KARACHI: Pakistan Stock Exchange (PSX) has recommended modification in Shariah compliance criteria under Income Tax laws to make it practically possible to meet the requirement.
The PSX in its proposals for budget 2021/2022 said that the modification would held the promotion and development of Islamic capital markets by encouraging new listings of companies on PSX through mobilizing resources towards faith-based investor savings.
Giving rationale, the stock market said that the conditions imposed through the ITO, 2001 are impractical to implement given the inadequate depth of Islamic markets of Pakistan, constraining the taxpayers from achieving the Shariah Complaint status and therefore failing the reforms’ underlying objective – (e.g. 100 percent income from manufacturing operations, financing through licensed Islamic financial institutions only, issuing dividends in last five consecutive years etc.
Highlighting the background, the PSX said that in 2016, the Federal Government through Finance Act 2016, had introduced certain amendments in the ITO which allowed 2 percent rebate in corporate income tax rate to companies which qualified the criteria for Shariah Compliance specified in Clause 18B of Part II of Second Schedule of ITO.
Thereafter in January 2017, Rule 231H was inserted in Income Tax Rules, 2002 (Rules) which provided further guidance on the Shariah Compliance criterion mentioned in ITO.
The objective for this rebate, as explained by Securities and Exchange Commission of Pakistan (SECP) in its press release of July 11, 2016, was to incentivize listed manufacturing companies to become Shariah Compliant and that this was introduced in the ITO as part of reforms, with collaboration of SECP, for promotion and development of Islamic Capital market.
Thereafter, in November 2018, the corporate regulator introduced the landmark Shariah Governance Regulations 2018 (Regulations), which entailed a comprehensive jurisdictional framework to regulate and govern the corporate sector, including the capital markets, Islamic capital markets, Shariah-compliant securities and Islamic financial institutions.
The framework was a major break-through to lay the foundation for a true Islamic financial and economic system. The Regulations encompass a number of elements of Shariah governance which are practical to adopt and implement, ensuring long-term sustainability.
On the other hand, the requirements contained in the ITO, as introduced in 2016, are comparatively stringent and impractical for taxpayers to adopt in letter and spirit, which is ultimately defeating its underlying objective i.e. development of Islamic market in Pakistan.
Hence, a re-alignment of income tax requirements with the SECP Regulations is critical so as to enable more companies to obtain Shariah Compliant status and avail the accompanying tax benefits.
Under clause 18B of Part II of Second Schedule of the ITO, 2001, a reduction in corporate tax rate by 2 percent is allowed to a company which meets the criteria specified in the said clause and Rule 231H of the Income Tax Rules, 2002.
However, the existing compliance requirements are very impracticable and more stringent then the requirements mentioned by SECP in Shariah Governance Regulations, 2018, which makes it practically impossible for the taxpayers to fulfill the criteria and achieve the desired status.