THE issue of capital gains tax (CGT) has once again surfaced on the eve of the national budget. While the government seems determined to impose GST this time, the stock exchanges are worried about it.

The Securities and Exchange Commission of Pakistan (SECP) and the Federal Bureau of Revenue (FBR) have proposed that CGT be levied in the coming budget in June. The row over CGT may impact the KSE index as it did previous years amidst speculations and rumours of all kinds.

According to FBR Chairman Abdullah Yusuf, the government lost Rs15-Rs20 billion as CGT was not imposed in the current year’s budget.

He says it is up to the government to decide whether to impose the CGT or not, but it could expand the tax net to new territories.

Mr Yousuf says there are a number of CGT models from which Pakistan can learn while introducing it. Some countries give total CGT exemption to stock exchanges, whereas in others either the CGT or the Capital Value Tax (CVT) is levied. There are others which have imposed both the CVT and the CGT simultaneously.

If the government imposes CGT in the next budget its revenue would go higher next year. But, if it opts to impose CGT on trading alone with holding period of investment or some other ways, revenue generation would be determined by the nature and scope of the CGT levy.

Normally, the capital gains are realised from the sale of stocks, bonds, precious metals and property, and that is what the government wants to target this year while levying the CGT.

According to some experts, the word CGT is rather a misnomer. They believe it will be more appropriate to call it the “capital formation” tax as it is a tax penalty imposed on productivity, investment and capital accumulation.

Some officials of the stock exchanges are of the view that there was an “unfairness” imbedded in the tax treatment of capital gains.

One was that capital gains were not indexed for inflation: the seller paid tax not only on the real gain in purchasing power but also on the illusory gain attributable to inflation. The inflation penalty was one reason that, historically, capital gains had been taxed at lower rates than ordinary income. In fact, most capital gains were not gains of real purchasing power at all, but simply represented the maintenance of the principal in an inflationary world, they think.

They said another problem of the tax was that individuals were permitted to deduct only a portion of the capital losses that they incurred, whereas they must pay taxes on all gains. That introduced an unfriendly bias in the tax code against risk taking. When taxpayers undertook risky investments, the government taxed fully any gain that they realised if the investment had a positive return. But the government allowed only partial tax deduction if the venture went sour and results in a loss.

Some people in the stock exchanges also say the CGT is a form of double taxation on capital formation. They say the government could choose to tax either the value of an asset or its yield, but it should not tax both. Capital gains are literally the appreciation in the value of an existing asset. Any appreciation reflects merely an increase in the after-tax rate of return on the asset. The taxes implicit in the asset’s after-tax earnings are already fully reflected in the asset’s price or change in price. Any additional tax is strictly double taxation.

They say that in the presence of the CVT, there is no need of any CGT in Pakistan. However, the SECP recently opposed a proposal of Karachi Stock Exchange (KSE) for incorporating a new clause in Second Schedule of the Income Tax Ordinance, 2001 to exempt capital gains from any kind of tax during the demutualisation process of the Karachi, Lahore and Islamabad stock exchanges.

The KSE also seeks exemption from stamp duty on transfer of immovable assets during the demutualisation process that can take quite a few years keeping in view the fact that the draft of demutualisation law is yet to be tabled in the parliament for a debate after President Pervez Musharraf refused to sign its ordinance.

But, the SECP thinks otherwise. It says tax exemption had already been granted last year on transfer of capital assets of the existing stock exchanges to new corporatised stock exchanges and on transfer of capital asset, being a membership right for acquisition of shares and trading or clearing rights in new corporatised stock exchanges.

According to SECP Chairman Raziur Rehman, the commission has proposed CGT from five to 10 per cent depending on the period of holding of the capital gains. He said the SECP had done its job to propose the CGT while it was up to the government to implement it or not.

At the international level not all countries have imposed the CGT and that the rate is not the same everywhere.

Keeping in view fiscal and current account deficit and limited revenue, it seems the government will impose the CGT in the forthcoming budget despite the years-old resistance from the bourses, brokers and some other stakeholders.