Federal Board of Revenue

LETTER FROM LETTER FROM AMIR ALAM KHAN & CO. CHARTERED ACCOUNTANTS, RAWALPINDI TO CHAIRMAN, FEDERAL BOARD OF REVENUE (Re: Clarification of the anomalies regarding taxability of capital gains on disposal of securities under section 37A of the Income Tax Ordinance, 2001) No.Misc/003 July 27, 2010 The Chairman, Federal Board of Revenue, Government of Pakistan FBR House, Constitution Avenue, Islamabad SUBJECT: CLARIFICATION OF THE ANOMALIES REGARDING TAXABILITY OF CAPITAL GAINS ON DISPOSAL OF SECURITIES UNDER SECTION 37A OF THE INCOME TAX ORDINANCE, 2001 Dear Sir, Capital Gains arising on the disposal of "Securities" (shares of a public company, vouchers of Pakistan Telecommunication Corporation, Modaraba Certificates or instruments' of redeemable capital and derivative products) have been brought in the ambit of chargeable capital gains under the Income Tax Ordinance, 2001 and for this purpose amendments have been made in section 37, a new section 37A has been inserted, a new Division VII in Part-I of the 1st Schedule has been inserted and clause (110) of Part-I of 2nd Schedule has been omitted through Finance Act, 2010. A cumulative reading of the aforesaid amendment, insertion and omission needs clarification on the following anomalies: (1) Taxability of capital gains arising on disposal of securities held for a period of exactly twelve (12) months and six (6) months: (a) Subsection (1) of section 37A reads as under: "The capital gain arising on or after the first day of July, 2010, from the disposal of securities held for a period of less than a year, shall be chargeable to tax at the rates specified in Division VII of Part-I of the First Schedule: Provided that this subsection shall not apply if the securities are held for a period of more than a year:" (b) Division VII of Part-I of the 1st Schedule reads as under: "The rate of tax to be paid under section 37A shall be as follows:-- (1) Where holding period of a security is less 2011 10.00% than six months. (2) Where holding period of a security is more 2011 07.50% than six months but less than twelve months. (3) Where holding period of a security is more 00.00% than one year. (c) From the bold and underlined words above it will be observed that the capital gains arising on the disposal of the "Securities" held for the period of exactly twelve (12) months is not covered under section 37A as well as Division VII of Part-I of the 1st Schedule. (d) Similarly, no rate of tax has been prescribed in Division VII of Part-I of the 1st Schedule for capital gains arising on the disposal of the "Securities" held for the period of exactly six (6) months. 2. Determination and computation of capital gains arising on disposal of securities held for a period of less than a year:-- (a) Section 37A is silent as to how the capital gains arising on disposal of "Securities" held for a period of less than a year shall be determined and computed. (b) Provisions similar to subsections (2), (4) and (4A) of section 37 are missing in section 37A and nor these subsections have been cross referenced in section 37A for determination and computation of capital gains arising on the disposal of "Securities" held for a period of less than a year. 3. Taxability of capital gains arising on disposal of securities held for a period of exactly twelve months and more than a year: - (a) Section 37 applies to all capital gains arising on disposal of "Capital Assets" which includes the "Securities" as well. However, the capital gains arising on disposal of "Securities" held for a period of less than a year stands automatically excluded from section 37 for which specific provisions are made under section 37A. (b) Accordingly, the capital gains arising on disposal of "Securities" held for a period of one year or more being not covered under section 37A, in the absence of any exclusion from section 37 continue to be chargeable under section 37 (earlier this was covered by exemption granted under clause (110) of Part-I of 2nd Schedule). (c) We understand that instead of granting exemption to the capital gains arising on disposal of "Securities" held for a period of one year or more by making a specific provision in the Part-I of 2nd Schedule an alternate route has been adopted through First Proviso to subsection (1) of section 37A and Serial No. (3) of Table in Division VII of Part-I of the 1st Schedule has been adopted. However, this alternate route adopted is of not a valid legislation and the capital gains arising on disposal of "Securities" held for a period of one year or more shall be chargeable to tax under section 37 for the following reasons: (i) Subsection (1) of section 37A applies to capital gain arising from the disposal of securities held for a period of less than a year and therefore the First Proviso to section 37A providing for that subsection (1) of section 37A shall not apply if the securities are held for a period of more than a year is a self-contradiction, redundant and irrelevant. (ii) Similarly, the "Zero" rate of tax provided at Serial No. 3 of Table in Division VII of Part-I of the 1st Schedule for capital gains arising on disposal of "Securities" held for a period of more than a year, is also a self-contradiction, redundant and irrelevant since this Division is subservient to subsection (1) of section 37A which does not apply to "Securities" held for a period of more than a year. 4. Set-off of capital losses against capital gains arising on disposal of securities held for a period of less than twelve months: (a) Subsection (5) of section 37A reads as under: "Notwithstanding anything contained in this Ordinance, where a person sustains a loss on disposal of securities in a tax year, the loss shall be set off only against the gain of the person from any other securities chargeable to tax under this section and no loss shall be carried forward to the subsequent tax year." (b) A plain reading of the subsection (5) of section 37A reveals that loss on disposal of "Securities" in a tax year, irrespective of the disposal period (i.e., held for less than six months, six months, more than six months and less than twelve months, twelve months or more than twelve months) can be adjusted against the capital gains on disposal of any other "Securities" chargeable to tax under section 37A (i.e. gains arising on disposal of "Securities" held for a period of less than twelve months). (c) The capital gains arising on disposal of "Securities" for the purposes of taxability is divided into following categories:-- Disposal after holding for Basis of Taxation Rate of Tax (i) Less than six months Under section 37A Separate Block 10.00% (ii) Six months Under section Separate Block 37A Not provided (iii) More than six months but less than twelve months Under section 37A Separate Block 07.50% (iv) Twelve months Under section 37 - Taxable Income* Not provided for** (v) More than twelve months Under section 37 - Taxable Income* Under section 37A Separate Block** 00.00% * In view of anomalies stated above ** F.B.R's view (d) The mode of taxation and the rate of tax of each of the above five categories of capital gains is different. However, this subsection is silent as. to whether capital loss on disposal of "Securities" under each of the categories stated above can be adjusted against the capital gains of that category alone; or capital loss under one category can be adjusted against the other category. We shall be highly obliged for an early clarification of the above anomalies.