FEDERAL BUDGET 2007-2008
AN ANALYSIS
BY
Syed Shabbar Zaidi
Partner A F Ferguson & Co
KARACHI
1
TABLE OF CONTENTS (1)
1)
Understanding of the Concepts
2)
Trends over the years and future strategy
3)
Trickle Down Effect–Misnomers
4)
Utilisation of Public Sector Development (PSDP)

Capacity / Capability

Devolution of responsibilities
5)
Basic Infrastructure:

Roads

Energy

Water

Irrigation System
2
TABLE OF CONTENTS (2)
6)
Basic Requirements:

Food

Housing

Medical

Education
7)
Policy framework in the Budget for Income Tax
8)
Direct and Indirect Taxation and Composition of
direct taxation
9)
Abolition/Reduction in the Presumptive Tax Regime
10)
Tax at Import Stage
11)
Group Relief
3
TABLE OF CONTENTS (3)
13)
Group Taxation
14)
Computation of Income for Banks
15)
Amalgamation
16)
Inter-corporate Dividends
17)
Private Equity Funds
18)
Real Estate Investment Trust
19)
Exports
20)
Mergers & De-mergers
12)
Bulk Importer Of Industrial Raw Materials
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UNDERSTANDING OF THE CONCEPT (1)
Whenever we listen discussion on ‘Budget’ we hear the
words:
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–
–
–
–
–
–
–
–
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Budget Deficit
Trade Deficit
Total Revenue
Tax to GDP Ratio
GDP Growth
Per Capital Income
Public Sector Development Programme
Inflation Rate
Foreign Exchange Reserves
Foreign and Local Debt to GDP
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UNDERSTANDING OF THE CONCEPT (2)

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All these terms are relevant and important economic
indicators.
However, we have to admit that even a substantial number
of educated people cannot exactly understand the practical
applied economic effect of these terms.
Furthermore, for a common man now such discussions are
becoming ‘irritating’ and ‘meaningless’.
There is a need to translate and integrate the combined
effect.
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UNDERSTANDING OF THE CONCEPT (3)

For economies like us these terms become partially irrelevant
for the reason that:
– A large part of our economy is informal and
undocumented. As a conservative estimate the extent of
such sectors is around 100 percent of the documented
sector.
– Even on the documented sector there are pampered
babies outside the tax net either exempt or under
presumptive regimes.
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TRENDS OVER THE YEARS AND FUTURE
STRATEGY


This country was made for economic independence of
Muslims of certain parts of India. However, economics have
been highly overshadowed by religious obstructionism and
political exigencies. This could lead to disastrous
consequences if immediate corrective measures are not taken.
Our future strategy for economic growth should focus on:
–
–
–
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Growth of employment
import substitution
human development
devolution of financial resources
8
POLICY FRAMEWORK IN THE BUDGET
FOR INCOME TAX

Following are the policy framework for income tax:
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–
–
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Gradual abolition of presumptive tax.
Reducing the cost of doing business and indirect taxation.
Providing space for the private limited companies to grow.
Providing space for documentation in the real estate
sectors.
– Consistency of policy.
– No tinkering with the law.
– Reducing possibility of interaction and litigation.
9
DIRECT AND INDIRECT TAXATION AND
COMPOSITION OF DIRECT TAXATION
(1)



In the financial year 2007-2008 the ratio of direct taxes to
indirect taxes will be 40 percent which is substantially higher
than 23 percent in 2000.
Furthermore, out of the total expected collection of around
400 billion a substantial part will be tax on income not being
withholding tax. So all other past myths have been broken.
This is a very positive indicator.
However, with reference to the question of distribution of
wealth it is important to note that out of Rs 400 billion a
substantial part is corporate tax. Real distributional equity will
arise when out of the same around Rs 200 billion is personal
tax. Now we have reached the stage where companies are
being seen as having paid the taxes. Real distributional
equality will arise when individuals start paying taxes on their
income. The trends are correct.
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DIRECT AND INDIRECT TAXATION AND
COMPOSITION OF DIRECT TAXATION
(2)

The other positive aspect is that this amount has been
collected without chaos, harassment, and sensationalism. I
believe system is working. If economies grow taxes grow
provided policies are correct and taxation matters are dealt
with economic considerations.
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ABOLITION / DEDUCTION IN THE
PRESUMPTIVE TAX REGIME

This budget clearly indicates a process towards the abolition
of PTR. The specific steps are:
– Public companies exempted from PTR even on execution
of contract.
– All companies out of PTR on supplies.
– Bulk importers out of PTR.
– This means that companies are under PTR only in the case
if such companies are engaged in import for trading and
such companies are not bulk importer.
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TAX AT IMPORT STAGE

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
This budget has brought a major change in the tax rate at
import stage. Under the new regime rate of tax has been
reduced from 6 to 1 percent. This rate is however subject to
the condition that import represents raw material for own use
and the importer is registered as manufacturer under the
Sales Tax Act.
As a consequence of this amendment the possibility of
obtaining exemption certificate has been restricted to the case
of companies having losses or which are exempt from tax.
Previously there was a possibility of obtaining a certificate
where there was payment of tax etc.
This is a very positive step and is a gradual return to the
sensible system of income based taxation.
In the past there was an issue of abuse of certificate.
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GROUP RELIEF (1)


Group relief (as introduced in 2004) that allows surrendering
of loss of one group company against other has been
improved. It is proposed that group relief will be available
with 55 percent holding as against 75 percent in the past
provided one of the companies in the group is a public
company. Furthermore, in those cases where none of the
company in the group is a public company 75 percent holding
will be required and it would be essential for the group to list
one of its components within three years.
Under this concept a subsidiary may surrender losses to its
holding company or another subsidiary or vice versa.
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GROUP RELIEF (2)



Concept of group relief has been extended to companies
engaged in all sectors except that such relief would not be
applicable for trading losses.
As in the past group relief would not be available for past
losses being the losses prior to acquisition of the company by
the group.
It has been further clarified that a company surrendering the
losses will be paid cash equivalent to the losses being
surrendered. The receipt of such amount and the deduction
by the other side would not represent a taxable event.
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GROUP RELIEF (3)

A special concession has been introduced whereby transfers
of shares for the formation of the group are not to be treated
as a taxable event. However, an approval to that effect would
have to be obtained from the Securities & Exchange
Commission of Pakistan that such transfers are for the
formation of the group.
16
GROUP TAXATION

A concept of group taxation is being introduced in Pakistan for
a 100 percent holding company. In this situation, both the
companies or the group as the case may be are treated as a
single fiscal unit meaning thereby that for tax purposes
provisions of tax law will apply as if both the companies are
one entity. This provision would be applicable for domestic
companies only. Option to be taxed on group basis shall be
applicable for five years.
17
COMPUTATION OF INCOME FOR BANKS
(1)


A separate schedule has been introduced for the computation of
income and tax payable by a scheduled bank. This is termed as
Seventh Schedule.
Under this new system for taxation purposes the income of a
bank shall be taken to be the income as disclosed in the accounts
to be furnished to the State Bank of Pakistan. However, for
taxation purposes only the following adjustments shall be made:
– Charge for irrecoverable advances as per Prudential Accounts
as included in the accounts shall be accepted except that the
portion relating to ‘Sub-Standard’ shall be added back. An
external auditors’ certificate to that effect shall be required to
be furnished.
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COMPUTATION OF INCOME FOR BANKS
(2)
– Depreciation on asset and amortization shall be allowed
under the income tax laws and accounting.
– Charge for depreciation and amortization shall be added
back. There shall be no adjustment for asset under finance
lease and for that purpose accounting treatment would
also represent the tax treatment.
– An adjustment on account of application of IAS 39 shall be
deemed to be a non-taxable event.
– Head office expenses shall be allowed only if such
expenses are recorded in the books of the Permanent
Establishment and a certificate to the effect of nature of
expenses and reasonableness shall be furnished by the
auditors.
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COMPUTATION OF INCOME FOR BANKS
(3)


In case of Shariah Compliant banking a statement shall be
furnished providing adjustment between the two systems in
the accounts and the reported profit shall be adjusted for tax
purposes accordingly resulting in effect to a system that
income shall be computed as if would have been a
conventional banking system. This adjustment shall be
certified by the auditors.
Whole income of the bank shall be treated as income from
business and taxed accordingly. However, gross dividend and
capital gains arising on sale of shares where the holding
period exceeds twelve months shall be taxed at the rate of 10
percent.
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COMPUTATION OF INCOME FOR BANKS
(4)


Banks have been exempted from all provisions relating to
withholding or collection of taxes as recipient.
Banks shall be required to pay advance tax in 12 equal
installments.
21
AMALGAMATION

Brought forward and capital losses will not be
available in case of Amalgamation. Unabsorbed
depreciation continue to be available through
section 97A.
22
INTER-CORPORATE DIVIDENDS

As an important measure to promote corporatisation of
businesses and development of holding companies intercorporate dividends between resident companies have
been treated as adjustable. Through this measure a
major bottleneck in the promotion of holding companies
and consolidation of shareholding has been removed. As
a result of the same companies shall not be subject to
presumptive tax regime on their dividend income.
23
PRIVATE EQUITY FUNDS




Private Equity Funds as registered by the Securities and
Exchange Commission of Pakistan (SECP) shall enjoy all the
exemptions as are available to mutual funds.
Under the rules being issued by the SECP, in the Budget Package
both local and foreign funds shall be eligible for such registration.
Such private equity would accordingly be exempt from tax if such
funds distribute 90 percent of their income.
In order to provide incentive for economic growth of companies
the owners of the shares of companies selling shares to a Private
Equity fund shall be taxable at the rate of 10 percent as against
normal rate under the law.
24
REAL ESTATE INVESTMENT TRUST


Real Estate Investment Trust is treated as pass through
entities and is not subject to tax.
In order to promote the development of REIT and correction
in the valuation of recorded price of the properties it has been
proposed that any seller of property to a REIT shall not be
taxable on the income arising from the sale of property even
if such transaction represents the normal business activity of
the seller. For that purpose an amendment has been proposed
that the concept of ‘Adventure in the nature of trade’ shall not
be applicable on transaction of sale of properties to REIT.
25
EXPORTS


Rate of withholding uniform at 1 per cent;
Services for export to be treated as Services rather than
export; not for companies.
26
MERGERS & DE-MERGERS (1)

Tax law has appropriately been amended to clarify that
transactions on account of reconstruction of companies
resulting in merger and demerger would not result in taxable
event both for the company and the shareholders. A separate
section has been introduced for this purpose. Under the
proposed status all reconstruction of companies under Section
284 to 287 and 282L of the Companies Ordinance, 1984 or
section 48 of the Banking Companies Ordinance shall be
treated as a non-taxable event both for the companies
involved and the shareholders. Mergers and demerger of all
companies, non-banking financial institutions, and banks shall
qualify for this provisions.
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MERGERS & DE-MERGERS (2)



These provisions are in line with international practices.
Unabsorbed depreciation prior to merger or demerger shall be
available to the company to which the assets are being
transferred.
Any receipt, allotment or cancellation of shares under the
Scheme of Arrangement shall not be treated as disposal. For
the purposes of any subsequent sale of such shares the
original cost of the share prior to merger or demerger shall be
taken into account to determine the amount of capital gains.
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BULK IMPORTER OF INDUSTRIAL RAW
MATERIALS

Companies engaged in bulk import of industrial raw materials
shall not be subject to presumptive tax regime. Income of
such companies shall be taxed at the normal rate. This
exemption shall however be available if the following
conditions are fulfilled:
– Paid up capital of companies exceeds Rs. 100 million
– Fixed assets of the companies exceed Rs. 100 million

Those companies are subject to audit under the Companies
Ordinance, 1984.
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