Capital Gains is defined as the gain in value you get after selling of an asset having bought it earlier. For example, I buy a plot of land for Rs 1 million in 2006. In 2010, I sell it for Rs 1.2 million. My capital gain is Rs. 0.2 million or 20%. This gain is value wise and does not account for inflation that may have taken place during this period. Capital Gains Tax is till now not introduced in Pakistan, mainly for the reasons that the basis of doing so is not well established. Another major concern is what happens to the currency movement. For example, in 2006, USD/PKR was 63; now in 2010 USD/PKR is 85. Even though I have made a 20% gain on value of my plot, but in essence, in 2006 I had bought the property at an equivalent USD 15,873 which is now worth USD 14,117. In this case, a 20% gain in value is an 11.06% loss.
The same example is true for the stock exchanges. There are a few myths that I wanted to present:
1. “There is no tax on stock exchange business” – When you buy or sell shares of a company, you have to pay a Capital Value Tax which is paid along with commissions to the broker; Similarly, during the period you have held the shares and a company gives a cash dividend, a 10% Withholding Tax is deducted at source. Moreover, brokers pay an income tax on their income through the trading of shares. The stock exchange as a company pays taxes on its income.
2. “Small investors always lose money in comparison to big brokers at the stock exchange” – Small investors also make money when markets go up. How many times we’ve heard people boasting that “we made a profit”. Yes, small investors do lose money when they take undue risk by buy shares through loan. If you make a loss, you have to pay. It is a simple relation to risk vs reward.
3. “Brokers make a lot of money!” – Yes, they are there for the purpose of making a profit. But, they lose money too when the stock business dries up. The KSE 100 index lost 68% of its value in the period of April 2008 to Jan 2009. A number of brokers went under. Shares business was decimated. Wealth reduced.
I can go on and on. The reason why I am compelled to post is that I am an avid investor in Pakistan’s equity markets. I am living abroad, yet 90% of my investment is in Pakistan. I am not doing it for the love of anyone but because there is enormous value in our market and companies listed on it. Our stock market trades at a Price to Earnings Ratio of 8.5 times compared to India which is at nearly 19 times. An investor can get up to 8% easily in form of dividends yield in Pakistan than just 2% in India. I need not talk about the Gulf region where both the above factors are insignificant. Pakistani companies are showing their growth in profitability at 12% per annum.
Moreover, I can easily liquidate the value of my investment whenever I need to and use the funds elsewhere. I can challenge, this sort of liquidity is not available in any other market of our country. A certain group of people is hell bent on demonizing the capital markets of Pakistan. If a foreign investor comes to Pakistan, he looks at the valuation of companies on the stock exchange and liquidity available.
Now coming to the matter of Capital Gains Tax, the issue has been pending since 1975. Absence of Capital Gains Tax gives the people an avenue to purchase assets without being taxed. Yet, it is important for people to at least declare their income through capital gains in their annual returns filings. Considering the overall difficult fiscal position of our country, the Government has decided and that has amicably been agreed by the KSE. Now there are some procedural issues that are causing difficulty in investors’ minds.
Hanif Khalid is a senior and veteran reporter at Jang. He is a lesser evil compared to the Sehbais, Abbasis, Nooranis, Mirs and Khans. He has been covering various matters of the Federal Budget for the last few weeks with a special interest in Capital Gains Tax. In his report of June 15, 2010, titled “Stock Market’s Fall, Finance Minister calls emergency meeting”. He has mentioned in his report a source which says “yeh loag (KSE members) chahtay hayn kay daulat to kamatay rahayn magar iss par qanoon kay mutabiq poora tax ada na karen“. Such filings in reports are really bad and reflect poorly on the understanding capabilities of our reporters.
We as a nation have to set our priorities. Pakistan is a frontier market which is one step below the status of Emerging markets. In order to become an emerging market, along with economic performance, we need to spice up our image. The difference between us and other countries can be summed up in following two headlines “India needs USD 500 billion investment in it infrastructure to ensure continuous growth of 8% per annum going forward” and “Money to Pakistan in form of Aid likely to be eaten up by the corrupt”.