KARACHI: The government has announced massive tax relief to foreign investment in debt securities considering the attractive environment due to higher interest rate in the country.
The foreign investment in domestic debt market including government securities including Market Treasury Bills and Pakistan Investment Bonds, is around $1.5 billion during first six month (July – December) of 2019/2020 and in total it is around $2 billion when investment included in the equity market.
Through Tax Laws (Second Amendment) Ordinance, 2019, the government facilitated the foreign investment by making significant changes to Income Tax Ordinance, 2001.
A commentary released by Pwc A F Ferguson Chartered Accountants on the tax ordinance 2019 explained the tax relief on the foreign investment through changes brought into the main statute.
The chartered accountancy firm said that foreign investors particularly foreign institutional investors invest in Pakistan’s capital market through Foreign Portfolio Investment (FPI) scheme, which allows such investors to invest in equity and debt securities (including Government Bonds, Term Finance Certificates, Pakistan Investment Bonds) without any physical presence.
The FPI scheme makes it mandatory for foreign investors to open Special Convertible Rupee Account (SCRA).
The requirement for non-residents to open SCRA is provided in Chapter 20 of the Foreign Exchange Manual issued by the State Bank of Pakistan (SBP).
The funds available in SCRA can be transferred outside Pakistan or credited to a foreign currency account of non-resident investor maintained in Pakistan at any time without prior approval of SBP.
Such non-resident corporate investors not having a Permanent Establishment in Pakistan are hereinafter referred to as NRI.
The tax incidence applicable on NRI on return from their investment in equity instruments, either as dividend or capital gains, is largely aligned and same (being 15 percent).
However, tax incidence applicable on return from investment in debt securities by NRI is not aligned. Interest income from debt investment is subject to final tax upon tax withholding at 10 percent whereas capital gains from disposal of debt instruments are taxable at corporate rate of tax which is presently 29 percent.
The Second Amendment Ordinance has aligned and rationalized the tax incidence through following amendments, apart from relieving NRI from certain compliances:
(i) Banking company / financial institution maintaining SCRA of NRI is now required to deduct tax from capital gains arising on disposal of debt instruments and Government securities (including Treasury Bills and Pakistan Investment Bonds) @ 10 percent.
Such tax deduction constitutes final tax on such capital gains. It appears that tax withholding is required to be made at the time when proceeds from disposal are accounted for in the SCRA and also that no adjustment for any capital loss may be made by the Banking company / financial institution while deducting tax @ 10 percent from capital gains earned by NRI on disposal of debt securities.
(ii) The requirements to obtain tax registration [under Section 181 of the Income Tax Ordinance, 2001 (‘ITO 2001’)] and also to file statement of final taxation [under Section 115(4)] will no longer apply, in case capital gains or profit on debt is earned from investments made through SCRA (maintained with a banking company or financial institution) in debt instruments & Government securities (including treasury bills and Pakistan investment bonds).
Despite not appearing on Active Taxpayers List (ATL), they will not be subjected to higher tax withholding under the Tenth Schedule on interest income and capital gains relating to such securities.
(iii) Advance tax under section 147(5B) will also be not payable in respect of capital gains arising on investment made through SCRA (maintained with a banking company or financial institution) in debt instruments and Government securities (including treasury bills and Pakistan Investment Bonds).
(iv) Tax withholding applicable on banking transactions by those not appearing on ATL (under section 236P) will not apply to SCRA. This is a blanket exemption for companies maintaining SCRA regardless of whether investment is made in equity or debt securities.