collection as per projections; however, it reduced the number of transactions and helped correct the real-estate prices. That was an unintentional but welcome result of the tax reforms.
The government introduced another set of tax reforms in the federal budget 2018. These include the removal of FBR rates on property, requests to the provinces to end DC rates, and a bar on non-filers from buying property exceeding Rs5m. At the federal level, the advance tax has been cut to one per cent of the declared value.
The size of the real-estate sector and its contribution to the gross domestic product is substantial. Any impact on it will have an immense multiplier effect on the 70 plus construction-related industries.
In the GDP composition of 2016-17, the size of housing services and construction was $28 billion, which was 9.3pc of the total GDP of Pakistan.
In the last seven years, the contribution of housing services and construction has been over 9pc of GDP. As per an estimate, the size of real estate sales transactions in 2016 was $60bn.
The non-filers in the country are paying 4pc withholding tax, nonadjustable, on real-estate purchases and 2pc withholding tax, nonadjustable, on sales transactions. The provinces are getting 5pc on account of stamp duty and CVT.
Non-filers form a major population of property transactions. Taking non-filers out of the real estate transactions’ net means that the federal government and provinces are going to lose their collective share of 11pc from this revenue.
Considering the quantum of transactions (estimated to be R6,000bn), this would be a heavy cost, which in the back drop of the existing fiscal deficit the government can hardly afford. Builders and land developers pay a sizeable advance tax of R210 per square yard.
Expecting fewer buyers, they will also stay away and the government would lose their tax contribution as well.
As regards the documentation of economy, it is a misconception that real estate accommodates the entire chunk of the undocumented economy. Another major reservoir is the banking sector that has been left unattended in this phase of tax reforms.
Non-filers continue opening and maintaining accounts with banks. In a country where the GDP has been growing in the range of 3-5pc, the banking sector has been growing at 12-15pc on an average, as per State Bank of Pakistan’s annual reports. This translates into trillions of rupees.
This necessitates an immediate review of the tax reforms. A holistic consideration of all sectors is required to facilitate gradual documentation of the economy in the next 10 years, without creating a dent in existing tax collections.
Pakistan can take a leaf out the United Arab Emirates’ real-estate business model to build investor confidence. The gross income of UAE has grown by over 190 times within just 40 years. The catalyst in this process was an enabling environment with a business-conducive tax regime that attracted investors in real estate.
This was supplemented by the government’s investment in public wellbeing and family tourism from all across the world that in turn attracted renowned brands to enhance their activity in a duty-free UAE.
The writer is the Director Retail at Knightsbridge Capital Group; a private equity management group.