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Introduction

In a significant move aimed at alleviating the tax burden on the banking sector, the federal cabinet of Pakistan has approved the removal of a 15% additional tax that was levied on banks’ profits derived from lending to the government. This decision, however, comes with a catch — an increase in the standard income tax rate for banks, set to rise to 44%. This change is expected to largely offset the tax losses the government faces while striking a balance between encouraging capital formation and maintaining fiscal discipline.

The Ordinance: What It Entails

On Friday, the federal cabinet, led by Prime Minister Shehbaz Sharif, gave its approval for the promulgation of the Income Tax Amendment Ordinance 2024. This ordinance outlines several changes to the tax regime for banks, most notably the abolition of the 15% additional tax on profits from loans extended to the government.

According to Deputy Prime Minister Ishaq Dar, who played a pivotal role in negotiating the deal, this adjustment aims to protect the interests of both the banking sector and the government. The decision ensures that the government is not left with significant tax losses by raising the tax rate for banks to 44%.

Key Changes in the Tax Structure for Banks

Abolition of 15% Additional Tax

The initial 15% tax was introduced in 2022 as part of an effort to incentivize banks to lend to industries rather than investing in government debt. The government hoped that by imposing this tax, banks would shift their focus to providing loans to the private sector, especially industries in need of capital. However, banks often circumvented this tax by restructuring their lending portfolios just before the deadline, which proved inefficient for the government’s objectives.

Under the new ordinance, this additional tax will be eliminated. However, the government has not let go of the opportunity to adjust the tax burden on the banking sector, thereby recouping losses through other means.

Increase in Standard Income Tax Rate to 44%

In place of the 15% additional tax, the standard income tax rate for banks will be raised from 39% to 44% for the current tax year ending December 31. This increase is expected to generate an additional Rs 65 billion for the government. Furthermore, the tax rate is expected to gradually decrease in the coming years:

• For tax year 2026, the rate will drop to 43%.
• For tax year 2027, the rate will further decline to 42%.

This move ensures that the government will continue to collect substantial revenues from the banking sector, while at the same time removing the cumbersome 15% tax that had been viewed as a disincentive for banks.

Impact of the Ordinance on Tax Collections

The Federal Board of Revenue (FBR) had been facing a significant revenue shortfall, with a collection of Rs 5.08 trillion as of December 27. The government needed to gather an additional Rs 1 trillion by December 31 to meet the International Monetary Fund (IMF) conditions.

By implementing the changes, the government is set to recover a portion of this gap. The increase in tax rates and the full repeal of the additional tax are expected to generate a total of Rs 65 billion in the short term.

Implications for the Banking Sector

Encouraging Private Lending and Capital Formation

The primary objective behind these tax reforms is to encourage private lending by the banking sector. The government has expressed its reluctance to lend directly to the private sector and is instead relying on banks to voluntarily step in and finance businesses and industries.

While banks are receiving a temporary reprieve from the additional 15% tax, they are expected to increase lending to industries to help bolster the economy. The government’s new tax structure is designed to strike a balance between incentivizing the banks to lend and ensuring the government continues to generate adequate revenue from the sector.

A Win for the Pakistan Banks Association

The Pakistan Banks Association (PBA) has long argued that the 15% additional tax, imposed on profits from loans to the government, had led to significant challenges in their operations. With the new amendments, banks will be relieved of this burden, although they will now face a higher standard income tax rate. The increase to 44% is still lower than the potential 55% they could have faced under the previous rules for certain thresholds of gross advances.

Impact on Bank Operations and Profitability

Although banks may now have some leeway in terms of their tax obligations, the increase in income tax could impact their profitability. As the tax rate rises, banks may need to reassess their cost structures and lending portfolios to ensure they remain profitable while complying with the new regulations.

What Does This Mean for the Salaried Class?

While the cabinet’s decision provides relief to the banking sector, it offers no such comfort for the salaried class, who have borne a colossal Rs 198 billion in taxes over the last five months. The government’s focus on ensuring fiscal balance through tax reforms has led to significant pressure on salaried employees, who are paying substantial amounts in taxes.

Tax Burden on the Salaried Class

The salaried class remains heavily taxed, with little to no relief in sight. The government has continued to prioritize corporate tax reforms and banking sector adjustments, leaving individual taxpayers with the short end of the stick.

Key Provisions of the Tax Changes

The Income Tax Amendment Ordinance 2024 includes several important provisions:

• Abolition of 15% additional tax: This tax will be abolished for the current fiscal year.
• Increase in standard tax rate: The tax rate for banks will rise to 44% for the current year, with a gradual reduction in the following years.
• Provisions for future taxation: For tax year 2025 and beyond, banks will face the normal tax rates outlined in Division II of Part 1 of the First Schedule.

FAQs: Key Questions Answered

1. Why did the government decide to abolish the 15% additional tax on banks?

The government decided to abolish this tax to reduce the financial burden on banks, which had been circumventing the tax by restructuring their lending portfolios. The goal is to encourage private sector lending while balancing the government’s revenue collection.

2. How will the increase in the standard tax rate affect banks?

The increase in the standard income tax rate to 44% will have a direct impact on banks’ profitability. However, the government hopes that this adjustment will help recoup lost revenue while still incentivizing banks to lend to industries.

3. How much additional revenue will the government generate from these changes?

The government is expected to generate an additional Rs 65 billion through the increase in tax rates, helping to fill the revenue shortfall faced by the Federal Board of Revenue (FBR).

4. Will this change affect individual taxpayers?

No, this ordinance primarily affects the banking sector. Individual taxpayers, especially salaried employees, will continue to bear the existing tax burden with no relief provided in this particular reform.

5. What are the future projections for the tax rate on banks?

The tax rate for banks is set to decrease gradually: 43% for tax year 2026 and 42% for tax year 2027 and onwards.

Conclusion

The federal cabinet’s approval of the Income Tax Amendment Ordinance 2024 brings about important changes for the banking sector, with the removal of the 15% additional tax on government loans. However, this relief comes with a significant trade-off: an increase in the standard tax rate to 44%. While this adjustment is intended to recoup the government’s tax losses, it raises questions about the broader tax burden on the salaried class, who have not seen any immediate relief.

These changes are expected to reshape the banking sector’s role in financing the economy, potentially encouraging more private sector lending, while also helping the government meet its fiscal targets.