Govt Reverses Lending Tax on Banks But Hikes Corporate Tax to Collect Rs. 70 Billion

In a recent development, the Federal Cabinet has approved the promulgation of an Income Tax Ordinance to implement changes in the Advance Deposit Ratio (ADR) for banks. The proposed additional income tax of 10-15 percent on banks due to low ADR is to be abolished, Topline Securities said in a report. However, the standard income tax for banks has been increased from 39 percent to 44 percent for the current tax year ending on December 31, 2024. For tax year 2026, starting from January 01, 2025, the rate will go down to 43 percent. For tax year 2027 and onwards, the rate will be 42 percent, according to the draft ordinance. The current super tax of 10 percent will continue to remain unchanged. This increase in the tax rate to 44 percent is expected to generate additional revenue of Rs. 60-70 billion for the government and erode banking sector earnings by 10-12 percent. Among listed banks, Meezan Bank (MEBL) has already accounted for a tax impact of Rs. 6 billion in 9M2024, resulting in a lower impact on its 4Q2024 accounts. This development is negative for the banking sector, as banks are now required to pay an additional 5 percent tax in the current year, 4 percent in 2026, and 3 percent from 2027 onwards, regardless of the ADR level. Rumors of higher taxes on banks have been circulating in the market in the past few days, and the report suggests the market has already incorporated the impact to some extent. The report maintains a market-weight stance on the sector due to attractive valuations, with Habib Bank (HBL) and Meezan Bank (MEBL) as top picks for 2025. At the time of imposition of this new ADR-related tax, many banks had ADR of below 40 percent. In that case, the effective tax rate of the banks would have been 59 percent (assuming 65 percent income from investments). However, after today’s development that also removed the uncertainty, the effective tax rate of the banks is now 54 percent, subsequently coming down by 100bps each in the next 2 years.