Comprehensive Guide to Section 7E Deemed Income Tax: Implications and Analysis

Introduction:

The implementation of Section 7E is finally taking place. Section 7E focuses on deemed income tax on immovable properties in Pakistan and represents a transformative shift in the country’s tax structure. This section, introduced through the Finance Act 2022, aims to levy tax on the deemed income from capital assets held by taxpayers, fundamentally altering the dynamics of property investment and ownership in Pakistan.

The following comprehensive analysis explores the essence of Section 7E Deemed Income Tax in the following order:

1. Understanding of Section 7E and its applications.
2. The government’s rationale behind this move.
3. Its intended impact on the real estate sector, and the broader implications for the economy and potential investors.
4. Potential challenges.

Understanding Section 7E Deemed Income Tax

Section 7E imposes a tax on the deemed income from capital assets, specifically targeting immovable properties such as land and buildings located in Pakistan.

7E Deemed Income Tax is calculated as 5% of the fair market value (FMV) of these assets, as notified by the Federal Board of Revenue (FBR Values), with this income then subjected to a 20% tax rate. Essentially, this results in a 1% effective tax on the FBR value of the property.

The primary aim is to tax wealth in the form of immovable properties, which might not be generating reportable income, thereby widening the tax net and increasing revenue for the state.

Important Exemptions:

1. 7E Deemed Income Tax Exemption on the house which is used for your personal living.
2. When the FMV (FBR Value) of the property or properties, together, excluding the capital assets stated above, does not exceed Rs. 25 million.
3. A person’s personally owned place of business where they do their business at any time of the year which is registered and actively taxed.
4. Farmhouses and the land they are annexed to are not considered to be self-owned agricultural land for agricultural operations.
5. Capital assets allocated to specific people, including federal and provincial governments, war-injured soldiers serving in the Pakistani military, Shaheeds or families of Shaheeds.
6.  7E Deemed Income Tax Exemptions Income from any property subject to tax under the Ordinance and proof of payment of tax.
7. Acquisition of a capital asset on which advance tax u/s 236K has been paid during the tax year.
8. Property owned by the provincial and municipal governments, or Property owned for land development and construction by a development and local authority, builders, and developers who are registered with the Directorate General of Designated Non-Financial Businesses and Professions Board (DNFBP).

Government’s Rationale and Objectives on 7E Deemed Income Tax

The government’s decision to implement Section 7E Deemed Income Tax is multifaceted, aiming to achieve following:

1. Enhance tax revenue.
2. Stimulate broader economic activity.
3. Targeting undeveloped land and properties not generating taxable rental income.
4. Through this initiative the government intends to discourage speculative investment in real estate, which often leads to unproductive asset hoarding.
5. Encourage investments in sectors that generate employment, innovation, and economic growth.
6. Address the issue of tax evasion among property owners who underreport rental income or claim that their properties are unrented. By imposing a tax based on the FMV of properties, the government aims to ensure a fair and consistent revenue stream from real estate assets, irrespective of their rental status.

Impact of 7E Deemed Income Tax on Property in Pakistan

The introduction of the 7E  Deemed Income Tax is poised to significantly impact property ownership and investment patterns within Pakistan. Property owners, particularly those with large portfolios exceeding the PKR 25 million threshold, now face an additional tax liability based on the FMV of their assets. This move could lead to several outcomes:

1. Selling Pressure on Plots:

   Anticipating the new tax burden, property owners might opt to liquidate their assets, particularly plots and undeveloped land, to avoid the deemed income tax. This could result in increased supply in the property market, potentially leading to price adjustments.

2. Shift Towards Built-up Properties:

   Investors might redirect their focus towards built-up properties, such as houses, apartments, shops, and commercial spaces. These assets not only offer potential rental income but also might be viewed as more viable and productive investments under the new tax regime.

3. Diversification of Investments:

   With the government planning to adjust interest rates, investors are encouraged to diversify their portfolios. Although bank deposits currently offer attractive returns, the anticipated reduction in interest rates may prompt investors to explore other avenues such as stocks, bonds, mutual funds, or direct investment in new businesses. This aligns with the government’s broader objective to stimulate economic activity beyond the real estate sector.

Potential Challenges and Considerations

While the objectives behind Section 7E are clear, the policy is not without its potential drawbacks.

1. One significant concern is the possibility of capital flight; property owners, particularly those with the financial means, may seek investment opportunities abroad, such as in Dubai or other markets perceived as more tax-friendly.
2. Expatriates, might reconsider investing in Pakistan’s real estate market due to the additional tax burden.
3. Moreover, the government’s strategy requires careful calibration to avoid unintended consequences. While encouraging investment in built-up properties and other sectors is desirable, there is a need for robust regulatory frameworks and incentives to ensure that the construction sector and new business ventures offer attractive and viable alternatives for investors.

Moving Forward: Balancing Taxation with Growth

To mitigate the potential negative impacts of Section 7E Deemed Income Tax and achieve its intended benefits, the government must adopt a cautious yet proactive approach. This includes:

1. Regulating the Construction Sector:

   Enhancing transparency, efficiency, and investor protection in the real estate sector can make built-up properties more attractive to investors, balancing the shift away from speculative land investments.

1. Creating Investment Opportunities:

   Developing policies that foster new business opportunities within Pakistan is crucial. This could involve tax incentives for startups, investment in infrastructure, and support for sectors with high growth potential.

2. Monitoring and Adjustment:

   The government should closely monitor the impact of Section 7E on the real estate market and the broader economy, ready to adjust the policy as needed to ensure it achieves its objectives without causing undue harm.

Shahnawaz Yaqub Bhatti

Investment Consultant and CEO Imlaak.com

+92 333 1616160

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