ISLAMABAD: The Federal Board of Revenue (FBR) has removed all tax incentives available to the private fund (PF) industry that provide it with a level playing field with other pooled investment asset classes like funds mutual funds and the Real Estate Investment Trust.
According to a latest report by the Securities and Exchange Commission of Pakistan (SECP) on the private equity industry, the SECP has called the taxation of the FP industry a “fiscal dilemma” for the country.
The SECP report recommended that there is an urgent need to remove the tax obstacles created by the 2021 finance law to restore investor confidence in the sector. In addition to advocating for specific tax proposals, it is essential to convey that tax policy coherence is vital to maintaining foreign investor confidence. Tax measures for the sector should therefore be seen on a perpetual basis as in other jurisdictions and not as a temporary makeshift arrangement that can be withdrawn if there is pressure to reduce the number of exemptions.
The report pointed out that the transfer status previously enjoyed by PFs has been removed by the removal of clause 101 from Part I of the 2nd Schedule to the Income Tax Ordinance (ITO). The removal also triggered a PF minimum tax under sub-clause (xii) of clause 11A of Part IV of the 2nd Schedule.
Section 103 of Part I of the 2nd Schedule which extended to the distribution received by a taxpayer of a PF’s capital gains has also been removed. 37. Similarly, the proposed amendments to Section 47B resulted in the applicability of withholding tax on FPs, even though this tax is not applicable to other classes of funds which have transfer status in accordance with to tax legislation. Consequently, the following charging layers become applicable on a PF.
Investing through PFs now has an inherent disadvantage due to multiple layers of taxation. This unfavorable tax environment has severely hampered the growth of locally domiciled FPs. It should be taken into account that the first fund under the revised Private Funds Regulations of 2015 was launched in 2017.
While the previous transfer status with built-in sunset clause granted by FBR until 2024 was a cause for concern for new entrants to the industry considering a fund life of 5-7 years. Uncertainty surrounding the sector’s fiscal environment has been further heightened due to recent pullbacks which have also bolstered the views of many overseas investors who cite the lack of consistent policies as a key reason for not investing directly in locally domiciled funds. .
The venture capital industry has, however, obtained clarification from leading audit firms that clause (57) of Part I of the Second Schedule of the ITO provides for an exemption of total income from a PE&VC fund, other than specified capital gains, provided that the fund distributes 90% of its income for that year among its unitholders.
In addition, the insertion of clause (103D), Part I of the Second Schedule of the ITO provided an exemption for dividend income and long-term capital gains from a PE&VC fund that invests in enterprises established in the Special Technology Zones (as defined under Special Technology Zones Authority Ordinance, 2020) for a period of 10 years from the date of issuance of the license by the STZA authority to the enterprise.
It should be noted that the SECP has pursued tax reforms for the FP sector, in line with similar tax measures adopted by various other jurisdictions.
Majority jurisdictions such as UK, USA, China, Malaysia, India, Italy, France, South Korea, Turkey, Bangladesh etc. offer transfer status for private equity and venture capital funds (practices in other jurisdictions for fund-level taxation on PE&VC funds.
Interestingly, in some jurisdictions such as Israel, which has become a destination for venture capital investment, in addition to transfer status, beneficiary companies in which a venture capital fund invests have also been granted exemption. ten-year tax.
Such measures adopted in other jurisdictions have not only ensured tax neutrality, but have also encouraged investment through PE&VC funds.
In addition to actively pursuing tax reforms with the RBF, the SECP has also been advocating the same in various forums including the Asian Development Bank as part of its recommendations for the implementation of the market development plan. of capital and the 2020-2027 roadmap, the SECP Report added.
Copyright Business Recorder, 2022