On presenting the Finance Act, the Finance Minister deplored the country’s low tax-to-GDP ratio, which has been stagnant at 8.5 percent – 9.5 percent for the past decade despite a 16 percent increase in tax collections over last year. The stated goal of measures in the Finance Act is to increase the tax-to-GDP ratio to 13 percent next year. However, most of the measures aim to promote compliance among taxpayers through higher withholding tax rates for non-filers.
Highlights of the Finance Act are as follows:
New alternate corporate tax
The Finance Act introduces an ‘alternate corporate tax’ (ACT) of 17 percent of accounting profits (after specified adjustments). The ACT is the minimum tax a company is required to pay effective Tax Year 2014.
Previously, a local company paying no corporate tax due to accelerated tax depreciation or tax exemption was required to pay a minimum tax of 1 percent (0.5 percent in specified cases) of its local sales. While this rule is retained, the ACT applies to all local and foreign companies (except insurance, banking and oil exploration companies) that make book profit but declare tax losses on their tax returns. The ACT does not apply where income is tax-exempt or is subject to final tax withheld at source.
To the extent ACT exceeds corporate tax on taxable income, the excess ACT can be carried forward for up to 10 succeeding years for adjustment against corporate tax.
Corporate tax rate reduced
Following last year’s 1 percent corporate tax rate reduction, the rate is further reduced to 33 percent (from 34 percent) and will eventually drop to 30 percent. The reduction does not apply to banking companies and companies whose income is subject to withholding tax that is considered final discharge of tax liability.
Withholding tax rates
As an easy source of tax collection for the Federal Board of Revenue (FBR), it is no surprise that Pakistan’s withholding tax rates get a boost each year. This year is no exception, with separate withholding tax rates introduced for ‘filers’ and ‘non-filers’ and increases to the existing rates on services, goods, dividend, imports, commission, interest etc.
‘Filers’ are defined as persons on FBR’s active taxpayers list or holders of taxpayer cards. Filers will bear comparatively lower withholding tax on their receipts than non-filers.
The proposed measure could significantly increase the compliance cost for the withholding agents, mainly in the corporate sector. Agents will have to check the tax status of the payee before making payment and could be penalized by FBR, even for honest mistakes in such assessments.
Tax on capital markets
Pakistan’s capital markets have been a lucrative investment avenue for investors, who enjoy both steady return and preferred tax treatment. These include the non-taxation of bonus shares received in lieu of dividends and exemption for capital gains on investments sold after a 1-year retention period.
The Finance Act partly withdraws these exemptions by subjecting bonus shares to tax at 5 percent of their fair value, a tax that is to be collected and paid by the company issuing the shares. This significantly deviates from decades-old practice and judicial pronouncements on non-taxation of bonus shares and may raise practical issues in its administration.
The Act also increased the retention period of listed securities to 2 year for full exemption on capital gains on their disposal. Further, the advance withholding tax is extended to apply to foreign investors on sale of listed shares.
Tax on dividend payments by mutual funds and stock funds to corporate investors has also been increased to 25 percent and 12.5 percent respectively.
Incentives to investors
To boost investment in strategically important industries, the Finance Act provides for complete exemption from tax on coal mining projects in the province of Sind that supply coal exclusively to power generation projects. Further, a 5-year tax rate reduction to 20 percent (from 34 percent) is provided for companies setting up industrial undertakings having at least 50 percent financing through owner’s equity as direct foreign investment.