Pakistan Budget 2019-20 brings structural reforms into the real estate tax system with an aim to bring real estate economy into the tax net. Will the tax reforms bring government some more taxes and will push the sector towards greater transparency; or will it overburden property buyers and sellers with more taxes, is, of course, something that time can tell. This article discusses new tax reforms and their impact on the real estate industry, investors, and general buyers and sellers.
i. Income from Capital Gains to be Taxed under Normal Tax Rates
Capital gains here refer to the profit one makes from the sale of any property. Tax on capital gains (Capital Gains Tax – CGT) is always paid by a seller. Earlier, tax on capital gains (the profit) would be charged on the basis of how long one holds one’s property. For example, if you buy a property and sell it within three years, Capital Gains Tax rates for the first year would be 10% on the gain, 7.5% on the gain for the second year, and 5% on the gain for the third year. No CGT would be charged if you sold your property after three years.
The current budget cancels this provision and applies normal tax rates to 100% of the profit (capital gains) one makes from the sale of a property. Consider the given example for more understanding:
It is to be kept in mind that capital gains will now be considered as business income; hence, will be taxed as per normal rates. Tax slabs for business income/non-salaried income are as follows:
Secondly, as you can see in the table that the holding period of a plot has been extended to ten (10) years, while for a constructed property it is five (05) years. No tax will be imposed if a property is being sold after its respective holding periods.
ii. 3% Tax on Differential Amount between FBR Value and DC Rates of the Property has been Withdrawn
There has always been quite a difference between FBR value and DC rate and the actual market price of a property. Sometimes, it even gets more than 200%. Earlier, any buyer would pay just 3% of the difference between the two values (FBR and DC rate) of a property and invest his/her money without revealing its source. This facility was perceived as a safe way for money laundering, parking ill-gotten money, and tax evasion. Therefore, Budget 2019-20 abolishes it and makes every buyer liable to disclose his/her source of income.
iii. Withholding Tax on Immovable Property has been Reduced from 2% to 1%
Withholding tax is a federal property tax that is paid by both buyer and the seller. This tax can always be adjusted in annual tax returns. Since the government has decided to bring FBR value of any property closer to or around 85% of its actual market value, the incidence of tax is likely to increase; therefore, the government has no problem to reduce the withholding tax from 2% to 1%.
iv. Withholding Tax on Buying Immovable Property is to be Collected Irrespective of its Value
Earlier, withholding tax was payable on the purchase of any property whose value was more than four million rupees (PKR 40,00,000). Properties of lesser values were exempted from paying withholding tax. It gave birth to various illegal practices of escaping tax payment. For example, the buyer would mention a false value (less than four million rupees) in the sale agreement to evade the payable tax amount. Or, if the purchase value is much higher than four million rupees, the payment would be made through various checks and transactions (each less than four million rupees) to dodge the tax net. Under this tax reform, every purchase value will now be taxed with a rate of 1% withholding tax.
Similarly, there was no withholding tax payable on the sale of a property that is being held for more than three years. Now, the holding period for the plot has been extended to ten years while for a constructed property it is five years.
v. Non-filers can now Buy Immovable Properties Worth more than 5 Million Rupees
At present, the law restricts registration or transfer of any immovable property – whose value exceeds five million rupees – to the name of a non-filer. The purpose was to compel non-filers to become tax filers and discourage their participation in major economic activities. This restriction has now been lifted. Non-filers can now purchase or own property of any value, but of course, they’ll have to do it through banking channels, as discussed below.
vi. Immovable Property worth more than Five Million Rupees could be Purchased through Banking Channels only
Earlier, a property of any value could be purchased through cash, which was viewed by the government as yet another way to facilitate tax evasion or whitening of undisclosed assets. It is no longer possible now. Upon purchase of any property whose value exceeds 5 million rupees, the payment needs to be done through proper banking channel only. Consequently, the bank to bank transfer of the amount will bring the real estate transaction into the tax net.
In case of violation, a penalty equal to 5% of the FBR value of the property will be imposed.
Impact of Tax Reforms on Property Buyers and Sellers
With new reforms, applicable tax on capital gains has become payable even after three years. The seller who was earlier exempted from paying tax on the profit he makes from selling a property (after three years of its purchase) will now have to pay it till ten years. On the other hand, the new tax rates (income tax rates) appear to be lesser than capital gains tax (levied earlier) in some cases. Nevertheless, the tendency for a seller to pay tax on his profits has considerably increased.
Similarly, the abolition of paying 3% differential amount to conceal investment source has closed yet another door for non-filers. It is once again a step towards documenting real estate economy by bringing the participation of non-filers in the real estate economy to its end. Additionally, though withholding tax for a seller and buyer has been reduced to 1% from 2%, it would not much affect what is already payable by them. For example, as discussed, FBR valuation will be brought closer to 85% of the actual market value of a property. Since the sale value of a property is always documented as per FBR valuation or DC rates or above, the rate of applicable tax on the transaction will also increase. Hence, a reduction in withholding tax may not be much applauded by property purchasers.
In a nutshell, the new tax reforms may not much favor general buyers and sellers, as overall payable tax rate on property deals is certain to go high. Nevertheless, there is no doubt these measures could play a major role in regulating the real estate sector and bringing it into the mainstream economy.