The real estate sector in Pakistan is experiencing a lull. With newer tax regulations, stock market trading in real estate backed securities isn’t expanding at a favorable rate according to Muhammad Ejaz, Chief Executive Officer at Arif Habib’s Dolmen REIT. This highlights how so far the new regulations by the government have been ineffective in delivering favorable results.

The need for real estate taxation

In an ideal situation, within developing countries, the revenue contribution from property tax should have a share of one per cent or more in the GDP; while developed countries have a share of two per cent. Western European countries, United States, Canada and Australia on average collect property taxes close to two per cent of their GDP while various transition countries in Central and Eastern Europe and former Soviet Republics revenues from PT represents close to one per cent of their GDP.

In reality, real estate taxes in developing countries often yield under 0.1% of the GDP, and rarely more than 0.5%. But they can be more than 50% of local government revenues. While the potential of real estate taxes to strengthen national revenues is limited, the potential to finance improved local government services - local and government accountability and governance - is considerable. Many developing countries (including Egypt, Namibia, and Vietnam) have consequently embarked on real estate tax reforms. Thus, if Pakistan employs this tax revenue effectively within each respective provincial domain then there’s a chance that it can expand the overall tax base in the country.

These taxes can be employed to create a benefit charge that can be used to finance services that would improve the property values and seen as a medium to pay for various services like local roads, sewerage, refuse collections etc. The efficiency of real estate taxes appeal to the location specific attributes that provide a relatively immobile tax base, less vulnerable to tax competition than others. With lower rates the inefficiencies from marginal increases are likely to be modest and their progressivity arises from the positive correlations between property ownership, income and wealth.

This is classic theory of real estate taxation and countries have successively aimed to incorporate these in their standard taxation laws. However, Pakistan’s progress has been slow and inconsistent and the new reforms introduced have been largely difficult to administer. This can be attributed to the fact that as with any economic agent, property tax is costly to administer in an effective way as the cost of maintaining a full roll of liable taxpayers and an effective system of valuation and revaluation are expensive. Secondly, as with many other taxes, property tax is hugely unpopular with taxpayers and elected local politicians.

Present trends in Pakistan

Overall, there seems to be more activity in Gwadar that is seen to be shadowing Karachi’s property market at the moment. The Zameen.com’s Market Report for 2017’s 1Q shows that the realty sector in different cities such as Lahore, Gujranwala, Karachi and Islamabad are moving close to stability but this has been at a slow pace. However, with new tax regimes in place the effects are yet to be realized throughout the economy.

Pakistan’s real estate sectors are experiencing a steady growth but this isn’t showing up on the country’s stock exchange on the real estate backed securities. Real Estate Investment Trust (REIT) is a security that invests in real estate through property or mortgages and trades on major exchanges like a stock. Arif Habib’s Dolmen REIT is the only share in the last decade that has been listed at the PSX and since then its Chief Executive Officer Muhammad Ejaz has proposed the finance ministry to do away with additional taxes as this would help the government document construction and real estate projects. Therefore, while some would argue that the tax base under new regulations in expanding it isn’t accruing a marked difference on the country’s stock market.

Under the Federal Budget 2016-17 the tax regime for the real estate sector was redefined and the DC rates (Collector Rate) became the prerogative of the provincial governments. However, this caused a problem when the gap between the DC rates and market prices widened; engendering a black economy that couldn’t be accounted for. Resultantly, neither the government of Pakistan nor the income tax authorities had any idea of the total income individual sellers and real estate sector was generating as a whole. To correct this Finance Act 2016 was introduced which further deteriorated the situation, causing an 85% decrease in property transactions. To contain, an amnesty scheme was passed by the National Assembly in December 2016 which became a mechanism to increase tax revenues and document the tax filers. This was seen as a rather controversial move owing to the fact that with a nominal amount a previous non-filer could become a registered tax payer. But the government is optimistic that in the near future this would bring almost Rs7 trillion.

Furthermore, under the new budget that announced on May 26, a three-tiered capital gains tax has been introduced to encourage foreign investment in the equity market for the next three fiscal years. This has been introduced as a way of undermining the negative impacts of frequent changes in capital gain tax regime on foreign institutional portfolio investment.

Overall, with the increase in tax rates and the imposition of newer taxes, the costs for the firms would go up and hence cause an overall shift in the markets. Albeit the new tax regime introduced by FBR and proposals for the local governments seems to be counter-productive as a way of essentially declining transactions, however, in the long run they should be welcomed because as prices fall, the trading activity will eventually increase.