A capital gains tax of 10% set to be implemented this month was thrown out by Minister of Finance Samir Radwan after tremendous opposition from Egypt’s business elite. Analysts describe the tax as a mistake that served to scare away investors already spooked by the nation’s uncertain economic future. (Soon after the announcement was made on June 1, Egypt’s benchmark index, the EGX 30, fell 2.65%, reversing its gains that day.)

The EGX made a statement soon after the decision was revoked, saying the tax was dropped to protect the "Egyptian economy and the need to attract more foreign investment which would create more job opportunities and increase Egyptian gross domestic product and boost economic growth," according to Reuters.

Mohamed Ali, assistant fund manager at Cairo Funds Management, says the defunct tax has sent a negative message to investors and could have long-term effects on growth and investment.

"This has […] a negative effect on the local investors and foreign investors as well. If I am going to get taxed from an emerging market, I am going to shift my money away from this market to another emerging market that doesn’t have taxes on capital gains," says Ali.

Ahmed Kamaly, professor of economics at the American University in Cairo, disagrees, saying a tax won’t prevent foreign direct investment (FDI) from flowing into Egypt.

"Lots of people said that this is going to drive the stock market to go further down, some people said that this is going to discourage foreign investment, but this is nonsense. It is not going to discourage FDI, definitely. FDI is already affected by other things such as security, stability, etcetera."

The abrupt June announcement was part of a set of measures to raise revenues as the country faces a budget deficit of LE 164.1 billion. "The benefit is clearly directed towards the balance of the financial statement of the government because it is a profit from taxation," says Ali.

Kamaly defends the tax, saying it eases the budget deficit and acts as a market stabilizer. "It induces the speed by which money is transmitted in and out of the country. This has a positive effect for the stability of the capital account in the financial system," he says, adding that many countries do this as it decreases speculative activity.

However, opposition groups raised concerns about the questionable timing of the decision as analysts worried the economy will be unable to bear any more stressors of this magnitude.

"They are desperate to make money. The stock exchange is nothing, it is a tiny segment [of society]. We are in a state of panic. We cannot take everything as credible as it should be," says Neveen El Tahri, chairwoman and managing director of Delta Holding for Financial Investments.

Poor timing

Ali explains how the tax could hurt Egypt’s economy, which is already fragile after the revolution, particularly given its status as an emerging market. He says that the best solution for now is to fix the numerous economic problems facing the nation before focusing on rebuilding.

"[...] The timing was very wrong [and] when the economy stabilizes and becomes better and everybody has money, you can do this, but given the fact that the current condition of the economy is unstable, you are trying to fix all the damage that was done for the last [couple of years]," he says.

El Tahri does not support a capital gains tax of 10% because it hurts people financially instead of those who really should be taxed — companies holding initial public offerings (IPOs).

"[…] You need to sit back and think who you are harming. I would tax the guy who [covered his IPOs several times over], I could have taxed him and at least he puts it in consideration when he sells with massive amounts," she says.

Ali adds that this kind of tax is not a good solution as it decreases profits earnings and decreases investment.

"It’s good for the country in terms of money, but you won’t have investment," he says, adding that when people are taxed, they may invest their money in a bank instead of investing it in the stock market.

"You are not going to get money from outside, you are losing money from local and foreign investors. You might be winning in the short term but you are losing in the long term," he says, emphasizing the marginal long-term benefits.

But its defenders say the tax could give Egypt some much-needed time to get back on its feet. Kamaly says the tax is necessary now because the economy has bottomed out. A decision like this might depress the market for a short time, but it also reduces speculation, which could be good for market stability.

"We have two scenarios. One: If there is no capital gain, the investor will take the money out and it will destabilize the financial system. Two: If there is capital gain, he will think twice, because if he takes his money out, he will lose, so in a way this tax rewards long-term investment," he says

Ali disagrees and thinks that this tax could be a good solution, but only if investors support it.

"Investors are not looking for taxes, it is better to [be] tax free, especially for FDI. It is kind of redundant to do a capital gains tax in an emerging market," he adds.

If all emerging markets have taxes while Egypt chooses not to impose them, this could give it an investment advantage.

Although the tax was cancelled, it could be reinstated. Kamaly thinks the capital gains tax may be a useful tool in the future, adding Malaysia’s decision to impose a similar tax in 2007 helped it through difficult economic times.

However, Ali thinks that future is at least 10 years away, when the political climate is more stable, Egypt finds sustainable sources of income and there is a lower rate of unemployment.

"They might [reconsider], I don’t know. I think the market will take it badly — just hearing the news, the market took it very badly, but I am not sure [they will impose the tax]. I hope not." bt