Karachi, February 28, 2023 (PPI-OT): Government likely to do away with ADR linked taxes
News flows suggest higher tax on income from federal government (FG) securities for banks reporting less than 50% ADR is being removed for Tax Year 2024, which is CY23. We await FBR’s official notification on the same.
In the ongoing fiscal stress for the government, the tax was proving to be counterproductive as banks not only limited their deposit growth but also channeled funds away from investments towards advances to beef up their ADR to at least 50%. Removal of the tax could hence see banks channeling more funds towards government securities.
In terms of banks’ P and L, while some banks did book a higher tax during 2Q and 3QCY22 due to low ADRs, most achieved 50% ADR by 4QCY22 and booked tax reversals. The move is hence neutral from an EPS perspective for our universe but deposit growth could pick up after slowdown witnessed due to the tax – 7% YoY deposit growth in CY22 was a 14-yr low.
ADR linked taxes likely to discontinue from CY23
News flows suggest higher tax on income from federal government (FG) securities for banks reporting less than 50% ADR is being removed for Tax Year 2024, which is CY23. To recall, higher taxes were applied on the banking sector in Budget FY23 as per the slabs in the table alongside.
As per our understanding, in CY23, only additional income from FG securities will be taxed at 37.5% (which was 2.5% higher than Corporate Tax Rate previously), applicable since CY19. We await FBR’s official notification regarding discontinuation of the aforementioned tax and clarification on the tax rate for additional FG securities income.
After banks meet the ADR requirement in CY22
Meeting and / or maintaining the ADR levels to avoid higher taxes had been among the top priorities of the banking sector in CY22. This led to banks working on both ends, further expanding lending books and limiting deposit collection. During CY22, sector Advances reported 17% YoY growth, while Deposits marked a 14-year low growth at 7% YoY.
From JS Banking Universe, UBL, MCB and ABL were below the 50% Gross ADR mark as at Sep-2022 and had booked higher taxes in 9MCY22 accordingly. The said banks have now booked relevant tax reversals in 4QCY22, indicating meeting the 50% Gross ADR mark. This makes all banks under JS coverage (HBL, UBL, MCB, MEBL, ABL, BAHL, BAFL, HMB, AKBL, FABL) meeting the Gross ADR above 50% criteria as at Dec-2022
The move indicates more lending to govt
If these taxes are done away with, the pressure on banks to maintain ADR levels may ease. We believe discontinuing higher taxes condition on lower ADR would lead to banks going back to higher deposit growth and parking it in FG securities investments. This would also bode well for the government as this comes at a time when the government is in dire need of funds to bridge its deficit amid expanding fiscal deficit and limited borrowing avenues, also highlighted in our note, ‘Banks to open direct credit lines for the government’, released yesterday.
To recall, the government has already borrowed net Rs4.4trn through government securities auctions in 7MFY23 (total auctions less maturities), almost equal to FY23’s budgeted fiscal deficit. The need of higher borrowings arises from delay in prospective external borrowings, which were budgeted at Rs1.6trn at the start of FY23. In contrary, the government has so far recorded net debt payments on the external side.