PSX proposes tax relief for exchange traded fund

PSX proposes tax relief for exchange traded fund

KARACHI: Pakistan Stock Exchange (PSX) has proposed Exchange Traded Funds, transfer of Portfolio (basket of securities) from Authorized Participant (AP) to ETF’s Account should not be treated as disposal.

In its proposal for budget 2020/2021, the PSX suggested that in order to facilitate the market for Exchange Traded Funds, transfer of Portfolio (basket of securities) from Authorized Participant (AP) to ETF’s Account should not be treated as disposal and therefore holding period of ETF constituents be carried forward to the ETF, upon conversation of Portfolio Deposit to ETF units, for the purpose of CGT calculation.

Tax relief for ETF instrument will play a significant role in not only the benefit to existing ETFs recently launched but also in the successful launch of further ETFs in Pakistan, as the current structure would trigger capital gains in the creation of ETFs units. Moreover, a rationalization rate of tax on ETF investments, at par with the tax on other asset classes, would attract more investors towards ETFs.

An Exchange Traded Fund (ETF) is a pooled investment vehicle, with shares which can be traded throughout the day on a stock exchange, at a price determined by the market. Similar to a traditional mutual fund, an ETF provides investors a proportionate share in a pool of underlying securities.

ETFs are one the fastest growing category of passive fund investments. Globally ETFs are an integral part of product offerings in the capital markets. It is a product with significant presence in over 47 countries.

Internationally, there are over 8,000 ETFs with aggregate Assets Under Management of about USD 6.5 trillion by the end of 2019 and estimated to grow to around USD 7.6 trillion by the end of 2020.

ETFs typically track an underlying index; they can also be based on sectors and strategies. They hold immense potential for investors to gain exposure to various market themes, without paying excessive management fees for getting a diversified exposure or developing a portfolio.

PSX proudly announced on March 24, 2020, the successful listing and commencement of trading in Pakistan’s first ever Exchange Traded Funds (ETF).

Two ETFs, namely NIT Pakistan Gateway ETF and UBL Pakistan Enterprise ETF, were launched on March 24, 2020 by the National Investment Trust Limited and UBL Fund Managers Limited, respectively.

Given the current circumstances and in the interest of safety, a first of its kind virtual launch was organized by PSX for the landmark launch of the ETFs.

This virtual launch is a step taken to make sure that the message of availability of ETFs in the Pakistani Capital Market goes across to all investors and market participants while ensuring their safety in the wake of the current threat of the potential spread of the Covid-19 virus.

Therefore, as PSX is working actively with all market participants and regulators, the tax structure for ETFs needs to be rationalized to incentive prospective Aps to deal in ETF’s Account (both maintained with Trustee), would trigger Capital Gains Tax (CGT).

Internationally, the growth and attraction of ETFs has been driven by the essential requirement that creation of ETF units by authorized participants are not subject to capital gains.

A fundamental feature of ETFs is that the creation of their units are made in-kind, and not in cash as in the case of a mutual fund, so it does not trigger capital gains tax.

In almost every market where ETFs are traded, regulators have allowed the practice of in-kind transfer portfolio securities. Examples include Saudi Arabia, Canada, UK, and USA.

The following proviso should be inserted after sub- section 3 of section 37A to the Income Tax Ordinance, 2001;

“Transfer of Portfolio (basket of securities) from Authorized Participant (AP) to ETF’s Account should not be treated as disposal and therefore holding period of ETF constituents be carried forward to the ETF, upon conversion of Portfolio Deposit to ETF unit, for the purpose of CGT calculation.”

Appropriate amendment to be made in the Income Tax Rules, 2002.

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