Moody’s says super tax extension credit negative for banks

KARACHI: Moody’s has termed the continuation of super tax on banks credit negative, and said that after it expires in 2021, banks may see some improvement, but higher government borrowing will clip lending to the private sector.

The credit outlook report released by the financial services company on Thursday analysed Pakistan’s recently proposed federal budget 2018/19, which included a one-year extension of special tax on banks’ taxable income.

“The tax extension is credit negative for Pakistan’s banks because until it fully expires after 2021, it will continue to weigh on banks’ profits and add to ongoing profitability challenges,” Moody’s said.

The report said Pakistani authorities first imposed the tax in 2015. The tax equals four percent of banks’ taxable income for the last accounting year, and was imposed on banks’ semi-annual results.

The special taxation was one of a number of changes on banks’ taxation, including the 2015 imposition of a uniform tax rate of 35 percent on all sources of income (including dividends and capital gains).

Together, these taxes impose a high effective tax rate on banks of around 39 percent, which has been a drag on their earnings.

In 2015, Pakistan imposed a three percent special tax on corporations with income of more than Rs500 million, but the new budget introduced a gradual reduction in the corporate tax rate to 25 percent by the 2023 tax year from 30 percent for the 2018 tax year.

The taxes on banks’ earnings have added to banks’ ongoing profitability challenges and narrowing margins from lower yields on government securities (in which the banks invest roughly half of their balance sheet) and one-off costs, including higher pension costs.

Pakistan’s Supreme Court in February ordered banks to raise the minimum monthly pension to retired employees to Rs8,000 and to apply an annual five percent increase starting in January 2019.

“We expect all rated Pakistani banks to be affected by the tax extension, which we estimate will lower the banks’ return-on-equity ratios by approximately one percent,” the Moody’s report said.

However, as part of the budget, the authorities for the first time announced the gradual phasing out of the tax by one percentage point annually beginning in fiscal 2019. Once fully eliminated after 2021, the banks’ effective tax rate would return to around 35 percent.

Government projected that borrowing from banks will increase by more than 70 percent to more than Rs1 trillion, which Moody’s suggested would likely increase banks’ appetite for government securities (amid potentially rising interest rates) at the expense of lending to the private sector.

Already on Wednesday leading brokerage house of the country said super tax was expected to erode around seven percent of annual earnings of banks that have already witnessed a decline in quarterly profits.

“The proposed finance bill 2018 will extend 4 percent super tax to tax year 2018, causing our universe (banks) earnings to decline in the range of 4-6 percent for calendar year 2018,” Taurus Securities Limited said in a report.

“The sector’s earnings will continue to remain under pressure for another three years. Resultantly, banks will end up paying the most super-tax, and the longest than any other industry in Pakistan.”