In April, the Executive Board of the International Monetary Fund completed the second review under the Stand-By Arrangement for Pakistan, allowing for an immediate disbursement of SDR 828 million (around $1.1 billion), bringing total disbursements under the arrangement to SDR 2.250 billion (about $3 billion). Subsequently, they reached a staff-level agreement with the Pakistani authorities.

They also requested Pakistan’s Federal Board of Revenue to raise taxes on the real estate sector and eliminate the special tax regime for construction.

The fixed tax scheme for the construction sector had been announced and enacted via the Finance Act of 2020. This fixed tax scheme is applicable to builders and developers, who opt for the scheme by registering their projects with the FBR. The tax payable by builders and developers under this scheme is based on their income. Profits and gains emanating from the sale of buildings or plots are determined on a project-by-project basis on the basis of specified rates per square foot/ per square yard for commercial and residential buildings and commercial, residential and industrial plots. Under this package, provisions of Section 111 on unexplained income source of the Income Tax Ordinance, 2001, were also rendered inapplicable on capital investments on land and cash if the cash investment was deposited in a new bank account on or before December 31, 2020, and if the investor had legal ownership title of the land at the time of promulgation of this scheme.

Moreover, with the last year’s budget the government had decided to provide 10 percent or Rs 5 million tax relief on the business income of builders for the next three years. Individuals were to be provided 10 percent or Rs 1 million tax relief for the next three years. The tax relief was to apply to projects starting after July 1, 2023. The government had also proposed ending the tax on overseas Pakistanis and relieving construction materials taxes as well as to declare Gwadar a Tax-free zone.

However, at the time of their introduction, both these tax reliefs were met with criticism and resistance by the IMF and the Financial Action Task Force. Hence, it is no surprise that the IMF is asking for these schemes to be scrapped. If authorities eliminate the current tax schemes in the upcoming financial budget, it could have significant impact on the construction sector and subsequently the real estate sector.

The construction sector has been a significant driver of economic activity in Pakistan, not just in construction but also in allied industries like cement and steel. Removing tax benefits could lead to reduced construction activity, impacting the related sectors and possibly leading to job losses.

By implementing higher taxes on real estate and scrapping special incentives for construction, Pakistan is expected to see an increase in revenue collection, which is essential under the conditions of the $3 billion bailout package from the IMF. However, this could also lead to a slowdown in the real estate market, as higher taxes may deter investment and reduce speculative buying, potentially stabilising prices but also dampening the growth of the sector. Higher taxes, particularly on capital gains from real estate, will likely decrease speculative investment. Investors who previously benefitted from low tax rates might find the new tax regime less attractive, potentially leading to a halt in rapid price inflation within the real estate market.

The construction sector has been a significant driver of economic activity in Pakistan, not just in construction but also in allied industries like cement and steel. Removing tax benefits could lead to reduced construction activity, impacting these related sectors and possibly leading to job losses. The scrapping of the special tax regime for the construction sector may reduce the financial incentives for launching new projects. Developers often rely on tax incentives to offset the high costs of construction and development, particularly in urban areas. Without these incentives, some projects may become financially unviable, leading to a slowdown in new developments.

Collectively, for the real estate and construction sectors, a raise in taxes could lead to higher capital costs. Developers and real estate investors often rely on debt financing to fund projects. Increased taxes can reduce net profits, making it more difficult to service debt and potentially leading to higher borrowing costs as lenders adjust to the increased risk. Potential home buyers might become more cautious due to the anticipated rise in property taxes. This could lead to a decrease in demand, particularly at the higher end of the market, where the tax increases would be most felt. Over time, this could result in a market correction with more stable prices, but initially, it might lead to diminishing sales volumes.

A downturn in construction activity could have a ripple effect, impacting the related sectors and potentially leading to job losses and decreased economic activity in these areas.

Potential budget adjustments due to IMF’s demands, while aimed at improving fiscal stability and meeting IMF requirements, necessitate careful planning to mitigate adverse effects on the real estate and construction sectors, which are significant contributors to Pakistan’s GDP.

The writer is the CEO at ZAK Casa and Verde as well as a managing partner at a law firm, namely Lex Mercatoria