Federal Cabinet Eliminates 15% Additional Tax on Banks

ISLAMABAD: On Friday, the federal cabinet, headed by Prime Minister Shehbaz Sharif, approved a law to raise the ordinary income tax rate for banks to 44%. This move aims to recover most of the tax losses while eliminating a 15% additional tax on profits generated by lending to the government.

Agreement with Pakistan Banks Association

The cabinet provided legal backing to a deal between the federal government and the Pakistan Banks Association regarding an advance-to-deposit tax of up to 15%. This deal was the result of Deputy Prime Minister Ishaq Dar’s skillful negotiation, which enabled the government to recover significant losses by raising the tax rate.

The government plans to remove the 15% additional tax in June without any form of compensation for banks.

Four days before the banks’ fiscal year ended, the federal cabinet promulgated the Income Tax Amendment Ordinance 2024. This ordinance safeguards prior transactions and completed deals.

Despite this measure, Prime Minister Sharif has done little to alleviate the tax burden on the salaried class, who paid Rs198 billion in just five months.

Changes in Tax Rates for Banks

The amendments eliminate the 10-15% additional income tax imposed on banks, which was previously applicable if their loans to the government exceeded a specified limit.

Key changes include:

• 44% tax rate for the fiscal year ending December 31, 2024 (up from 39%).
• 43% tax rate effective January 1, 2026.
• 42% tax rate starting in 2027.

The government expects to collect Rs65 billion from the tax hike before Wednesday. President Asif Ali Zardari anticipates that the ordinance will be issued within a few days.

Revenue Shortfall and IMF Requirements

The Federal Board of Revenue (FBR) has collected Rs5.08 trillion as of December 27, but faces a significant revenue shortfall. To meet an IMF requirement, the FBR must collect Rs6.009 trillion by December 31.

Minister of State for Finance, Ali Pervaiz Malik, stated, “We want to encourage capital formation, and it is a reasonable deal.” He emphasized the preference for banks to lend voluntarily to the private sector rather than to the government.

The government’s attempt to remove the 15% tax in June was thwarted when reports emerged in The Express Tribune. To avoid the levy, banks shifted towards private lending.

Prime Minister Sharif formed a committee earlier this month to address the matter. Under Ishaq Dar’s leadership, the committee raised the income tax rate to 44% while eliminating the 15% tax. This decision is expected to allow banks to recover more than 45% of their losses.

The government amended Section 1 of Schedule 1 and Rule 6C of Schedule 7 of the Income Tax Ordinance to legally protect prior decisions, including the waiver of the 15% additional tax for 2022.

The amendments clarify that from the 2025 tax year onwards, banks will be subject to standard tax rates under Division II of Part 1 of the First Schedule. Additionally, provisions were added to define the computation of gross advances-to-deposit ratios, ensuring clarity for tax calculations.

Objective of Increased Income Tax

The increased tax, first introduced in 2022, aimed to incentivize banks to lend to industries rather than relying on safe loans from the government. Previously, banks rearranged government loans close to the December 31 tax deadline to evade the additional levy.

Under the former system:

• An ADR (Advances-to-Deposit Ratio) below 40% faced a 55% tax.
• An ADR between 40%-50% was taxed at 49%.
• An ADR above 50% was taxed at the standard 39% rate.

By restructuring the tax framework, the government seeks to encourage greater lending to the private sector.