World Bank suggests countrywide property survey

[Naveed Yaseen]

ISLAMABAD (September 09 2009): The World Bank (WB) has suggested to the provincial governments to carry out survey of all kinds of properties to effectively tackle the issue of under-valuation of property across the country. The WB in its recently issued 'Pakistan Tax Policy Report' has elaborated comprehensive guidelines for provincial governments to improve valuation system of property.

According to the WB, survey of property is needed so that a full cadastre is available for compiling the tax roll. All declared transfer values should be verified from the independent valuations carried out by the board of revenue (BOR). There is also need to increase the staff of qualified property assessors used in updating the tax roll and in making the assessments.

If the goal is to subject all property transfers, or even all suspect declarations to desk and possibly field verification, a significant (and costly) increase in staff will be called for. The WB also suggested to chalk out a method of valuation for development of appropriate procedural manual.

Given the present state of valuation in the two provinces, this method will likely involve making use of a combination of expert judgement and objective information (eg realtor opinions) and the valuation data established in urban areas for urban immovable property tax (UIPT).

There is also need to carry out regular sales assessment ratio studies to monitor valuations and to update the valuation tables in both urban and rural areas. This could be done by the increased staff, and with the use of expert opinions.

Moreover, there is a need to enact a substantial surcharge on tax due in the case of declarations that are found to be well below market levels based on independent valuation. A potential check on valuation might be made by co-ordination with the valuations placed on urban properties by the excise tax department for purposes of UIPT. At present, there is no such co-ordination, the WB added.

The WB said that a crucial element to any sustainable reform is to improve the method of valuing property transactions so as to better approximate true market value. There are a number of necessary actions that must be taken to eliminate or at least reduce the gap between assessed and market value.

In addition, simplification in the tax structure should be sought, especially given the limited administrative capacity of the provincial government. An obvious change is to collapse the three different provincial property transfer taxes into one levy. This would simplify the tax regime and make it more transparent and manageable.

While there is reliable sales-ratio studies available to estimate the revenue impact of better valuation, anecdotal evidence suggests that a 50 percent under-valuation of transferred property might be a reasonable, even though perhaps conservative, estimate. In this case, a 15 percent increase in taxable values, and tax collections, would be well within the reach of provincial governments if they chose to make the necessary administrative improvements.

A more comprehensive reform of the taxation of the rural sector might pull back from taxing property transfers altogether. The rationale for this proposition is straightforward. Provincial taxes might be seen as a payment for public services received.

It seems more reasonable to extract this payment yearly rather than at the time of a transfer. Moreover, there might be some administrative economies since UIPT and the agricultural income tax are annual taxes, and since a cadastral survey is required in any case. The present regime of taxing only transfers could be replaced with an annual tax on land in rural areas, perhaps imposed as a presumptive income tax on rural land.

The umbrella for this new tax would be the agricultural income tax in the case of lands used for agricultural purposes, as discussed further in the next section. For rural lands not used in farming, it would be a tax on annual rental value at highest use. Valuation would be carried out following the steps noted. Urban land would continue to be taxed under the UIPT.

The WB further suggested that the restructuring could be done in three steps. First, the mutation fee, registration fee and stamp duty on property transfers would be combined into a single land tax, levied on the basis of the market value of land.

The rate would be set according to revenue considerations. Second, in order to move to a unified annual tax, it will be necessary to prepare a cadastre showing the ownership and physical characteristics of every parcel. After this, a valuation table would be prepared for the province, and updated on a periodic basis.

The revenue unified from a unified annual tax on urban and rural property will depend on the nominal tax rate that is chosen. The elasticity will depend on the accuracy and timelines of revaluation and the indexation of property values. A unified, annual land tax with "reasonable" rates and proper valuation could easily more than double rural land tax revenues, the WB said.

A capital gains tax on land could be introduced in addition to the annual land tax. The tax liability would be taken on the difference between the buying and selling price of the property, indexed for inflation. The buying price would be set according to historical records of purchase price.

Owners could petition to have this base increased. The selling price would be verified by the valuation staff in the capital gains tax office. The nominal gain would be adjusted for inflation and for the cost of allowable improvements to the property (eg irrigation). A major drawback is administration, especially establishing the basis for a capital gains tax, and developing a method for indexing for inflationary increases and adjusting for qualified investments in real property.

As complicated as these administrative requirements seem, they are not any more daunting than the present requirement of establishing a true market values for every real estate transaction. Once a capital gains tax becomes established, the unified administration would be more efficient at collecting revenues than is the case under the present regime. The incentives for under-declaration of property prices at the time of sale would be lessened. The better flow of information about land prices would help to develop a property market, the WB added.

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