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What is Capital Gain Tax and How it Work?

What is Capital Gain Tax and How it Work?

Introduction

In Pakistan, as they have done in many other countries, the taxpayer earns money in many ways and they pay the tax under the rules and regulations of the country, on the profit made through the assets selling also. The tax charged on such sales is referred to as Capital gain tax (CGT) and only aims at any income arising from the sale of other assets like property, stocks, and bonds among others. With the gradual evolution of the economy of Pakistan, it becomes of paramount importance to know how CGT has been working with people involved in the purchase and selling of assets in one way or the other whether for personal or business use. In this blog, we will explain what CGT is in Pakistan, how it is computed, and how you can minimize or deal with it properly.

What is Capital Gain Tax (CGT) in Pakistan?

CGT in Pakistan is faced on the profit or gain accruing on the disposal of a capital asset that may consist of real estate or shares that have appreciated in value over time. The tax is only if the asset is sold for a higher price than what was paid for the product initially (cost recovery amount). CGT is controlled under the provision of Income Tax Ordinance 2001 It is one type of huge revenue resource of government.

For a CGT and the manner in which it is computed The rate of CGT, and the manner in which computations are arrived at are dependent on certain factors such as the type of the asset that is being sold and the holding period that a person has held the asset.

Types of Capital Gains in Pakistan

Capital gains in Pakistan can broadly be divided into two categories based on the holding period of the asset:

Short-Term Capital Gains

In the context of taxation, these gains resulting from the sale of property that has been held for less than one year are referred to as short-term capital gains. However, in Pakistan, these gains carry a higher tax rate as compared to long-term gains. Usually, short-term capital gains attract tax rates between 15% – 30% depending on the kind of capital assets sold.

Long-Term Capital Gains

Long-term capital gains are gains achieved on the sale of fixed assets that have been held by an entity for 12 months or more. Capital gains tax is usually lower than those of income tax: long-term CGT is lower than short-term gains tax. The tax rates can be as low as zero and as high as fifteen percent depending on the asset and with variations for special cases in its tax liability by type of the asset.

How Capital Gain Tax Works in Pakistan

In Pakistan, the capital gain tax on property is determined by the revenue obtained from the sale of such assets. Profits can be computed in various ways depending on the conception applied but taking into consideration the cost base such as the price for which the asset was purchased plus other costs that may include the maintenance and improvement costs and the selling price which means merely the price at which the asset was sold.

Determining the Cost Basis

The cost basis includes:

  • The market cost of the asset at the date of acquisition. 
  • Any other costs occurring during the purchase or sale stage including registration fees, legal fees, and charges for the broker(s).
  • Restorative and preventative costs that add value to the asset (for example, restoration costs for properties).

Calculating the Capital Gain

After establishing the cost base, the spread is arrived at by subtracting the cost base from the sale price to get the capital gain.

Capital Gain = Sale Price – Cost Basis

For instance, if you purchase property for Rs. 2,00,000 only and sell it for Rs. 3,00,000 then capital gains arc Rs. 1,00,000.

Applying the Tax Rate

After calculating the capital gain, the tax rate will be applied according to the length of time the asset was held:

  • Short-Term Capital Gains: If the asset was held for less than 12 months, some or all of this gain will be subject to higher taxation (up to 30% on property depending on the asset.
  • Long-Term Capital Gains: Realized from the disposition of an asset held for more than 1 year the tax rates are usually lower, starting from 0% up to 15%.

Capital Gain Tax on Different Class of Assets

Real Estate (Property)

In Pakistan, there are special rules applicable to the capital gains made from the property. The specific rate for such property is 15 percent of the gain if the property was held for a year or less. However, for the property being held for more the 1 year the tax rate applicable is ten percent. Assets that are disposed of for more than five years could be exempted from capital gain tax section when he disposes of a property for the first time after owning the property for at least five years.

Stocks and Securities

Income earned by selling the stocks traded under the Pakistan Stock Exchange (PSX) also has less chance of being taxed as compared to income from real estate. In case the shares are sold within one year from the date of purchase, the tax is charged at 15% of the profit earned. On the other hand, if the shares are sold after 1 year, tax is charged at 0% on long-term gains.

Other Assets

For other assets such as bonds, gold, and other financial instruments; the CGT rate will depend on the type of asset, the holding period for the asset, and the tax law in force at the time of realization.

Exemptions and Deductions in Capital Gain Tax

Pakistan’s tax laws provide certain exemptions and deductions that can reduce the CGT or property gain tax burden:

Primary Residence Exemption

Occasionally the sale of the main home is not subject to CGT and this would depend on some conditions fulfilled. For example, where the property has been the seller’s home for some length of time the seller might be entitled to some sort of capital gains exemption.

Tax-Free Gains from Listed Shares

Any gain arising from the sale or other disposal of listed stocks or shares therefore attracts no CGT provided the shares are held for a minimum of twelve months.

Tax-Loss Harvesting

An example of an investment loss refers to a capital loss which is an instance when you sell an asset at less than cost and you can use this loss, to reduce your taxes on capital gains on other assets, for instance, when you have sold an asset at a higher price.

Capital Gain Tax Calculation Example

Let’s take a simple example to see how CGT works in Pakistan:

  • You invested in the purchase of a plot of land for Rs 2,500000.
  • When they spend 2 years, they sell at Rs. 4,000,000 and make a profit of Rs. 1,500,000.
  • If the property was held for more than 1 year, then the CGT rate would be 10%-rate for collecting the tax.
  • The tax payable would be:
  • Gain Tax = 1,500,000 × 10% = 150,000.

Tactics on Mitigating CGT on Property in Pakistan

While CGT is inevitable, there are several strategies to reduce its impact:

Hold Assets Long-Term

Everyone invests in physical assets like Real estate and stocks so that they be protected from lower taxes most especially on items that have been referred to as long-term capital gains.

Use Tax-Advantaged Accounts

Most people would prefer to pay low taxes on capital gains and this can be achieved by investing through the current tax-friendly instruments. For example, employment pension funds or investment products that provide for tax favorable products delay taxes.

Offset Gains with Losses

Even in other trading structures, you may have losses for other investments, well they are allowed to be used to minimize taxable income through offsetting against capital gains realized.

Conclusion

Explore: Understanding Section 153 Income Tax Ordinance

This blog focuses on the capital gain tax in Pakistan, especially for persons who engage in the sale of capital assets. Whether you are selling a property, shares, or other investments learning how capital tax gain works will assist you in making the correct decisions so that you can pay as little tax as possible. 

The following are common ways that help you manage the effects of capital gain tax: The holding period of assets, losses, and gains, and the exemptions specifically used in minimizing the payment of tax.

You can visit PK TAX CALCULATIOR website and use Capital Gains Tax Calculator or you should always consult a tax advisor chartered accountant or any other senior person in your tax department based in Pakistan to ensure maximum compliance with the latest tax laws.