ISLAMABAD (October 23 2002) : Unlike other sectors, Pakistan's banking sector was highly taxed where all the explicit and implicit taxes raised the effective tax rate of a bank to between 75 percent and 80 percent. This rate has, however, declined but not substantially.
Apart from 58 percent corporate income tax (now 50 percent) on the net profits, financial institutions are also subject to a 30 percent withholding tax on income from government securities, 2 percent turnover tax, and 5 percent interest-free cash reserve.
Now this 50 percent rate of corporate income tax would be reduced in each year, for three years, by 3 percent and would be brought down at par with other tax rates ie 38 percent.
The problem of refund with banks is very interesting. The National Bank has its refund claims of Rs 17 billion-Rs 12 billion in litigation — and a portion would be refunded by the federal government by issuing bonds. Nearly Rs 22 billion bonds were issued to repay the refund of various banks. Even the National Bank would receive its refund claim of Rs 12 billi0n in not less than two years. It puts an extra cost burden on the bank and ultimately is shifted to customer.
In case of Habib Bank Rs 2 billion refund is also in litigation.
In the World Bank programme of $ 300 million 'Banking Sector Restructuring And Privatisation Project', a condition was placed for Financial Sector Revision of tax policy and administration to reduce the taxation of the financial sector in line with the rest of the economy.
The corporate income tax on bank's net profit is 58 percent, which is higher for financial institutions than for non-financial companies that are taxed 35 percent. Until recently, the tax authorities did not allow banks to deduct their non-performing loan loss provisions from income for tax purposes.
Earlier, the government had allowed the deduction of future loan loss provisions, although losses accrued as a result of previous provisions are not deductible. Financial institutions are also subject to a 30 percent withholding tax on income from government securities, which take a few years to refund, a 2 percent turnover tax, and a 5 percent interest-free cash reserve requirement. All these explicit and implicit taxes raise the effective tax rate of a bank to between 75 percent and 80 percent, says a World Bank document.
The proposed reforms consist of an initial reduction in the income tax rate from 58 percent to 50 percent, on a path towards the ultimate target of 35 percent. Loan loss provisions that are certified by the central bank are now tax deductible. Interest in suspense will not be taxable. The withholding tax would be reduced. And, banks will be allowed to estimate the advance turnover tax and pay on that basis that if the estimates were less than 80 percent of the actual tax liability a penalty would be imposed. These reforms have facilitated privatisation, attract needed capital to the sector and encourage banks to expand lending activities to the middle market.
In general, the policy reform allows banks to open or close branches on the basis of commercial reasons. In “banked” areas, the closing of bank branches is already liberal. In “un-banked” areas, the recommendations of the inter-bank committee which proposed a sharing of the “tax” of maintaining bank branches among the five largest banks appear to be an acceptable interim solution until more efficient alternative institutional arrangements for providing financial services to the rural areas are found.