Monetary and Capital Market Exclusive, March 2004

Monetary and Capital Market in Iran

Tax in the Capital Market

We must come up with a clear definition for investment companies that are major players in the scene.

Issa Shahsavar Khojasteh, Deputy Minister of Economic Affairs and Finance

The relationship between tax and the capital market is sophisticated, yet delicate. Each has immediate effects on the other, but not everyone can predict what those effects will be. To determine the true nature of the link between these two concepts, namely taxes and the capital market, we realized no man would be better suited than Issa Shahsavar Khojasteh, who is the Deputy Minister of Economic Affairs and Finance and head of Iran Tax Organization. His unique combination of information and expertise on the subject give an insightful analysis on the matter, as can be seen from his following interview.

Until now observers believed that the capital market was controlled by the Central Bank of Iran (CBI) and argued for the separation of the capital market from the Central Bank. The related bill has been ratified by Majlis. What impact do you think the division of the capital and stock markets would have on the Iranian economy?

I personally advocate separation of stock market from the capital market as such a division would pave the way for more growth of capital. Naturally, if management of the stock market were delegated to the Central Bank, the stock market would dominate the capital market and I support this. Of course, Iran’s capital market Iran is not a developed market and its volume compared to gross domestic production (GDP) is meager. The circulating capitals in the Iranian capital market are much lower than similar countries.

However, during recent years we have witnessed a suitable growth in the capital market and this growth continues. The capital market should further grow in efficiency and more companies should be accepted. At present, there are only four kinds of instruments in our capital market: stocks, bonds, participation bonds and forex certificates. There are various kinds of instruments in foreign capital markets, but they have not been defined in our securities and bourse laws. On the other hand, the laws controlling capital market should change and be upgraded. We have many flaws in this regard. The law should both define major players at the capital market and make their behaviors more orderly. At present and in the absence of such laws anything would be permissible.

We must come up with a clear definition for investment companies that are major players in the scene. Their activities should be carried out within legal frameworks and they should avail of legal supports as well. We have problems with the executives too. Of course, the Ministry of Economic Affairs and Finance has taken effective steps to solve these problems.

How do you define the relationship between tax organization and the capital market?

Perhaps we better say the relationship of the tax system because the tax organization has no specific relationship with the capital market. When the tax law was being amended by the Majlis we projected mechanisms for supporting both the capital market and companies whose stocks were accepted in the market as this was necessary for developing production and industrial activities that required investments. One of the problems faced by production and industrial companies is finance at the high interest rate offered by the domestic banking system. If companies whose stocks are accepted in the stock market were active, the value of their stocks would naturally rise and even exceed their actual price; a phenomenon known as stock exchange.

We projected that if such companies needed finance, they could sell their stock according to predicted stock exchange rate. The difference between nominal value of those stocks and the real value sold at the capital market only include 0.5% tax under Article 143 and no other tax would be exacted. This would be a great prerogative for financing such companies. The note that has been inserted in the current year’s budget bill, has proposed that tax exacted on the sold stocks should change from 0.5% to 2% for legal and real entities. Therefore, the sector will not come to harm and companies whose stocks have been accepted in the bourse could take advantage of this prerogative.

Investment companies would pay no tax on profit for the stocks that belong to them, in addition to the routine tax which is being taken from them. Companies that accept investment would have to pay taxes while investor companies would pay no tax. This has both made computations easier and has increased trust in companies. Another issue is that companies whose stocks have been accepted could avail of a 10% tax discount.

What is the argument of the opposing group that is against your proposed facilities? They say there are no such taxes in other countries.

When we want to use experiences of other countries, in addition to paying attention to those experiences that pave the way for a scientific analysis, we must also consider the experiences of our own country. Our capital market is a special market. The stock index has reached from 5,000 to 10,000 in the market; in other words stock output is about 97%. During the nine months of the current Iranian year (started March 2003), based on what I have heard from the esteemed Secretary General of Tehran Stock Exchange, the output has reached 107%. However, the market lacks efficient legal frameworks to assure positive performance of an efficient capital market.

At present, the share of executives is much higher than the government’s share. There is no such thing in other parts of the world. We only exact 0.5% tax from stock sellers while the executives take 0.5% from purchasers and 0.5% from sellers. Why should the share of executives be as high as the government? What we can do is to establish tax justice. All those active in economic fields must avail of a balanced income tax in relation to the activity that they carry out. At present, the profits of stock deals is reaped by people who are active in the market which is sometimes less than the 0.5% projected by law. It is true that the proposed tax would be exacted on sales price, but when you consider stock output as mentioned before, if the output in capital rate were 100%, the tax would be exactly the same. If the profit reaped by stock sellers during a whole fiscal year is about 25% of the sales price, after exacting a 2% tax, the profit tax exacted in a whole fiscal year would be 8%.

If somebody sells 40 million tomans stocks to reap a 5% profit, we would consider his tax share at 800,000 tomans and he would be obliged to pay no other tax. If you compare this 8% tax with 25% tax exacted on companies you would accept that the stock market is more attractive. Of course, the value of some stocks may fall, but every financial market in the world entails risks. I don’t know what the current regulations in the United States are, but until 8-9 years ago virtual funds in that country were exempt from tax provided they distributed the profit among the stockholders.

Those who speculate on dealings in the market, generally quote a high tax rate. If you sell stocks within two or three months, the tax rate would be different from when you sell them in six months. We have also aimed to adopt policies or make decisions after consulting experts. We aim to establish tax justice and take suitable taxes from economic activists.