Impact of capital gains tax on quoted shares

By C. Samaranayake
The Colombo Stock Exchange (CSE) has so far come up a long way in terms of share price indices and market capitalization during the last three decades. The market has directly contributed to the economic growth of the country and assisted all sectors of the economy, viz., manufacturing, leisure, food and beverage, power and energy, exports, plantations, real estate, banking and finance, services, etc. The Colombo bourse started the development stage in the early 90s and has not looked back despite the periodic downward trends due to no fault of theirs.

As explained in my previous article dated March 14 this year, the Colombo stock market is subject to many internal and external economic shocks from time to time. It is the prime duty of all concerned parties, namely, the quoted companies, brokers, investment advisors, market research personnel and the investors to rally round and present their own proposals to the CSE for long-term stability and vision for a sustained growth of the market. 

The CSE needs to consider specific proposals that would benefit all stakeholders, including the state, and discuss remedial action with the state officials and policymakers and implement such proposals without any delay. The stabilization of the market is the key factor to attract both local and foreign funds.
 

Value-addition measures 
To the credit of the stock exchange officials both present and past, they have implemented many value-addition measures under volatile market situations in the past. Some of which are the location of the offices at the World Trade Centre (WTC), introduction of Central Depository System, automated share trading, improved investor services, mega promotions in Sri Lanka and abroad and beefing up surveillance mechanisms. These measures resulted in more listings in the market and the expansion of the investor base.

These developments assisted our economy with more Initial Public Offerings (IPOs) providing long-term capital for both relatively new and old established companies, provision of direct and indirect employment to a large number, contributions to state revenue by way of taxes, boosting the country image overseas, higher real estate prices, technological advances in the private sector, strengthening of the banking and finance sectors, etc.

The new investment culture also brought about an upliftment of social and living standards of the public and assisted in suppressing youth and public unrest by the provision of income avenues through share trading. At present, even the lower grades of employees in both the public and private sectors, housewives, senior citizens and even the school leavers generate monetary gains on a smaller scale regularly to meet their basic needs such as household expenses, meeting of utility bills, medication, higher education and other daily and monthly needs. 

Some even contribute to religious and charitable institutions and purposes out of market gains. Almost all listed companies carry out corporate social responsibility (CSR) activities on a yearly basis. The expenses are met out of internally generated profits. Therefore, it is vital for them to ensure the maintenance of profitability at stable levels to sustain their regular CSR projects. It is the country that will gain by assisting the stock market in their bid to ensure a sound corporate culture in the country and the improvement of the most vital aspect of human resource development.
The listed companies are required to furnish quarterly financial statements and the annual audited accounts within a stipulated period of time for the benefit of investors and also as a measure of statutory compliance. Quoted company management announcements, dividend/rights/bonus issue declarations, solvency declarations are also informed in writing by all listed companies whenever applicable. These compliance measures leave very little room for malpractices and frauds especially the income tax evasion aspect.

At the same time, these measures safeguard the job security of all employees and also offer opportunities for whistle blowing by any aggrieved section of workers or management pointing out any irregularities in the management.
 

Market plunges 
The market took plunges from time to time especially during the Janatha Vimukthi Peramuina (JVP) insurgency times, north-east war times, airport attack in 2001, after every major bomb attack in Colombo and other major towns, times of political assassinations, after the tsunami, at times of power interruptions and also due to regular elections in the country and at times of political regime changes. The CSE weathered all obstacles and are standing tall. 

The All Share Price Index (ASPI) reached a peak of 1378 points in March 1994 during the last few months of United National Party (UNP) rule from 1977. The ASPI reached a level of 7800 plus in the not too distant past reflecting a near sixfold increase. The liquidity of the market also improved over the years. 

Earlier, it was the retailers who dominated the market. However, the scenario changed with the local and foreign institutional funds entering the market bidding for strategic parcels and stakes. Active participation of high-net-worth individuals – resident both in Sri Lanka and overseas – was also a contributory factor for changing the shape of market platform.

The recent market falls were very much beyond the control of the stock exchange authorities. The market falls were triggered by the slowing down of Chinese and European economies, international currency devaluations and the lowering of our country ratings and the speculation over the introduction of capital gains tax to augment tax revenue.

I recently read an article on the Bangladesh Bank heist and learnt that their official foreign reserves stand at US $ 28 billion. One wonders why our foreign reserves are at a low level. In the mid 70s, Bangladesh was among the handful of the poorest countries in the world and their literacy levels are below than that of Sri Lanka even now.

If not for the rigid time frames for submission of quarterly accounts and annual audited accounts set by the stock exchange for listed companies, the collection of taxes would have taken a further back seat. Effectively, the CSE has filled in the role of a tax collector as well for successive governments. The annual income tax returns were forwarded in time by almost all quoted companies who are not in the default board.

Talking about the senior citizens of our country again, they were able to get a higher return for their savings better than the rates offered by the banks and finance companies, sometimes by many a times and they did not depend on their children and relations for a decent and dignified lifestyle and a stable standard of living. They even found money for their occasional vacations.
The share trading activities in the CSE was subject to a turnover tax a few years back and both the stock exchange and the investors took it with a smile and contributed to national coffers. This way a daily sizable tax revenue was generated by the state through the CSE.
 

Negative consequences 
Any capital gains tax on quoted share dealings will result in the following negative consequences.
1    Drop in daily turnover
2    Exit of local and foreign investors from the market
3    Lower volumes of turnover tax based on bourse turnover
4    Drastic drops in indices
5    Absence of bonus and rights issues
6    Drop in market capitalization
7    Holding of expansion drives due to lack of fresh capital
8    Delistings from the market
9    Inability to create more private sector jobs
10 Flow of foreign institutional funds to overseas markets with no capital gains tax and lower transaction costs
11 Net foreign outflows from the market burdening the rupee further
A new additional tax collection mechanism will be the need of the hour. I recommend a six-pronged strategy to augment state revenue. The tax collection process should be monitored and administered under a system of public/private partnership. The proposed strategies are:
1    Collection of more taxes outside Colombo
2    Collection of more taxes from economically unproductive income sources
3    Collection of more taxes at source on hitherto untapped income avenues
4    Taxing locals on remittances abroad for acquisition of products and services readily available in Sri Lanka at a lower cost and of high quality
5    Introduction of more provincial council, municipal council and local authority taxes to at least balance their budgets without burdening the treasury. In the alternative, these institutions be required to curtail costs especially the expenses which are of discretionary nature
6    Heavy fines for all illegal offences at airports and sea ports and also for acts such as human and drug trafficking, motor traffic offences, etc. It will force the public to desist from carrying out such acts.
It is the residents of the Western Province who bear a major portion of taxes, especially the residents of Colombo. Beefing up of regional Inland Revenue offices with improved technology and information systems is of paramount importance. There should also be a system to monitor collection of daily tax revenue. The government can easily make use of senior tax professionals in the country for this purpose.

We must also remember that almost all listed companies follow good governance measures at all times barring a few, who are placed in the default board. The CSE could be tagged as the best corporate governance institution in Sri Lanka which promotes a strong corporate culture throughout the year. It is my wish to see more and more companies being listed on the Colombo bourse to ensure economic prosperity and growth of our country.

Every successive government emphasized that the private sector is the engine of growth in the country. However, we have to oil and maintain this engine at regular intervals as a measure of preventive maintenance to avoid the breaking down of this engine.
Before the imposition of any capital gains or other additional taxes on the Colombo bourse, it would be a worthwhile exercise to consider the existence of similar taxes in other regional and major markets especially in the South Asian Association for Regional Cooperation (SAARC) and Association of Southeast Asian Nations (ASEAN) regions. In order to stem the flow of funds from our market into other foreign markets, all investors hope to realize a return over and above the rates of return expected from investing in other avenues.

The Colombo bourse received a large number of hard punches in the past three decades and may be eventually subjected to the ‘Parkinson disease’ if this trend is not averted. The stock exchange officials held regular road shows, seminars and other promotions in major overseas capitals to attract foreign capital to the bourse. Any additional taxes will nullify their efforts in promoting Sri Lanka as an 
investment hub.

(C. Samaranayake, a senior finance professional, portfolio consultant and a corporate trainer with over three decades of experience both in Sri Lanka and overseas, could be contacted via [email protected])