Back-door dealing: Legal loophole to be closed after banks dodge taxes

Tax rate of bank subsidiaries likely to be brought at par with its parent company.

ISLAMABAD:

To end the practice of banks using its asset management companies for transactions to dodge taxes worth billions, the government may jack up the tax rate of subsidiaries and bring it at par with the bank’s 35% tax from 20%.

The Federal Board of Revenue is considering a proposal to declare earnings from subsidiaries as ‘business income’ against the existing practice of it being treated as dividends from next fiscal year 2012-13, informed officials told The Express Tribune. The government charges 20% tax on dividends from earnings of asset management companies while the corporate tax rate is 35%.

The government had made a futile attempt to discourage this practice of arbitrage by banks in the current financial year’s budget by increasing tax rate to 20% from 10% for receiving dividends from an asset management company.

The country’s two leading banks have been found re-rooting their funds to these asset management companies for investing in government securities to evade taxes, said the sources. The two banks taking advantage of this legal loophole was unearthed by another top tier bank competing in the same league.

It has complained to the FBR that the two banks invested in government treasury bills and paid only 20% tax while the complainant paid 35% tax on its incomes. The tax avoidance was detected after publishing of banks accounts for 2011.

It is not yet clear whether tax authorities will take any action against these two banks. However, the FBR is now considering addressing this major legal lacuna being exploited by the banks.  Before 2009, banks used to pay corporate tax rate on the funds invested through these asset management companies but in 2009 when a new schedule was added into the Income Tax Ordinance, the FBR left this lacuna in the law.

State Bank of Pakistan recently increased minimum deposit rate to 6% from 5% – a welcome by different quarter who criticised the industry for making huge profits while paying their depositors peanuts. However, the spread – difference between lending and deposit rate – still stands more than 6.5% apart.

Meanwhile, Prime Minister Yousaf Raza Gilani has rejected a proposal by the FBR to increase income tax rate for banks from 35 to 37% from next fiscal year.

Another proposal to increase tax on income generated through making investments in government papers was also turned down by the economic managers. For the next fiscal year, the IMF has assessed Pakistan’s gross financing needs at Rs7.3 trillion or 30.3% of the total size of the economy.  According to State Bank of Pakistan, currently on average half of the banks’ exposure is in the government security papers while this ratio is 65% in case of top two banks of the country.

Published in The Express Tribune, April 20^th, 2012.