KARACHI: The government unveiled its third budget with an outlay of Rs4,451billion (+3.5% YoY), aligned towards (1) growth and (2) containment of fiscal deficit. Encouragingly, government announced measures to promote growth (FY16 GDP growth target of 5.5% vs. FY15E GDP growth of 4.24%), where development budget has been jacked up to Rs1,513 billion. Federal PSDP component of the development budget has been set 29% YoY higher at Rs700billion vs. revised FY15 PSDP allocation of Rs542billion. Measures have also been announced to promote construction, energy and agriculture sectors. In order to achieve the targeted growth, government eyes 3.9% growth in agriculture, 6.4% growth in industry and 5.7% growth in services. Meanwhile, measures (higher tax on capital gains and dividend income of banks, promotion of housing credit etc.) have been taken to facilitate credit offtake to support government’s growth plan. In line with larger belief, government also introduced/hiked taxes on certain sectors to contain fiscal deficit. Government intends to bring fiscal deficit down to 4.3% in FY16 from 5% in FY15.

KSE vantage point:

From the market’s vantage point, the budget announcement was largely negative. Government hiked Capital Gains Tax (CGT) rate to 15.0% from 12.5% on holdings less than one year and to 12.5% from 10% on holdings greater than one year but less than two years. Government has also introduced a new tax slab, where CGT of 7.5% will be charged on holdings greater than two years but less than four years. Moreover, the government has also proposed to increase tax on dividends to 12.5% from 10% for filers and to 17.5% from 15% for non-filers (5% shall continue to remain adjustable). For Mutual Funds the existing rate of 10% shall continue.

On the positive front though, it has been proposed to impose tax on companies not distributing dividends. Other than a scheduled bank or a modaraba, companies which do not distribute cash dividends within six months at the end of the said income year or distributes dividends to such an extent that its reserves, after such distribution, are in excess of hundred percent of its paid up capital, the excess amount may be taxed at the rate of 10%. We believe, this will either raise cash payouts of such companies or speed up expansion plans (energy companies, particularly PSO, OGDC can see higher payouts). That said it can turn counterproductive as companies may prefer to take a tax hit than payout higher cash dividends. Moreover, in line with expectations government cut corporate tax rate by 1% to 32%.

Sector specifically, heavy-weight banking sector is likely to take a significant hit. It has been proposed all sources of income of the banking companies will be charged a flat tax rate of 35% vs. various different tax rates applicable presently. Our back of the envelope working suggests 3-8% impact on banking sector’s profitability, with National Bank of Pakistan (NBP) and Allied Bank Limited (ABL) likely to be affected the most. Please refer to our Morning Briefing titled ‘Banks: Budget may spring up surprises on taxations’ dated June 3, 2015. Moreover, one-time tax of 4.0% will be levied on banking companies for Rehabilitation of Temporarily Displaced Persons (TDPs) vs. 3.0% for all others companies, individuals and association of persons earning more than Rs500mn in tax year 2015.

We are of view that Textiles and Cements have emerged as key gainers. For textiles, (1) EXIM Bank of Pakistan will start operations in FY16 to facilitate exporters, (2) Export refinance rate has been cut to 4.5% from 6.0%, (3) Long Term refinance rate has been cut to 6.0% from 7.5%, (4) benefit of duty drawback of local taxes and levies scheme will remain available for FY16 and (5) customs duty on import of textile machinery will remain zero in FY16 as well, has been proposed among other measures. Moreover, sales tax for export-oriented sectors has been increased to 3%, 3% and 5% vis-a-vis 2%, 3%, and 5% previously; however is better-than-expected flat 5% sales tax. Outstanding tax refunds, relating to tax periods till May 31, 2015, will be cleared by August 31, 2015.

For cements, (1) 29% YoY higher PSDP allocation (though Rs100billion relate to TDPs) and (2) incentives for construction sector including housing credit, suspension of minimum tax on builders, exemption of Sales Tax on bricks and crushed stone and reduction in customs duty on import of construction machinery bodes well. Focus on construction of highways in development plan will favor Attock Petroleum Limited (APL) in our view.

Other key measures include:

  1. Exemption for 4 years for Halal Meat Production Companies
  2. Exemption to Greenfield Projects is extended up to June 30, 2017
  3. Incentives for Aviation Sector, where exemption from customs duty and sales tax is provided; positive for PIA
  4. Five-year income tax holiday on all new manufacturing units set up in KP province between July 1, 2015 and June 30, 2018
  5. Rationalization of sales tax on steel sector melters, re-rollers and ship breakers
  6. Rate of further tax on supllies to unregistered persons is enhanced to 2%
  7. Restricting zero-rating on dairy products to milk only baby formula, negative for Engro Foods
  8. Enhancement of rates of Federal Excise Duty on locally produced cigarettes. Average tax incidence to increase from 58% to 63%
  9. The rate of FED on aerated waters is being enhanced from 9% to 12% of retail price
  10. Exemption to Electricity Transmission Projects for a period of 10 years provided that the project is set up by June, 2018
  11. To encourage saving and investment in new companies quoted on stock exchange the limit for individual investors is being enhanced to Rs1.5mn
  12. At present, a 15% tax credit is available to a company, if it opts for enlistment in any registered stock exchange in Pakistan. To encourage enlisting of companies on stock exchange, the credit is being be enhanced to 20%
  13. Holders of Mutual Funds and dividends are proposed to be subjected to same tax rates.

By Syed Atif Zafar