SECP Asks Govt Not to Treat Bonus Shares As Income in Budget 2024-25

The Securities and Exchange Commission of Pakistan (SECP) has proposed a reduction in withholding tax (WHT) on dividends in the new federal budget 2024-25. SECP has proposed not treating bonus shares as income. It said the present treatment of bonus shares as income of the shareholder is very detrimental to the growth of the capital market and has hampered the issuance of bonus shares by listed companies. Overall, the securities regulator has submitted a series of tax proposals targeting areas of investment, enhancing capital market depth, and promoting financial inclusion in the upcoming federal budget for the fiscal year 2024-25. The proposals focus on various sectors, including private equity, venture capital, mutual funds, insurance, and microfinance, with significant implications for economic growth and market development. SECP has suggested reinstatement of tax exemption for private equity (PE) and venture capital (VC) funds, conditional on 90% income distribution among shareholders. This aims to promote investment and startup growth by alleviating double taxation on the same income source. The continuity of this exemption is expected to encourage greater participation in the private funds market, increasing the size and depth of the capital markets, and boosting overall investment in the economy. The impact of this exemption was minimal in the past, costing just Rs. 3.63 million as per the Tax Expenditure Report for 2021. The SECP also proposes extending the withholding tax exemption to PE and VC funds. This procedural amendment is consequential to the reinstatement of tax exemption and aims to encourage greater participation in the private funds market. Additionally, the SECP recommends aligning the tax on dividends from PE and VC funds with mutual funds, reducing the rate from 25% to 15%. This proposal aims to foster investments in the PE sector, particularly SMEs. By reducing the tax burden on dividends, it would attract more local and foreign capital to local businesses, facilitating their growth and development. The SECP proposes the reinstatement of tax credits for investments in initial public offerings (IPOs), equity mutual funds, and exchange-traded funds (ETFs) if held for at least five years. This measure aims to encourage long-term investments and promote savings in regulated sectors, which is particularly beneficial for salaried individuals. The recent removal of tax credits on such investments has discouraged investors from saving in these sectors, and the reinstatement is expected to promote savings and increase new corporatization. The impact of such withdrawal was minimal, costing about Rs. 2.6 billion in mutual funds, shares, and insurance combined as per the Tax Expenditure Report 2022. The SECP has made several recommendations to enhance the insurance sector. One key proposal is the reinstatement of tax credits for life and health insurance premiums and extending these benefits to other micro-insurance products such as personal accident, travel, household, and private motor insurance. This proposal aims to provide financial protection and promote insurance penetration among the general public. Life insurance is a key saving and investment vehicle, while health insurance provides access to quality healthcare and helps reduce the government’s burden of providing health services. The SECP also proposes a reduction in withholding tax on dividends from 15% to 10%, aligning the total tax impact on dividends with other income sources. This measure is intended to promote corporatization and documentation, essentially offering a level-playing field between incorporated and unincorporated businesses. Currently, corporate businesses are taxed twice—once at the company level at 29% and again on dividend distribution at 15%—while unincorporated businesses are taxed at rates ranging from 0% to 35% in slabs. By reducing the withholding tax on dividends, the proposal aims to encourage the corporatization culture, leading to greater documentation and increased tax revenue in the long run. To align the taxation of capital gains, the SECP proposes removing the flat 12.5 percent rate applicable to securities acquired between July 1, 2013, and June 30, 2022. This change aims to bring the capital gains tax on listed securities in line with that on the sale of immovable property, eliminating the tax-driven distortion between different asset classes. By doing so, the proposal is expected to encourage the documentation of real estate activity and ease speculative pressure on real estate prices. Another significant proposal is the reinstatement of tax exemptions on inter-corporate dividends for group companies. This amendment aims to promote consolidated corporate ownership, deepen capital markets, and attract investors by providing a level playing field for group companies. The removal of such exemptions in the past has gone against the government’s objective of promoting investment in Pakistan. The SECP also proposes including non-profit microfinance institutions in the second schedule to streamline the process of obtaining tax exemptions, which are currently cumbersome. Non-profit microfinance institutions play a critical role in providing financial services to low-income individuals and small businesses, and this amendment aims to reduce the practical difficulties they face in obtaining tax exemptions. Additionally, the SECP recommends reducing tax rates for non-bank microfinance companies transitioning from non-profit to for-profit status over five years, starting at 5%. This measure aims to ensure their sustainability and continued provision of financial services to underserved populations. By reducing the tax burden on these companies, the proposal is expected to support their growth and development, promoting financial inclusion and contributing to poverty alleviation. SECP has proposed reducing the WHT on Modarabas from 8 percent to 3 percent at par with many other services. The modaraba faces withholding deduction @ 8% under Section 153(1)(b) of the Ordinance on payment made by customers against rental of machinery. The withholding rate under section 153(1)(b) shall be brought down to 3% i.e. in line with the withholding tax on 32 services as mentioned in section 153(1)(b). The 8% withholding tax rate works out to a net taxable profit margin of 32% which is on a very high side and tantamount to piling of Tax refunds. In order to understand the hardship faced by Modarabas, let’s take an example of Rs. 100 sales. In the above example if we take 10% as the taxable profit margin of Modaraba then, Rs. 10/- will be the taxable profit of Modaraba. At 29% corporate tax rate the tax liability of Modaraba comes out to Rs. 2.9/-. However, the minimum tax / withholding tax deducted by the customer is Rs. 9.28/-, therefore, resulting in an excess deduction of Rs. 6.38/- (or 6.38% of total gross sales). Now imagine this on actual sales of Rs. 4 billion, the excess deduction per year works out of Rs. 255 million (4 billion × 6.38%) per year. It is pertinent to mention here that as of December 31, 2022, the total income tax recoverable from FBR is Rs. 775 million.