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Pakistan Economy: Tax Amnesty Surprisingly Lenient & Likely Positive for Market

• With less than 2 months remaining before the end of the ruling Govt.’s tenure, Prime Minister has announced a comprehensive tax reforms package in yesterday’s press briefing. The announced scheme is better than expectations and also the materialization of inflows will likely occur earlier (by Jun 2018) than our previous estimates (FY19-20).
• In our recent report titled “Life with IMF & its Likely Impact” dated Apr 3, 2018, we had written that Pakistan was expected to launch Foreign Assets tax Amnesty Scheme with rates from 2-7% and flows expected in the next 2 fiscal years given that this scheme had been pent up for a while.
• The announced scheme is different from previous schemes announced in last 10 years as this is the first time that a tax amnesty on foreign assets has been given. Further, it looks similar to 1999 tax amnesty scheme announced by the Govt. of Musharraf. It is more liberal than initial expectations as it not only allows legalization of foreign assets but also local assets, which could be channelized to equity markets.
• We expect that US$2-3bn could potentially be earned from such a tax amnesty scheme, more than half of which could come from local assets (local dollar holdings and US$6.2bn in foreign currency accounts), while the remainder could be repatriated from abroad.
• We believe that announcement of dollar linked bond seems very lucrative for Pakistanis holding foreign currency as they can earn 3% return on these bonds and can also benefit from currency devaluation. Foreign currency account holders currently earn a very nominal return in local banking deposits.
• The negative impact of around Rs100bn (0.3% of GDP) from reduction in tax rates on income of individuals is expected to be compensated by higher amount of tax collected from declared wealth post amnesty scheme. The Govt. may also announce other revenue measures in the upcoming budget later this month.
• The Govt. can potentially earn around Rs300bn (1.0% of GDP) assuming up to US$70bn (foreign assets US$25bn, local assets US$45bn) is declared under the amnesty scheme. In a similar scheme on local assets in the year 2000, the Govt. earned Rs10bn in tax revenue.
• The amnesty scheme is expected to alleviate pressure on foreign exchange reserves, which fell to US$11.6bn (3-Year low) as of Mar 30, 2018. Also, one time additional tax revenues should ease pressure on fiscal deficit, which will lower our estimate of 5.8% for FY18 (in line with last year).
• Equity markets are expected to react positively to the announcement of this amnesty scheme due to both expectations of foreign inflows as well as local amnesty that can potentially lead to increased declared liquidity for local equity markets in the months to come.
• We are maintaining our index target of 50,000 pts for Dec 2018 and believe that the market will likely trade in the PE range of 8.5-9.0x, as mentioned in our Dec 2017 strategy report. Market is currently trading at 2019F PE of 8.5x, based on our sample companies.
• Key risk to the announced tax reform package will be its timely and smooth implementation where it could potentially face opposition.
• Details of yesterday evening’s announcement on tax reforms is as follows:
• Foreign Assets* (One time and valid till Jun 30, 2018): 1) 2% tax on FX sent from abroad, either converted in Rupees or through purchase of Dollar Bonds; 2) 2% on undeclared money lying in local dollar accounts; 3) 3% on foreign assets declared but not brought back to Pakistan (valued at market price and not less than cost of acquisition) and 4) 5% tax on foreign liquid assets like bank accounts declared and not brought back.
• Local Assets* (One time and valid till Jun 30, 2018): Undeclared local asset or income to be taxed at the rate of 5%.
• Reduction in Tax Rates (effective from Jul 1, 2018): Tax rates on individuals have been substantially reduced. Income of Rs100,000/month is tax exempt. Maximum rate of tax on annual income exceeding Rs4.8mn to be 15%. Current maximum tax rate on income is up to 30%.
• Real Estate (effective from Jul 1, 2018): Adjustable tax on immovable property at the rate of 1% (previously 3%). Govt. will have the pre-emptive right to acquire such property at twice the declared value during FY19 to curb under declaration.