AKD Quotidian about — Pakistan Market: Reduced tax rate on the cards?

Karachi: According to recent news reports, the FBR has proposed a reduction in corporate income tax rate to 30% from 35% at present.

According to AKD Securities, this is in line with countries like US, Canada, UK and Australia that have called for lower corporate tax rates. From a macro vantage, while 8MFY12P revenue collection of PkR1,122bn is up a robust 28%YoY, continuing expense slippages entail the FY12 fiscal deficit is likely to cross 6.6% of GDP. Within this context, it appears unlikely that corporate income tax rate will be unilaterally reduced i.e. without any accompanied broadening in the tax base/RGST implementation. In this regard however, the FBR reportedly believes that a reduction in tax rate will improve compliance and result in a net positive effect on revenue mobilization over the medium to longer term. If the corporate tax rate is reduced to 30%, estimated earnings impact on the AKD Universe would be -72%. Together with CGT reform/strong corporate profitability, this could serve as a key rerating trigger at the KSE. Nevertheless AKD Securities would attach a low probability to implementation while AKD Securities does not rule out renewed calls for sustained/higher tax rate on Banks in the run-up to Budget announcement.

Can Pakistan afford lower tax rates? FBR has reportedly proposed a reduction in corporate income tax rate by 5% to 30%. Earlier news reports had indicated that tax rate could be reduced to 32%-33% in the first phase, to be gradually brought down to 30%. In this regard, FBR believes that Pakistan’s tax system requires simplification and rationalization which will in turn increase corporate earnings growth. According to a study by economists Young Lee and Roger H. Gordon it was found that “cutting the corporate tax rate by 10% can increase the annual growth rate by around 1.1 %.” This will be reflected by 1) higher investment from domestic sources as well as FDI, 2) increased competitiveness by lowering cost of doing business, 3) higher wages and improved living standards and 4) lower corporate debt as debt payments reduce tax burden. While reduced corporate tax rates would likely pinch the state’s finances in the near term (the FY12 fiscal deficit is projected to exceed 6.6% of GDP), there is a case for a net positive impact from a medium to longer term perspective.

Investment Perspective: At less than 10%, the Tax-to-GDP ratio in Pakistan is one of the lowest in the region. In AKD Securities’ view, tax reforms are an essential prerequisite for sustainable long-term growth where any move to reduce corporate tax rate may be accompanied by measures to broaden the tax base (including GST reforms) AKD Securities estimates that a 5% reduction in corporate tax rate would increase profits for the AKD Universe by ~7.2% that may also lead to a pickup in dividend payouts. While AKD Securities conservatively attach a low implementation probability (considering robust CY11 profit growth, Banks may yet face calls for a higher tax rate), this could unlock further upside at the KSE where valuations (forward P/E of 7.0x and D/Y of 7.5%) still remain the lowest in the region despite 18.5%CYTD gains.

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