Published in Jul-Aug 2022
Many years ago when Shabbar Zaidi, former head of the Federal Board of Revenue, worked as a senior partner at a top audit firm and provided tax consultancy to Pakistan’s rich and mighty, I asked him what exactly he meant by the term “vested interest in tax policy.” “Banks,” he replied. “Every government makes the annual budget to please the banks.”
Even accounting for some hyperbole, his answer had merit. No government in Pakistan has ever functioned without help from banks. The government is perpetually short of cash, but banks have lots of it in the form of deposits. The government borrows from the banks to bridge its fiscal deficit, which is the fancy term for the ever-widening gap between its expenditure and tax revenue.
The government takes on new loans every year to retire old ones and then borrows some more. The chief beneficiary of the arrangement is the banking sector. It gladly collects deposits from the general public but shies away from making commercial and consumer loans that carry default risks and require hard work, such as assessing the credit worthiness of potential clients.
True, banks have been subjected to a slightly higher tax rate than the rest of the corporate sector, but the overall scheme has worked wonders for them. Take a look at their financial statements that show a source-wise breakdown of their pre-tax earnings.
An overwhelming share of their income originates from treasury operations. In other words, a small team of a dozen or so members buy (and sometimes sell) government debt papers to generate most of their income, while their retail and corporate banking counterparts play second fiddle to the major league treasury boys. However, this arrangement is poised for disruption, thanks to Finance Minister Miftah Ismail. Legislators have approved the tax recommendations for the banking sector and, as a result, commercial banks will pay a total tax of 49% on their 2022 earnings, up 10% from 2021, according to tax commentary issued by Arif Habib. As a result, reports are now circulating that the banks are planning to challenge the proposed super tax in court, although there is no final word about that. So let’s stick to what we already know in the approved Finance Act 2022-23.
The new legislation increases taxes on banks on three counts. One, it will increase the rate of corporate tax; two, it will increase the rate of the super tax, and three, it will increase taxes on the mark-up (or interest) banks generate by parking their funds in government securities.
Let’s consider the three new tax measures one by one. Until the passing of the budget, the corporate tax rate on banks was 35%. In addition, they paid a super tax of four percent which was imposed by former finance minister Ishaq Dar in the previous PML-N government. The two taxes were pre-tax earnings. Thus, it could be said that banks had the minimum applicable taxes of 39%. The originally proposed budget for 2022-23 increased the corporate tax rate to 45% (from 35%) while eliminating the super tax. Now the approved amendments have increased the corporate tax rate to 39% while the finance Act has increased the rate of the super tax to 10%.
Therefore, the post-budget minimum applicable taxes on commercial banks equal 49%. “The (super tax) levy of 10% will be applicable for the tax year 2023 (calendar year 2022), which signals the erosion of 2022 earnings,” says the commentary by Arif Habib. Elaborating the point further, Amreen Soorani, Head of Research, JS Global, says “the sector has been laden with hefty taxes across the board over (the) expanding profits in the ongoing monetary tightening environment.”
Moreover, the proposed budget imposes a higher tax rate on the mark-up income banks earn by investing in government securities like treasury bills and investment bonds.
The legislature recently approved the SBP Amendment Act 2021, which stops the government from borrowing directly from the central bank – a practice that leads to excessive money printing and causes inflation (the worst kind of ‘tax’ on the general public). Hence, the government is now all the more reliant on bank borrowing to meet its spending needs – a fact which, according to Umair Naseer, Associate Director of Research, Topline Securites, has resulted in a rise in secondary-market yields on government securities. The secondary market is where banks buy and sell the already-issued government debt papers. The purpose of the higher tax on this source of earnings is to stop banks from taking “undue advantage” of the new legal framework under which the government cannot resort to central bank borrowing, he adds.
The government has notified different tax rates on the interest generated by government securities with varying advances-to-deposits ratios (ADR), an indicator that measures outstanding loans as a percentage of deposits. A low ADR shows the bank is investing a disproportionately high amount of its deposits in risk-free government papers and vice versa.
The proposed tax rate with banks having ADRs of 50% or more is 39% versus the 35% currently in place. The rate will go up to 49% from 37.5% for banks with ADRs ranging from 40% to 50%. The rate will be 55% for banks with ADRs of less than 40%. “Banks will now gradually try to shed high-cost deposits and will look to increase exposure to the advances to minimise the impact of these measures,” says Naseer, further noting that banks may take the matter to court.
AKD Securities estimated the measures proposed in the original Finance Bill would help the government raise additional Rs 70 to 80 billion in taxes annually. The total contribution to the national exchequer from members of the Pakistan Banks Association in 2021 was more than Rs 340 billion, according to the representative body of commercial lenders.
In all likelihood, banks will mount a legal battle to have the tax measures reversed. Their revenue streams are being squeezed left, right and centre. Vested interests do not take hits lying down.
Kazim Alam is a staff member of DAWN. firstname.lastname@example.org