Islamabad: The Federal Board of Revenue (FBR) has recommended a 5% tax on bonus shares issued by companies and their undistributed profits in the next budget. The proposal will primarily affect family-owned companies but will benefit minority shareholders.
Sources told JEE News that the FBR is considering reviving two old tax initiatives that were earlier scrapped for various reasons. These measures include imposing a 5% income tax on bonus shares issued by companies instead of paying dividends to shareholders.
If approved by the Finance Minister and subsequently by the Prime Minister, the bonus tax proposal will provide a double benefit to the tax authorities. FBR will get 15% tax if companies pay dividend and FBR will still collect 5% tax if companies choose to issue bonus shares. Finance Minister Ishaq Dar will soon start reviewing them and either accept or reject the tax proposals, as the budget announcement is just five days away.
The government had earlier levied tax on bonus shares through sections 236M and 236N of the Income Tax Ordinance in 2014. At the time, then Finance Minister Ishaq Dar had said that the 5 percent income tax on bonus shares was introduced to close loopholes used by companies to avoid tax.
For the next fiscal year, the government is considering a tax collection target of Rs 9.2 trillion, indicating a preference for extracting revenue from existing taxpayers rather than broadening the tax base.
Sources also revealed that the FBR has finalized a proposal to restore Section 5A of the Income Tax Ordinance, which deals with tax on undistributed profits. This tax was removed by the previous government. According to sources, FBR is considering imposing 5% income tax on undistributed profits of companies.
The proposal serves as an alternative to the Reform and Revenue Mobilization Commission’s (RRMC) proposal to tax companies’ undistributed reserves from 5% to 7.5%, which is a more comprehensive approach. However, the business community and the FBR have opposed the RRMC’s proposal, leading the tax authorities to consider reviving the old Section 5A.
During a meeting with the finance minister on Saturday, the Pakistan Business Council (PBC) expressed its opposition to the proposed 5 percent tax on undistributed reserves, citing liquidity concerns and the cost of funding working capital.
The PBC also opposed the abolition of the final tax regime for exporters and insisted that exporters should not be subjected to the minimum tax regime. At least under the tax system, exporters will need to fully document themselves, which they currently avoid under the final system.
The Tula Commission had recommended an income tax rate of 5% for listed companies and 7.5% for non-listed companies, to be levied on the distributable reserves of such companies. The Tola Commission estimated the annual revenue impact at Rs 338 billion based on a total value of Rs 5.44 trillion in company reserves. The report also estimates additional revenue of Rs 141 billion from listed companies that have not paid dividends in the past three years, with reserves of Rs 2.8 trillion. Similarly, unlisted companies have reserves of Rs 2.6 trillion and the FBR can potentially generate an additional annual revenue of Rs 197 billion at a rate of 7.5 percent.
However, the FBR is not in favor of this proposal and instead suggests reinstating tax on undistributed profits at the rate of 5%.
Following a report by JEE News on the RRMC proposal, companies with significant reserves started issuing bonus shares. The Securities and Exchange Commission of Pakistan (SECP) is estimated to earn at least Rs 500 million in fees, which is an average of 0.5 percent of the raised authorized capital of these companies. These companies are increasing their capital levels to avoid tax.
To counter this strategy, the FBR plans to impose a 5 percent tax on the issue of bonus shares, which is expected to generate significant revenue, sources said.
As of 2019, the government has imposed a 5 percent tax if a company does not distribute at least 20 percent of its after-tax profits in cash within six months of the end of the tax year.
This is not the first time that tax on undistributed reserves of a company has been proposed. Similar enforcement was attempted twice earlier under Section 12(9A) of the repealed Income Tax Ordinance 1979 and Section 5A of the 2001 Ordinance, as noted by former FBR Chairman Shabar Zaidi.
However, unlike the current proposal to tax the undistributed reserves of the entire corporate sector, the previous restrictions were limited to listed companies.
The government is trying to address the concerns of the business community, which is worried about rising risks of default and the negative impact of import restrictions.
During talks with various business houses, Dar “assured” the nation that Pakistan would not default and promised that the government planned reforms for the “long-term betterment” of the country.
The finance minister emphasized that the government’s aim is to control the crisis. He acknowledged the “extraordinary delay” in reaching a staff-level agreement with the International Monetary Fund (IMF) despite almost all requirements being met by Pakistan.
Furthermore, he acknowledged that the tough economic decisions taken by the government have placed a significant burden on the business community and the general public.
Criticizing those who predict the outcome of default, he said, “Some people like to give dates that Pakistan will default on such and such date. Shame on them.”
His predecessor, Miftah Ismail, had recently said that without IMF support, Pakistan could default by October this year.
