PM intervenes to maintain 15% tax on bank profits

The 15% additional income tax on banks may remain in place after Prime Minister Shehbaz Sharif intervened on Thursday, directing authorities not to provide any relief to the banks.

The premier’s intervention came as the government finalised new tax avenues that might be announced today (Friday) during the approval of the Budget 2024-25. The National Assembly is expected to approve the new budget and reveal new tax proposals, which are over and above the Rs1.5 trillion in taxes imposed on June 12th.

At least two cabinet members confirmed to The Express Tribune that the premier intervened after widespread reaction against an attempt to provide tax relief to the banks. The banking industry has enjoyed exceptionally high profits due to a desperate borrower in the form of a cash-starved finance ministry.

Deputy Prime Minister Ishaq Dar also sensitised the prime minister about the income tax relief issue to the banks, while advising the premier to stop the 15% income tax relief to the banks For the next fiscal year, the government plans to borrow Rs24 trillion outside the budget from commercial banks to repay maturing loans. Another Rs9.8 trillion will be spent from the budget on interest payments to banks and foreign creditors.

However, banks argue that they are not forcing the federal government to borrow money from them, and that the 15% additional income tax on the amount they lend to the federal government is unjust.

The development came after The Express Tribune reported that, despite severe economic challenges, the government might abolish the 15% additional income tax on profits banks make by extending loans to the cash-strapped finance ministry. This move could have provided approximately Rs60 billion in benefits to a sector that earned Rs960 billion in profits last year.

The Express Tribune had reported that an understanding was reached between commercial banks and the federal government to abolish the Advances-to-Deposit rate-based income tax.

About 27 banks made Rs960 billion in net profit in 2023.

Finance Minister Muhammad Aurangzeb did not respond to a question about whether he also stopped the FBR on Thursday from including the proposal to withdraw the tax in the Finance Act, to be passed by the National Assembly today (Friday).

Sources said that one Islamic bank, three larger conventional banks, and one small conventional bank were the main beneficiaries of the move. One field office of the FBR had estimated receiving Rs17 billion in this fiscal year.

The federal government unveiled an Rs18.9 trillion bloated budget on June 12th and set the FBR’s tax collection target at Rs13 trillion, based on Rs1.5 trillion in additional measures. The government once again hit the salaried class with Rs75 billion in additional taxes, bringing their total contributions to about Rs435 billion in the next fiscal year due to higher rates.

Banks often avoid the levy by readjusting their lending to the government just before the December 31 tax payment deadline. The FBR proposed calculating the tax liability based on average annual lending to the government rather than on the last day of the year.

If the government retains the additional income tax on lending to the government, it needs to plug the loophole that banks exploit to avoid the tax. The government can fix this loophole through a Statutory Regulatory Order, as it did by suspending the ADR tax last year.

Under pressure from banks, the government suspended the additional tax for 2023, but it became effective again in January 2024.

The normal income tax rate for banks is 39%. However, if a bank’s gross Advances-to-Deposit Ratio (ADR) is up to 40%, the government charges a 55% income tax on investments in government debt. For ADRs of 40-50%, the rate is 49%, and if the ADR exceeds 50%, the normal rate of 39% applies.

The banks’ current average ADR is near 41.8%, which would result in a 10% income tax. This ratio was significantly lower for the five banks that are the biggest lenders to the government. These banks are making easy money, with some having 94% of their balance sheet invested in government debt.