Historical Impact of Capital Gain and Dividend Tax changes on PSX
Recent market performance
In the past seven sessions, the Pakistan stock market has declined by 2.3%, losing 1764 points. This drop is attributed to fears surrounding potential increases in Capital Gain Tax (CGT) and dividend tax. There is also a rumor that the government may change the treatment of these taxes from a full and final tax to a normal tax for certain investors.
Historical market reactions
Historically, changes in CGT and dividend taxes have shown varied impacts on the market. Here is a summary of past market reactions:
| Fiscal Year | Tax Change | Market Reaction |
|---|---|---|
| FY15 | CGT increased by 250 bps to 12.5% | Market fell by 0.61% in 10 sessions (intra 10-day low: -1.7%) |
| FY16 | CGT and dividend tax increased by 250 bps | Market rose by 1.5% in 10 days after falling 1.71% during intra 10 days |
| FY18 | Single tier CGT introduced, dividend tax increased by 250 bps | Market fell by 5.9% in 10 sessions post budget (intra 10-day low: -9.8%) |
The significant decline in FY18 was also influenced by the MSCI reclassification from frontier to emerging markets, resulting in a net outflow of US$133 million.
Current taxation landscape
Currently, individuals generate over 70% of the market turnover and are taxed at a CGT of 15% and a dividend tax of 15%, assuming they are tax filers. These taxes are currently considered full and final. However, there is a proposal that the government may change this treatment to a normal tax regime.
Potential impact of tax changes
On Individuals
- CGT and dividend income would be added to the individual’s normal income, subjecting them to applicable tax rates based on their income slab.
- This change could create a disparity and put an extra burden on individual investors since their expenses are not deducted from their income, unlike companies.
- Ultra high net worth individuals (HNIs) might divert their trading to corporate accounts to manage tax rates by deducting expenses.
- Small investors may face higher taxes on dividends and capital gains.
On Companies (Including Brokers)
- Companies, contributing approximately 20% to trading activity, might see an increase in tax liability if the treatment changes to a normal tax regime.
- Companies with lower profits or higher expenses could benefit, as their tax liability may be lower compared to the 15% direct withholding tax.
- Banks and insurance companies, which contribute 4-5% to trading activity, will see no impact as their capital gain and dividend income are already treated as normal income.
Contribution to trading activity
| Investor Category | Contribution (%) |
|---|---|
| Individuals | 73% |
| Companies | 4% |
| Banks/DFI | 3% |
| NBFC | 0% |
| Mutual Funds | 2% |
| Other Organizations | 1% |
| Broker Proprietary Trading | 15% |
| Insurance Companies | 2% |
The proposed changes in tax treatment are expected to have a varied impact on different investor categories, potentially increasing the tax burden on individual investors while offering some benefits to companies with higher expenses or lower profits.
Disclaimer:
The information in this article is based on research by Topline Securities. All efforts have been made to ensure the data represented in this article is as per the research report. This report should not be considered investment advice. Readers are encouraged to consult a qualified financial advisor before making any investment decisions.
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