FBR mulls hiking tax rate on banks to 40 percent

The Federal Board of Revenue (FBR) has planned to increase the rate of income tax on the banking sector because of higher spread between the deposit and lending rates in Pakistan compared with other countries, a senior tax official said on Monday.

The revenue body is considering proposing 40 percent income tax for banking sector in the upcoming federal budget, up five percent from the existing corporate rate of 35 percent, the FBR official said on the condition of anonymity.

The revenue body estimated that the spread in the banking sector is between 8 and 10 percent as interest rate given on bank deposits fluctuates between 5 and 10 percent while the lending rate is from 15 to 18 percent.

The FBR comparison shows the spread in other countries is much lower at three percent to four percent. The revenue body, in a research on the banking sector, revealed that due to high lending rates, the profitability of other sectors is less, which ultimately resulted in low revenue collection. The banks create money out of the deposits placed with them by their customers, hence, the profitability vis-a-vis equity is higher in the case of banking companies as compared to other sectors of the economy, the official said.

Thus, the rate should be at 40 percent against the existing 35 percent normal corporate rate. Managers at tax departments suggested the FBR to incorporate the change in the upcoming budget 2011/12.

The income tax rate for banking companies was always high in the past against other limited companies. It was as high as 64 percent in 1993 against the tax rate of 42 percent for other companies during the same year.

The revenue body launched a tax relief measure for the corporate sector and reduced the tax rate for banking companies from 58 percent in 2002/03 to 35 percent in 2007 onwards.

It, however, realised that it was against the philosophy of progressive taxation and equitable distribution of income tax among different segments of the economy as the sector enjoys a huge share of national income.

The budget proposals regarding the banking sector also highlighted that the low tax rate is one of the reasons of increase in quantum of the non-performing loans (NPLs).

The banking companies are allowed one percent of the total advances as NPLs for tax credit. The tax managers told the FBR that although the banking sector was allowed credit against NPLs, most of the NPLs around 60 to 70 percent are subsequently recovered.

The tax managers said that the tax rate for the banking companies in Bangladesh stood at 45 percent and the Central Bank of Egypt pays 40 percent income tax. They also said that in the United States, Personal Service Corporation pays a flat rate of 35 percent on its income, but then various states also impose tax on the income of such corporations at various rates.

For instance, in California, the tax rate is 10.84 percent, which means that for personal services corporation such as banking companies, insurance companies and financial institutions, the effective aggregate rate in the state is 45.84 percent.