Calling a spade a spade; Is Capital Value Tax the new wealth tax?

“Tax the rich” has always been a popular political slogan that resonates with a lot of people. And why shouldn’t it? The rich have an excess of money available, tax them and put the money to good use. 

It’s not long before this thought leads one into a utopian realm of equity, of a society where the economic system offers the same facilities to both rich and poor. Everyone has enough, everyone is happy. But this thought cannot germinate for long. For starters, the rich do not want to be taxed. And more often than not, the rich get what the rich want. And then there is another problem. You can’t make the rich angry. Especially if you are a country that is desperately in need of capital. Private investment is the only way you will be able to crowd in wealth, so the poor can eat scraps of that wealth to survive. And most importantly, rich or poor, the idea of taxation has to have some importance. There needs to be a standardised imposition and enactment of taxes whether they are considered to be progressive or not.

In the last one year, Pakistan has seen all kinds of new taxes. Most of these were claimed to be for the rich. In the Finance Act 2022, the government of Pakistan imposed a Capital Value Tax on local and foreign assets of taxpayers. What seemingly had good intentions, turned out to be just a whole lot of confusion. In imposing the tax, the government forgot not only the nitty gritties of jurisdiction and nomenclature, but also the best interest of the country.

Problems with Nomenclature:

The problem starts with the very name of this tax. The tax is called a Capital Value Tax (CVT) but it taxes much more than just the capital value of the asset. For this we first have to understand what CVT means. 

What is Capital Value Tax? 

Globally, CVT stands for an amount payable by individuals, firms and companies which acquire an asset by purchase or a right to use for more than 20 years. The tax is levied on the recorded value of the asset at the time of the transaction. Say you buy a house today, and you are not a real estate broker. Traditionally, the seller would pay a fixed rate of tax, called CVT, on the value of that house at the time of the purchase. 

CVT was first introduced in Pakistan in 1989 as part of the Finance Act. The tax was levied on the sale, transfer or gift of immovable property, such as land or buildings.

What are wealth taxes? 

Wealth taxes on the other hand are a completely different concept. They are a tax measure aimed at disincentivising the accumulation of wealth. The major difference between wealth taxes and capital value taxes is that wealth taxes are supposed to be incremental. The higher the wealth, the higher the tax. 

Pakistan has a history of both CVT and wealth taxes. In the Wealth Tax Act, 1963, tax was levied on the net wealth of individuals. Meaning that tax was levied on the amount left after subtracting liabilities from assets. Ever since 2002, Pakistan has not had a wealth tax. Economic experts believe that the wealth tax was abolished because of strong resistance from big real estate owners, including military personnel.

CVT vs Wealth Tax

The current confusion exists because the current tax is a retrospective measure. As per Section 8 of the Finance Bill 2022: “A tax shall be levied, charged, collected and paid on the value of assets at the rates specified in the First Schedule to this section for tax year 2022 and onwards.” In the first schedule, this tax is estimated at 1% of the fair market value of these assets. 

Basically what this means is that anyone who is in possession of immovable and movable assets in the tax year 2022, is supposed to file and pay the taxed amount on that asset, regardless of whether that asset was traded or not.

Since it is not levied upon the transfer of asset, rather it is being levied upon the mere holding of that asset, it could better be characterised as a wealth tax. However, while talking to Profit, Adjunct Faculty Member LUMS and tax law expert, Dr Ikramul Haq stated that it could be better understood as a tax on the “notional gains”. 

“It is quite absurd, the manner in which this tax is imposed. Since the element of cost is missing it cannot even be categorised as a wealth tax, and similarly no transfer is being made, hence, CVT isn’t fit either,” said Ikram. 

The level of public debate in Pakistan is such that even if the government imposes an outright wealth tax, the majority would not have opposed it. However, the current regulations are nothing if not a comment on competence and policy homogeneity. 

A problem of Jurisdiction

A big part of the public debate in Pakistan revolves around the devolution of powers to local governments and provinces. This is exactly the reason why the 18th Amendment was brought about. Ever since that amendment, it has been the province’s right to tax immovable property. 

After the 18th Amendment, the federal government cannot levy wealth tax, CVT, Capital Gains Tax (CGT) or any tax under any nomenclature on immovable property as this is within the exclusive domain of the provinces.

Entry 50, Part I of the Federal Legislative List (FLL), Fourth Schedule to the Constitution [hereinafter “Entry 50”] gives exclusive power to provincial assemblies to levy “taxes on immovable property”. Under Entry 50, the Parliament can only levy taxes on capital value of assets excluding taxes on immovable property. Under such circumstances, the federal government to levy a tax directly in contention is either a mistake, or a deliberately non-constitutional move. Both of which do not reflect well on the government.

The Problem of Overseas Assets:

The overseas people have a bittersweet relationship with their homeland. They often leave the country in the hopes to earn a good future. A future ripe with the hopes of relocating to their homeland, as soon as they have enough money. And when the time comes, they want to bring their wealth back to the country.

However, to bring back any asset that they have acquired overseas, they need to first register that asset and pay a CVT on it. Think of it as an overseas Pakistani. All your life, you have paid a tax on the asset in its home country (depending upon that country’s tax law). Now that you want to relocate to your homeland, the homeland is asking for a certain chunk of that asset, that could very well still be overseas, to allow you to be a legitimate citizen. And if you fail to do so, you become a tax evader and are worthy of penalty or jail time.

Tragic as it may sound, it is almost customary for countries to tax overseas assets of their citizens. Most of the countries do that. What most countries don’t, however, face is a crippling balance of payment crises.

There is another problem with overseas assets as per Pakistan’s own laws, and that problem is one of jurisdiction. While movable assets are only taxed once they are brought back, immovable assets don’t fall under the purview of any province’s jurisdiction. Former Chairman FBR, Shabbar Zaidi, in one of his articles, states that, “Unless there is an amendment in the Constitution, the citizens of Pakistan cannot be taxed on the capital value of immovable properties outside Pakistan by the federal government in any manner whatsoever.”

On the other hand, even if the federal government claims jurisdiction over overseas assets, there is another alarming detail in the Finance Act 2022. In the section 8, subsection 3, part c (1), the Finance Act states that, “the value shall be – (i) the total cost of the foreign assets on the last day of the tax year, in relevant foreign currency converted into rupees as per exchange rates notified by State Bank of Pakistan for the said day.”

Explaining this act, Haq said, “Imagine if you bought a property for 100 pounds, 10 years ago and the property’s value did not grow in the UK market. The value of that property in PKR terms still grows more than twice in PKR terms, considering the fall in exchange rate. The government is asking for a tax on the PKR value of that same property. You as an investor did not have anything to do with the exchange rate fall, why should you be paying the price?”

“When we look at this it seems as if it is neither CVT nor wealth tax, rather it looks as if the government is trying to tax the notional gains of people.” he added.

A victim of politics and time

As if it was not complicated enough, the asset declaration laws of 2018 and 2019, or simply the amnesty on declaration of assets, awarded in 2018 and 2019, is exempt from any income or capital taxes after the payment of the upfront principal. Ironically, when Imran Khan’s government gave this amnesty, they did so to increase the tax net of the country. 

Whether those assets, under amnesty, are up for grabs in the Finance Act 2022, is still a debatable issue but the precedent suggests that if any pakistani had a time travelling machine, they would rather go back four years and pay an upfront tax rather than be saddled with a perpetual tax of a much higher value.

Those who held back on their declarations till 2018, get rewarded, whereas those who abided by the laws since the get go, get to pay the newest CVT.

Where do we go now?

There already is a hue and cry about the multitudes of problems that exist in the current version of this law. The Sindh High court resolved one of the cases regarding federal jurisdiction, in favour of the federal government, however the judgement still awaits appraisal from the Supreme Court.

It is also strange that no parliamentary debate was observed on this Finance Act 2022, otherwise legislators in the parliament themselves could have found discrepancies. And even if they didn’t, institutions and collectives almost always weigh in on such matters. But that chance was not given.

CVT is a legitimate form of taxation, and progressive economies encourage such public finance measures. However, carrying out steps such as these require a long-standing understanding of not only your fiscal needs but also the pressure points of your economy. To do that in Pakistan, the country would first have to be rid of vested interest.

The current CVT is riddled with complications, and there is no guarantee whether it will do the job that was required from it. Even in the context of real estate business, it is more predatory than progressive. 

To have progressive taxation, the country needs efficient institutional machinery. Something that it does not currently have. The machinery that it does have, runs the risk of inefficiency even with a perfectly drafted tax. With the current law, the state becomes vulnerable to a lot more than just inefficiencies.