Banks may have to pay extra Rs197b

Additional tax is due to heavy lending to govt; institutions seek exemption

ISLAMABAD:

A tax advisory firm has estimated that banks will have to pay an additional income tax of Rs197 billion on excessive lending to the federal government but the financial institutions are lobbying to get tax exemption.

In its Economy Alert note, Tola Associates – a tax and investment advisory firm – said that 27 domestic and foreign banks having operations in Pakistan would have to pay Rs197 billion in additional income tax on account of advance-to-deposit ratio (ADR).

The banks' overwhelming balance sheets are invested in government debt, although the law states if their lending to private sector falls below a certain threshold, they will have to pay 10-15% additional income tax.

Tola Associates has worked out the additional tax liability on the basis of published audited financial statements of banks for tax year 2024 and projected their tax liabilities for 2025. In case banks manage to increase private lending in the next two and a half months, their tax liability will come down accordingly.

The total tax impact of banks in tax year 2024 was Rs612 billion, during which they benefited from significant exemptions from the additional income tax, according to a brief note.

It added that keeping in view their profits for tax year 2024, the additional income tax liability would be Rs197 billion for 2025.

It said that considering the projected profit levels for tax year 2025, the actual tax potential could even exceed Rs197 billion.

The additional income tax was introduced in 2022 to encourage banks to lend to industries instead of extending safe loans to the government. Banks often avoid the levy by readjusting their lending to the government just before the tax payment deadline of December 31.

Under pressure from banks, the government had earlier 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 ADR is up to 40%, the government charges 55% income tax on investment in government debt. For the ADR of 40-50%, the tax rate is 49% and if the ADR exceeds 50%, the normal 39% rate is applied.

A working on the balance sheet of banks showed that out of 27 institutions, at least 13 were liable to pay 15% additional income tax in case they did not adjust their advances till December 31. Their ADR ranged from 21.9% to 39.7% that made them liable to pay 15% additional income tax.

In case of five largest banks, their additional tax liability ranges from Rs13.7 billion to Rs25 billion.

Nine commercial banks will be hit with an additional 10% income tax, if they do not shed their loans before the end of December. The tax is calculated on the last day of the year, which is exploited by banks.

The Economy Alert stated that the banking sector was rigorously pursuing exemption from the additional income tax for 2025 onwards. Any preferential tax treatment would have a significant impact on Pakistan's revenue collection, exacerbating the fiscal shortfall, it added.

It is the second time in less than four months when banks are seeking an income tax exemption. Earlier, a similar attempt was foiled on June 27 when Prime Minister Shehbaz Sharif stopped the exemption following a report published in The Express Tribune.

Under the $7 billion International Monetary Fund (IMF) loan deal, the government cannot give any type of tax exemption.

It has been learnt that to circumvent the ADR regulations, banks are compelling their customers to borrow from them and then deposit the entire fund in another bank, said former minister of state Ashfaq Yousaf Tola.

He said that the "round-tripping" of lending and deposit was tantamount to evading the additional tax. He stressed that the State Bank of Pakistan (SBP) should conduct an audit of those banks and stop them from deceptive practices.

The government should consider amending the law to calculate the ADR based on the yearly average of advances and deposits rather than the year-end balance, said Ashfaq Tola.

However, the commercial banks argued that it was an injustice to collect the additional 15% income tax as they were forced to lend to the government due to the restriction on central bank's direct lending to the state.

They called the total 55% income tax too high for them. However, business individuals are now being forced to pay up to 50% income in taxes and this ratio is nearly 39% for the salaried individuals.

The response of Pakistan Banks Association to the report of Tola Associates was awaited till the filing of the story.

The Economy Alert stated that in case the tax was exempted, three major banks would enjoy a relief of Rs71 billion. Additionally, one Islamic bank will benefit to the tune of Rs21 billion.

These figures have been taken from the audited financial statements of 2023, according to the brief note.

Topline Securities also reported on Tuesday that many banks are now racing to meet the gross ADR of 50% by December 2024 to avoid the additional tax.