According to this year’s Budget, GDP growth for 2014-15 stood at 4.24% – the highest since 2007-08, although trailing well below South Asia’s growth as a region. Furthermore, given that interest rates are at their lowest in 42 years and inflation is under control, one would have expected significant economic growth, yet the projection for GDP growth in 2015-16 is limited to 5.5%, possibly because structural impediments, such as energy shortages and security concerns continue to adversely affect the economy.
Looking at the Budget from the perspective of the advertising industry, it is clear that the impact will come from macroeconomic factors, coupled with direct and indirect tax changes. Short term macroeconomic indicators (lower cost of borrowing, moderate inflation and per capita income growth) should spearhead consumer spending. Studies have shown the positive correlation between consumer spending and advertising, if only because companies want to benefit from the increased spending associated with a growing economy and will therefore advertise to attract new customers. However, increased consumer spending also requires investment in capacity and the question is whether companies in Pakistan are ready to do this?
The dilemma for entrepreneurs is whether it is worth their while to set up new industries and then deal with the hassles of extortion, taxation, corruption, weak infrastructure and so on, when they can get a return of 20% or more simply by investing in stocks or property. There are entrepreneurs who are investing in growth, but they are doing so in significantly lesser proportions than what they are capable of. Clearly, building both business and consumer confidence is going to be as important as any change in policy.
In the meantime, until such obstacles to investment are reduced, economic growth will depend on government spending on infrastructure projects such as the Chinese Pakistan Economic Corridor (CPEC). Although these projects tend to increase government debt, they are needed in order to support long-term growth. However, to really reap their benefits, the government must fix inbuilt inefficiencies within the system which result in economic leakages, otherwise Pakistan will be trapped by an unsustainable level of debt with insufficient means of servicing it.
Taxation is another area that will affect the cost of doing business as the government tries to widen the tax net by creating a distinction between the people who file their tax returns and those who don’t, as this will significantly increase the workload of the company’s finance department.
Every advertising agency will have to check each vendor’s tax filing status on the Federal Board of Revenue’s (FBR) website before making payment. Given that agencies make payments to a large number of vendors and suppliers on behalf of their clients, this will make the process very cumbersome. In addition, potential disputes due to errors in the status of the vendor (for example he is classified as a non-filer on FBR’s website, but is in fact a tax filer) could potentially be a nightmare to manage. Finance departments within larger companies may have the capacity to manage this increased burden, but small firms and budding entrepreneurs will face an uphill task to comply.
Another issue is the Withholding Tax (WHT), which deducts tax at source as a means to reduce tax evasion. While the withheld amount is adjustable against a company’s final tax liability, increasing the rate reduces cash flows thereby decreasing the company’s capacity to invest (if only because the WHT can potentially turn out to be higher than the final tax liability, leading to tax refunds at the end of the year which are difficult to recover.
Yet, two measures are proposed in the Budget which will directly affect the advertising business. The first was to withdraw the WHT exemption on the print and electronic media as a means to eliminate discriminatory tax exemptions and concessions. The initial proposal would have entailed the imposition of a WHT of 10% on print and electronic media; however due to the proactive engagement of the All Pakistan Newspapers Society (APNS) and the Pakistan Broadcasters Association (PBA) the rate has been reduced to one percent. Nevertheless, agencies will see their workload increase in order to comply with the additional requirement to deduct, submit and reconcile the WHT on media. The second was to increase WHT from 7.5% to 10%, on media commission. Given the profitability and cash flows of most advertising agencies, an increase of 10% is unfair; in fact even 7.5% is already too high.
In the case of any small to mid-size advertising agency, if reasonably well-run, profit margins would be about 20% and the likely tax rate on profit about 25% (see table) .
Based on a 7.5% WHT rate, agencies must pay an additional 2.5% in advance – which will appear as a tax refund at the end of the fiscal year. However, the refund is likely to be stuck in the system for a year or more and may even not be fully recoverable. Based on 10%, the additional tax paid in advance increases to five percent of the revenue – meaning that even more revenue will be stuck up in the system – revenue that could be better used to build cash reserves for contingency or investment and expansion.
A lower WHT rate that is aligned with reasonable profit expectations will improve cash flows and increase an agency’s capacity to invest in growth and contribute to the overall economy. In fact, a fair WHT would be five percent on all revenue generated, inclusive of media commission.
Although budgets and policies are certainly important, the main obstacle to Pakistan’s growth is the trust deficit between citizens and the State. Citizens need to feel confident that their taxes will be used by the government to improve civic amenities and the government needs to trust that its citizens will pay their taxes and that therefore they will not need to impose complicated tax structures. Trust and confidence building can help realise Pakistan’s potential growth even more than budgets and policy. It needs to be a priority.
Amin Rammal is Director, APR, Firebolt63 and The Brand Crew.