Change in tax laws: Unintended consequences for property market

By Ali Salman

Published in The Express Tribune, July 25th, 2016.

The Finance Bill 2016 brought an amendment to Section 68 (4) of the Income Tax Ordinance that requires determination of fair market value of property to replace the flat rate set by district commissioners.

Accordingly, the State Bank of Pakistan (SBP) has issued its panel of valuers, who will be charged with determining the real value of property and will be subject to approval of the Federal Board of Revenue (FBR) Inland Revenue administration.

In the FY17 budget, the taxable period for capital gains on disposal of immovable property has been extended up to five years and a flat 10% tax has now been made applicable to the seller of the immovable property if he sells it within five years of purchase.

The law of property evaluation through the SBP-approved experts has been introduced presumably to curb speculation in property markets, discourage the whitening of black money and boost government revenue.

These are the intended consequences of the law, but let’s consider its unintended consequences.

Why investors speculate?

Speculation is part of the legitimate market activity, where speculators give a signal of buying when it is plenty and selling when it is short.

Speculators are autonomous responses to market fluctuations, though they may also cause these fluctuations. There has to be an excess supply in any commodity to attract speculation. In this case, it is the presence of surplus property files and vacant urban plots which attract speculation. This, in turn, is a function of bad zoning laws, which have pushed the cities horizontally instead of vertically.

In Pakistan, not only the bigwigs speculate, but everyone with even savings of Rs1 million does it through buying and selling property.

“Where else they would park their money if the business environment is not supportive, banks are giving loans only to the government and government keeps on increasing tariffs and taxes,” a fine point made by a Dubai-based Pakistani businessman Waliur Rehman.

Thus, the debate should be on the real drivers of real estate market and not the symptoms. Government should not penalise investors for spotting the arbitrage.

Whitening black money

Suppose that suddenly all criminals and corrupt individuals stop their property transactions because of new laws. They need an outlet to stash their “ill-gotten” money, which resides in either cash or Benami accounts.

Its next likely destination will be forex markets, which will induce an upward pressure on the dollar, making it further appreciate against the rupee. This will most likely be shifted outside Pakistan and return whitened via remittance.

Once landed back, it will help stabilise and size up forex reserves – something which will be good for the current account but bad for trade balance, as exports will become dearer.

Therefore, it is better to let the black money remain inside Pakistan, as it is an externality of Pakistan’s legal system.

Govt revenues

In Lahore, properties are being transferred at rates of Rs2 to Rs8 million set by the district commissioners (DC), while market values of these properties are in the range of Rs12 to Rs30 million.

Hence, on the DC rate evaluation method, the duties and taxes paid by the buyer were around Rs150,000 to Rs1.2 million, while the market rate evaluation method will increase these to Rs1 million to Rs3 million. Clearly, the government expects to make a windfall through the new valuation system.

However, there is a big assumption. Transactions will actually take place under new laws. While property speculation will be reduced, the transaction for even non-speculators will become costlier.

With additional duties and taxes slapped on property transactions, those wanting to buy property for their homes or businesses will be paying much more. Thus, the new law will penalise the legitimate buyers marginally more than the so-called speculators.

The Karachi Chamber of Commerce and Industry (KCCI) has proposed a better alternative – the prevalent DC rate system should be restructured and the changes in the DC rate can be made more frequent.

One demand should be added – the stamp duty and all other taxes on property sale and purchase should be drastically cut down. A combination of revision of the minimum price, lowered stamp duties and curtailment on Benami accounts will help create a win-win scenario for all the players.

As a result of the new legislation, three central government entities, which had no role in property valuation, have entered the marketplace. These are the SBP, FBR and Securities and Exchange Commission of Pakistan.

The mere thought of a sudden central government intervention in a market phenomenon is fearsome. It may be considered nationalisation of real estate market.

The consequences of nationalisation of businesses are well-established as anti-growth, anti-jobs and anti-economy. The case of nationalisation of property markets will be no different.

 

Leave a Reply

Your email address will not be published. Required fields are marked *