Super Gains Tax: Even a bad tax should be equitably applied

Monday, 9 February 2015 00:09 -     - {{hitsCtrl.values.hits}}

Much of the criticism levelled against the Super Gains Tax has centred on the soft issue of Finance Minister Ravi Karunanayake implying that every company that made a profit of over Rs. 2,000 million in 2013/14 did so through foul means       Much has been said and written on the Super Gains Tax proposed in the recent mini Budget of Finance Minister Ravi Karunanayake. The Minister identified this one-off tax as a tax on ‘ill-gotten gains’ of companies and individuals. Much of the criticism levelled against this tax has centred on the soft issue of the Minister implying that every company that made a profit of over Rs. 2,000 million in 2013/14 did so through foul means. While this unfortunate and probably unintended political rhetoric will soon fade away, companies will have to deal with the real adverse impacts on cash flows, profit after tax, earnings per share, return on equity, etc., in the 2014/15 financial year for March year end companies and 2015 financial year for December financial year end companies such as banks although the computation of the tax will based on the 2013/14 profit on a basis still to be set out. While the proposed tax has been referred to as a retrospective tax, it is the basis of measurement that is retrospective. The cost will have to be borne prospectively with the present shareholders of these entities bearing the cost. Not a new phenomenon This kind of one-off tax is not a new phenomenon and there are several precedents in the world. In 1980 the USA imposed a windfall profit tax on super profits from domestically produced oil and gas. In 1981 the UK Government led by Margaret Thatcher imposed a special levy on banks that collected about 20% of bank profits in that year. In the year after the UK Treasury cashed in on the high oil prices by imposing a special tax on North Sea oil companies. In 1997 when the Labour Government returned to power in the UK, they targeted the utilities privatised by the Conservatives who were considered to have made ‘excessive’ profit based on the agreed pricing formula. A mechanism was used to compute what this excess was and a 23% tax was imposed on the gain. More recently in 2008 there was a suggestion in the UK to impose a special tax on oil companies benefitting disproportionately from high oil prices and even in the USA in his pre-election campaign President Obama proposed such a tax. These were however not imposed. The most recent instance was the special tax of 50% on high bank bonuses imposed by the UK in 2009 (with France following) after tax payer bailout of banks. In 2013 Ghana proposed a windfall profit tax on mining but has put the plans on hold. One common feature of these levies is that they have been targeted at an industry or a sector and usually where due to market conditions, the profitability (not necessarily the absolute profit) in a particular year has seen a sharp jump compared to the norm. In Sri Lanka too the target has been identified as those who made ‘ill-gotten gains’ but the Minister may have realised that identifying this group is easier said than done and hence the proposal to tax those above the Rs. 2,000 million profit level. Absolute profit as opposed to profitability If we forget the reference to ‘ill gotten’ and use ‘super profit’ as a yardstick (whether or not ill-gotten), the starting point should be to determine those who have made such super profits. An absolute profit number has no meaning when determining this. For instance, if shareholders’ funds in a business is Rs. 2,500 million and the business makes a return of Rs. 2,500 million (ROE of 100%), it is very different to the same profit made by a business with shareholders’ funds at Rs. 25,000 million (ROE of 10%). The Budget proposal thus appears to be one based on the Sri Lankan obsession on absolute profit numbers as opposed to profitability. There have been reports that tax exempt companies will not be subject to this tax. This is necessary to preserve investor confidence in the Government. However, it is necessary to be fair by taxable companies as well. In order to make the proposed tax more equitable for taxable companies, consideration should be given to the following when implementing the proposal whilst of course, without compromising the revenue target. 1.Define a super gain using ROE or some other suitable benchmark. If the target pool needs to be expanded to collect the required revenue, consideration can be given to reducing the PAT threshold and then applying the criteria. 2.Impose the tax on the incremental profit above the threshold and not on the total profit. It would be inequitable if a company that made Rs. 1,900 m profit makes no payment but one that made Rs. 2,001 m being asked to pay Rs. 500 m. 3.Give a concession to those entities that are already subject to the Financial Services VAT. Sri Lanka is probably the only country that imposes such a tax and this is arguably in the nature of an ongoing super gains tax which brings the tax on financial services to above 40%. 4.Avoid double taxation of same income; e.g.: most dividend incomes are derived from after tax profit and a further tax is paid at the point of distribution. One-off and ad hoc taxes are not good but if political and fiscal realities make them necessary, even such bad taxes should be applied in an equitable manner. There lies the problem with the Sri Lanka Budget proposal as it stands.     (Nihal Fonseka retired as the CEO of DFCC Bank in 2013 after a banking career spanning 37 years. He was a former Chairman of the Colombo Stock Exchange and was a member of the 2009 Presidential Commission on Taxation. He currently serves on listed company boards and as a member of the Financial System Stability Consultative Committee of the Central Bank of Sri Lanka.)

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