In a significant development for Pakistan’s banking sector, a recent estimate by the tax advisory firm Tola Associates suggests that banks will face an additional income tax liability of Rs197 billion due to their excessive lending to the federal government. This comes as banks, both domestic and foreign, are actively lobbying for tax exemptions to alleviate this financial burden.
The Context of the Tax Liability
The analysis by Tola Associates indicates that 27 banks operating in Pakistan are likely to incur this substantial tax penalty based on their advance-to-deposit ratio (ADR). The law stipulates that when banks’ lending to the private sector falls below a certain threshold, they must pay an additional income tax ranging from 10% to 15%. Currently, many banks have significant portions of their balance sheets invested in government debt, which exposes them to this additional tax liability.
This additional tax, originally introduced in 2022, was designed to encourage banks to redirect their lending toward the private sector and industries rather than relying heavily on government securities. Tola Associates calculated the additional tax liability using the audited financial statements of banks for the tax year 2024 and projected similar liabilities for 2025. Should banks manage to increase their private sector lending before the end of the year, their tax obligations could decrease accordingly.
Current Financial Landscape
The total tax impact of banks for the tax year 2024 was reported at Rs612 billion, benefiting from significant exemptions from the additional income tax. However, Tola Associates projects that with the current profitability levels of banks, the actual tax liability could even surpass the Rs197 billion figure for 2025.
The normal income tax rate for banks in Pakistan is set at 39%. However, the government imposes a higher tax on banks with an ADR exceeding 40%. Specifically, banks with an ADR between 40% and 50% face a 49% tax rate, while those with an ADR above 50% are subject to the normal rate. Tola Associates’ analysis revealed that 13 out of 27 banks could face a 15% additional income tax if they do not adjust their advances by December 31.
Lobbying Efforts for Exemptions
The banking sector is reportedly pushing hard for an exemption from the additional income tax for the tax year 2025. Their arguments center around the assertion that they are compelled to lend to the government due to restrictions on the central bank’s direct lending to the state. Consequently, banks claim that the additional tax represents an undue burden on their operations.
Earlier this year, banks attempted to secure an exemption but were thwarted when Prime Minister Shehbaz Sharif intervened following a report published in The Express Tribune. Under the terms of a $7 billion loan agreement with the International Monetary Fund (IMF), the government is prohibited from granting any type of tax exemption, further complicating the banks’ lobbying efforts.
Round-Tripping and Regulatory Concerns
The ongoing lobbying has revealed some concerning practices among banks, particularly “round-tripping,” where banks encourage customers to borrow funds only to deposit them back into other banks. This circumvention strategy aims to evade the additional tax implications of the ADR regulations. Former Minister of State Ashfaq Yousaf Tola has called for the State Bank of Pakistan (SBP) to audit these banks and put a stop to such deceptive practices.
Tola also suggested that the government should amend the law to calculate the ADR based on the yearly average of advances and deposits rather than solely relying on year-end balances. This change could provide a more accurate representation of lending activities and lessen the tax burden on banks that may have legitimate needs for government lending.
The Wider Impact on Taxation and Revenue
The potential exemptions sought by banks could have significant ramifications for Pakistan’s revenue collection, exacerbating the existing fiscal shortfall. The Economy Alert report indicates that if these exemptions are granted, three major banks could collectively save Rs71 billion, while one Islamic bank would benefit by approximately Rs21 billion.
These savings would come at a time when individual taxpayers, including salaried individuals, are facing tax rates nearing 39% to 50%, raising questions about fairness in the tax system. Many citizens are increasingly burdened by high taxation, while banks argue that the additional 15% income tax is excessive.
Future Projections and Challenges Ahead
Topline Securities recently reported that numerous banks are racing against time to meet the gross ADR of 50% by December 2024 to avoid the additional tax. This push highlights the ongoing tension between the need for banks to lend responsibly to the private sector and the realities of government borrowing.
As banks grapple with the challenges posed by these tax liabilities, the government must navigate a delicate balance between fiscal responsibility and supporting the financial sector. The push for exemptions will likely continue, and as the December 31 deadline approaches, the banking sector’s strategies will be closely scrutinized.
Conclusion
The estimated additional tax burden of Rs197 billion on banks in Pakistan underscores the ongoing complexities in the country’s financial landscape. As banks lobby for exemptions and seek to adjust their lending practices, the implications for both the banking sector and the broader economy are profound.
Moving forward, it will be essential for the government and the State Bank of Pakistan to monitor these developments closely. Transparent communication and regulatory oversight will be key in ensuring that the banking sector remains resilient while fulfilling its obligations to both the government and the private sector. The path ahead is fraught with challenges, but it also presents an opportunity for reform that could ultimately strengthen Pakistan’s financial system.
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