Karachi, June 07, 2023 (PPI-OT): Banks: FY24 Budget likely to bring more taxes
We believe the FY24 Budget will likely carry more negative earnings implications for banks, as it has been among the key sectors historically for the government to reap tax collections.
For this year, there is a likelihood of Super Tax increasing from current levels of 4% for the sector to 10%, leading to earnings impact of 13% for CY23E.
Another likely tax measure could be flat tax on income from Federal Government Securities (FGS). We run a sensitivity analysis, applying 15%/30% flat tax on the same, leading to average earnings decline of 12%/25%, respectively.
Combining the two tax measures (worst case), P/Es remain attractive for CY23E/CY24F as they average sub 3.5x, while ROE averages at ~18%. While higher tax on income from FGS would dent banks' profits, it may dispel domestic debt restructuring concerns at the same time.
More taxes expected for banking sector
Given government’s challenging situation at present, running fiscal slippages with delayed IMF tranches, it is unlikely that any sector walks away with any meaningful wins in the Federal Budget FY24, scheduled to be revealed in 2 days. We believe the budget will likely carry more negative earnings implications for banks, as it has been among the key sectors historically for the government to reap tax collections.
The sector already not only pays higher Corporate Tax of 39% (other corporates: 29%), it pays 39% tax rate on all income sources (including capital gains and WHT on dividends) vis-à-vis lower rate charged to other segments. Moreover, the government has also penalized banks for placing higher deposits in FGS, that adds to the total taxes for some banks, which for CY23, the government has waived.
Other than taxes, measures towards incentivizing banking and digital channels, would be fundamental in increasing documentation, may bode well for the sector.
10% Super Tax may continue
For this year, there is a likelihood of Super Tax increasing from current levels of 4% for the sector. To recall, the sector was charged 10% Super Tax for Tax Year 2023 (CY22), declining to 4% from Tax Year 2024 onward (CY23 onward). An increase of the 4% Super Tax to 10% this year would result in base earnings estimates to decline 11% on an annualized basis. As 1QCY23 earnings have already been posted, with present sensitivity on CY23E earnings if Super Tax is increased to 10% for this year, leading to earnings impact of ~13%.
Income from govt securities may face flat taxes
Another likely tax measure could be flat tax on income from Federal Government Securities (FGS). While there have been precedents for such tax measures, it has widely been linked to respective ADR-levels of the bank, as a way to encourage lending, which is exempted for CY23 at present. There is a likelihood of tax on the said income to be charged at a flat rate, disregarding the ADR levels. To understand the impact of potential tax measures, we present sensitivity with application of 15% and 30% flat tax on income from FGS, leading to average earnings decline of 12% and 25% in respective scenarios.
Valuations remain compelling
In worst scenarios, P/Es still remain attractive for CY23E/CY24F as they average sub 3.5x, with ROEs at 18%. Moreover, higher tax on banks investment in GoP securities is paradox for market as it dents banks’ profits but at the same time can dispel concerns over domestic debt restructuring, a case of a lesser (more acceptable) evil from market vantage point.
Tax on cash withdrawals
WHT on cash withdrawals, a practice witnessed in previous years, is also said to be under government’s consideration for FY24 Budget. To recall, 0.6% of WHT was applied on all non-cash banking transactions in FY16 Budget, later reduced to 0.4%. The rate was later reduced for filers to 0.3%, and increased for non-filers to 0.6% on cash withdrawal exceeding Rs.50,000 per day.
As per an SBP report, the WHT brought immaterial improvement to tax collection or to documentation. In contrary it led to reduction of banking transactions. As per the report, the number of non-filers remained high around 70% of total registered income tax payers in FY16. Moreover, cash in circulation witnessed a spike, and remains at relatively higher levels to date. The report also reports private business deposits declining from 28% to 25% after imposition of the WHT, contrary to its objective-discouragement of the cash economy. We hence believe, this tax measure, if announced, would slightly bode negative for banking deposits.