In what is undoubtedly a depressing statistic, only 1.46 million people in Pakistan paid income tax in 2018, which is the last year for which reliable data is available. Sure, the tax net has grown much wider from the 980,000 people who were paying income tax in 2014, but not by much. This is especially true when compared to the 57.4 million employed labour force that the country boasts. The percentage could be a lot higher, but 42% of that labour force are employed in the agriculture sector, which is usually exempt from income tax or pays very little.
In the fiscal year 2019-2020, the Federal Board of Revenue (FBR) collected Rs.3,996.7 billion, reflecting 4.4% growth over the collection of Rs3,828.5 billion collected in fiscal year 2018-19. Still it is much lower than the original target for the year, set for Rs5,503.0 billion. And our tax-to-GDP ratio has fallen from 12.6 in 2015, to 11.4 in 2019.
So some things had to change, and now, it looks like those changes are at hand. In a note sent to clients on March 15, an AKD research analysis team pointed out that the federal government is likely to push forward the second Income Tax Amendment bill in the coming days. This will purportedly save around Rs140 billion, or around 0.3% of GDP in income tax exemptions or reductions, which would be effective from Jul 1, 2021.
According to AKD Research, the bill is part of a Rs600 billion revenue generation targeted in fiscal year 2022 through FBR’s current base in order to meet an aggressive target of Rs6 trillion, an increase of 27.6% year-on-year on revised fiscal year 2021’s FBR target. “However, our initial assessment suggests authorities would be able to generate around Rs44 billion, or 0.1% of GD additional revenue from said amendments,” the report said.
So, what are these amendments? According to AKD, there are ten different amendments, including:
- Removal of first year allowance: Plant, machinery and equipment installed by any industrial undertaking set up in specified rural and under developed areas are allowed a 90% tax allowance for the first year of operation. The allowance is expected to be removed.
- Tax credit on enlistment to be removed: a 20% tax credit of the tax payable was allowed in the first year of enlistment on stock exchange, which may be omitted.
- Conditions defined for IT companies to avail tax credit: Exports of computer software, IT Services or IT enabled services are exempt from tax, given 80% of the proceeds are remitted back through formal banking channels. However they are subject to minimum tax on their turnover. The proposed amendment means a 100% tax credit will be available, even against minimum tax liability on turnover.
- Tax credit on greenfield investments: Greenfield investments in the country will be liable for 25% tax credit on new investment.
- Removal of tax exemption on intercorporate dividend: Companies having more than 56% stake in a company were allowed a tax exemption on dividend from its subsidiaries, which will be removed.
- Tax exemption for establishment or up-gradation of refinery: New deep conversion refineries of at least 100,000 barrels per day will be liable for tax exemption for a period of 10 years.
- Removal of tax exemption of new electric power projects: Tax exemptions extended to electric power generation projects in Pakistan will not be available to projects issued Letter of Intent after June 30, 2021.
- Removal of reduced tax rate for listed companies: Listed companies who a) are shariah compliant, ii) derive income from manufacturing activities only, iii) have declared taxable income for last three years, and iv) have issued dividend for last five consecutive tax years were liable for a 2% reduction in tax rate. These exceptions are to be removed.
- Removal of tax exemption on profit derived by HUBC on its bank deposit or account.
- Removal on tax exemption on distribution by REIT, Venture Capital, Private Equity Fund or a Money Market Mutual Fund.
What are the ramifications of these? As per AKD Research, ignoring the fact that certain measures such as limiting the scope of exemption to refineries, or replacement of tax exemption on IT Sector with 100% tax credit, will translate to lower revenue potential. So essentially, even though the government may pull off this year’s target of Rs4.7 trillion, revised from Rs4.96 trillion, it will still be a ‘daunting challenge’ in fiscal year 2022, where the government is likely to undertake tough measures in the upcoming budget.
“From market’s vantage, abolishment of intercorporate dividends for conglomerates such as Engro which have stake in subsidiaries between 55-100% (7% earnings impact) would be negative while introduction of 25% tax credit for greenfield expansion would be positive for players such as Kohat Cement, and Fauji Cement. We believe amendments would be neutral for the IT Sector,” said AKD.
By the way, the market still has other concerns, not just related to the tax bill. According to AKD, the near term outlook is dependent on developments surrounding the IMF program particularly those relating to budgetary measures, and intensifying inflationary pressures that are likely to pull inflation in the coming months into double digits.
