Capital markets: Tax hike on banks’ investment gains surprises many

CGT rates also revised upwards; sale of shares to be taxed even after two years.

KARACHI:

Ignoring the vociferous criticism from stock market players, the government on Friday increased rates of capital gains tax (CGT) on the sale of equities in its budget proposals for 2015-16.

Besides proposing a significant increase in the CGT rates for the sale of shares within two years of their purchase, the government also aims to impose the CGT on the trade of shares whose holding period is more than two years. The current CGT rate is 12.5% for selling a share with a holding period of less than a year. The government is expected to increase it to 15% in 2015-16. The current CGT rate is 10% for securities whose holding period is between 12 and 24 months, but the government is likely to take it to 12.5% in the upcoming federal budget.

There is currently no CGT on selling shares after holding them for two years. But the federal government has now proposed to impose a 7.5% CGT on such securities in the new budget.

Speaking to The Express Tribune, Topline Securities CEO Mohammed Sohail said the government should ensure long-term stability in the CGT policy instead of changing the rates every year.

A blow to the banking sector

Finance Minister Ishaq Dar surprised many by announcing a tax hike on banks’ gains from stock and mutual fund investments in the 2015-16 budget.

“The government has realised that banks are making money from treasury and stocks, and now it is forcing them to lend to businesses,” Sohail noted.

Instead of different tax rates on a multitude of sources of investment income for banking companies, the proposed budget envisages a uniform tax rate of 35%. Although the current CGT on the sale of equities by banks within one year of their purchase is 35%, the rate comes down to 12.5% for securities with a holding period of more than a year.  According to Taurus Securities Head of Research Zeeshan Afzal, banks currently pay a tax of 10% on dividend income. He said the tax on dividends that banks receive from money market and income mutual funds is 25% while the tax on dividends received from asset management companies is 20%.

Afzal said each of these tax rates will be replaced by a flat 35% tax if the proposals are accepted in their current form. He noted that the proposed tax rate hikes will damage the banks’ profitability by an average of 3%-4%.

“Banks such as National Bank and Allied Bank, which have greater exposure to the equity and mutual fund investments, will take a bigger hit in the range of 6%-7%,” Afzal added.

Analysts expect banking stocks to go down on Monday when the share market opens the first time following the announcement of the federal budget.

The budget envisages that every listed company, except banks or a modarabas, that fails to distribute cash dividends in the six months after the conclusion of the financial year – or distributes dividends to an extent that its reserves post-dividend distribution are more than 100% of the company’s paid-up capital – the excess amount should be taxed at the rate of 10%.

Although this proposal is aimed at protecting the interest of shareholders and encouraging companies to distribute dividends, it is expected to lead to some confusion among stock investors in the coming weeks.

Investors will have to rely on their hunch: they will buy a share if the company is going to pay dividends to shareholders. But they will dump a stock if they expect the company to pay a 10% tax on the excess amount instead of paying dividends to shareholders, Afzal said.

The federal budget also proposes that the tax credit for investments made in the shares of a listed company be increased from Rs1 million to Rs1.5 million. Separately, the proposed budget also envisages raising the tax credit for the enlistment on the stock exchange from 15% to 20%.

The tax rate on dividends is proposed to be increased from 10% to 12.5% for income tax return filers — and from 15% to 17.5% for income tax return non-filer. The tax rate on mutual funds will remain 10%, the budget documents say.

Another blow to the banking sector will be in the shape of the proposed super tax levied to support internally displaced people. It will be a one-off tax for those who earn above Rs500 million per annum and be imposed at 4% for banks and 3% for the rest.

Published in The Express Tribune, June 6^th,  2015.

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