KARACHI: Pakistan’s caretaker government on Wednesday issued rules requiring banks to pay 40 percent tax on windfall income reaped from foreign exchange transactions during the last two years in an effort to broaden its revenue base and punish lenders for being involved in exorbitant currency speculation.
This move comes as Pakistan expects to secure a tranche of at least $700 million from the International Monetary Fund’s existing loan programme after completing a first review.
The IMF’s executive board is expected to approve the staff-level agreement with Pakistan for the first review of $3 billion stand-by arrangement early next month.
It’s thought that the government implemented this tax to satisfy the IMF and demonstrate to the global lender that it was committed to increasing the tax revenue.
In accordance with subsection (2) of section 99D of the revenue Tax Ordinance of 2001, the government has decided to tax banks’ windfall earnings for the years 2021 and 2022, based on a certain tax formula specified in the statutory regulatory order (SRO) issued by the Federal Board of Revenue (FBR).
Pakistan tax authority (FBR) in its SRO explains the working to be applied to calculate the 40 percent tax on the banking sector’s windfall income on the income from FX dealings, said JS Research in a note. “The working incorporates an arithmetic mean of income from FX dealing since 2015 and calculating windfall income above the mean. The tax will likely fall in 4QCY23 as it is to be paid by 30th November 2023,” it said.
Analysts at Optimums Research estimated that banks’ forex transactions in 2021 and 2022 generated a windfall income of Rs87.948 billion. Approximately Rs35.18 billion in taxes will be collected by banks throughout the course of these two years.
Extreme volatility and record lows of the Pakistani rupee vs the US dollar last year led authorities to suspect manipulation by banks and exchange businesses. The country’s foreign exchange crisis had created high volatility in the local currency, which resulted in large windfall profits for banks because the lenders were involved in currency speculation.
The previous coalition administration had considered taxing banks’ windfall profits from foreign exchange transactions last year, but the idea was shelved.
By approving a 40 percent tax on banks’ windfall income from forex dealings last week, the federal cabinet dealt a surprise blow to the country’s banks and sent shockwaves across the industry. Analysts predict that this new measure will further hurt the banks, which are already subject to astronomically high taxes on their profitability.
However, the central bank’s former governor said banks have reaped windfall profits in Pakistan not only from their foreign exchange dealings in the last few years but more importantly from the opportunity provided for a long time to them by the government and the State Bank of Pakistan to do effortless and risk-free “financial intermediation” between them.
SBP’s former governor Dr Muhammad Yaqub said Pakistan’s central bank --and the IMF that has remained engaged in policy formulation with the government of Pakistan for many years -- forgot that the central bank discount window is meant to meet temporary and reversible liquidity needs of banks or is used by central banks as an instrument of monetary policy to inject or siphon off liquidity of the banking sector.
However, in Pakistan for the last several years, it has been kept open by the SBP for banks to generate liquidity and indulge in risk-free lending to the government and thereby make huge profits -- and in the process neglect their key role in mobilizing deposits from private savers and take risks in lending them to the private sector, he said.
“Regardless, there is no doubt that in Pakistan banks have earned windfall profits and made bank owners extremely rich. Such profits should indeed be taxed in countries where the taxation system is fair and it ensures horizontal and vertical equity,” said Yaqub.
“In Pakistan, FBR is accustomed to proposing taxes based on convenience of collection rather than on sound fiscal principles. There are so many segments of the economy that make windfall profits but have not been brought into the tax net by FBR. For example, the huge agricultural sector is kept out of the tax net. Several other sectors of the service sector are not liable for taxation.” The huge informal segment of the economy escapes taxation. In such an unfair context, additional taxation of banks, which already pay a large amount in taxes,, will make the taxation system more inequitable and in the process retard the growth of a sector that should be used as an important instrument of saving and investment, according to Yaqub.
