Govt to plug lacuna allowing banks to avoid taxes

New policy targets Rs200b annual bank tax evasion, promotes private sector lending

ISLAMABAD:

The government announced plans on Thursday to plug a legal loophole that allows commercial banks to avoid an estimated Rs200 billion in income taxes annually. This move, which is expected to be part of the next budget, is also designed to encourage banks to increase lending to the private sector and spur economic growth.

Federal Board of Revenue (FBR), Chairman, Rashid Langrial stated that the additional 10% to 15% income tax on bank lending to the government is currently based on their December 31 balance sheet. "We are going to reverse this in the next budget," Langrial said during a meeting of the Senate Standing Committee on Finance, chaired by Senator Saleem Mandviwalla of the Pakistan People's Party (PPP). Langrial said that instead of determining tax liability based on the December 31 snapshot, the FBR will begin using an annual average to assess the additional income tax owed by banks.

During the meeting, FBR Member Policy Hamid Ateeq Sarwar also disclosed that under the current Income Tax Law, a deceased person remains liable to pay tax unless their death certificate is submitted to the FBR. This revelation came in response to a question from Senator Faisal Vawda.

The committee took up the issue of the Rs200 billion tax based on a report published in The Express Tribune last week. According to Tola Associates' Economy Alert note, 27 domestic and foreign banks with operations in Pakistan would be liable to pay nearly Rs197 billion in additional income taxes, linked to their advance-to-deposit ratio (ADR).

However, banks have been avoiding this tax and are reportedly considering seeking another waiver from the government. Minister of State for Finance and Revenue Pervaiz Malik told the committee there was no current proposal to exempt banks from the additional tax. The FBR chairman acknowledged that a legal lacuna has allowed commercial banks to circumvent the tax, despite lending heavily to the government.

The current law mandates that if a bank's lending to the private sector falls below 50% of its ADR, the bank is subject to an additional 10-15% income tax. Many banks manage to avoid this by adjusting their lending portfolios just before the December 31 deadline by lending money to sister concerns. To counter this, Langrial announced, "From the next fiscal year, we will determine the additional income tax based on the annual average lending position instead of December 31."

Most of the banks' balance sheets are invested in government debt, despite the legal requirement to lend more to the private sector. Tola Associates projected that if banks increase private sector lending in the coming months, their tax liabilities for 2025 could be reduced. Otherwise, the additional income tax for 2025 will remain close to Rs197 billion.

This tax was introduced in 2022 to encourage banks to lend more to industries, rather than relying on safer government loans. However, banks have often evaded the tax by strategically readjusting their portfolios just before the December 31 deadline.

The government had suspended the additional tax for 2023 due to pressure from the banking sector, but it was reinstated in January 2024. The FBR explained that banks are exempt from the tax if their ADR exceeds 50%. If their ADR falls between 40% and 50%, they are subject to a 49% income tax on investments in government debt, with a 55% tax for those with ADRs below 40%. According to the half-year report (January to June 2025), ADR at banks such as United Bank Limited was 21%, Habib Bank Limited at 35%, and Muslim Commercial Bank at 31%, all of which would face the 15% additional tax if their ADRs remain unchanged until December 31. Meezan Bank, with a 46% ADR, would be subject to 10% additional tax.

Thirteen out of 27 banks could face a 15% additional tax if they don't adjust their lending by the year-end, with their ADRs ranging from 21.9% to 39.7%. For the five largest banks, this could mean additional tax liabilities ranging from Rs13.7 billion to Rs25 billion. Nine other commercial banks will be subject to a 10% tax if they do not shed their loans before the end of December. The year-end calculation date allows banks to exploit the loophole, reducing their tax burden by adjusting portfolios just before the deadline.

The minister of State for Finance stated that the government's broader fiscal issues, including the budget deficit, have increased its reliance on bank financing. He also highlighted the need to control the deficit to reduce this dependency.

In response to questions about the government's digital invoicing initiative, Langrial clarified that the government's role should be limited to certifying digital service providers, not issuing licenses, adding that the concept would soon be corrected.