Analysts expect ADR tax formula to be changed

KARACHI: The committee set up by Prime Minister Shahbaz Sharif is expected to tweak the formula for the additional tax on low advance-to-deposit ratios (ADR), analysts said on Monday. Instead of using the year-end figure on December 31, 2024, the calculation might switch to an annual average—a move analysts say could bring more balance and fairness.

There is a possibility that the State Bank of Pakistan (SBP) could introduce a revised formula for calculating the ADR by excluding certain advances and including all deposits in the calculation. These changes are anticipated as the government intensifies its efforts to increase tax collection from banks based on income generated from government securities.

Last week, the prime minister established a committee to address the issue of the ADR, which will be led by Deputy Prime Minister Ishaq Dar. The committee is expected to submit its report within one week and will also recommend any necessary legal amendments and regulatory changes for legislation.

Currently, banks are required to achieve a 50 per cent gross ADR target by the end of the year to avoid incurring additional taxes on income from government securities. According to data from the SBP, the banking sector had already reached an ADR of 47 per cent by November 15, up from 40 per cent recorded on June 28.

If banks maintain an ADR between 40 and 50 per cent, they will face an additional tax of 10 per cent. If the ADR falls below 40 per cent, they will be subjected to a higher additional tax of 16 per cent on their income from government securities. “Yes, the formula could also be changed to average which canreduce the ADR significantly,” said Awais Ashraf, director research at AKD Securities Limited.

“Banks have parked advances in non-banking financial institutions (NBFIs) to comply with ADR criteria set by the government. However, if the government does not exclude these advances from the bank’s calculation, this is material negative for the banking sector profitability,” Ashraf added.

Back in 2008, the SBP, through a circular, revised the definition of ‘Advances’ and ‘Deposits’ to calculate the ADR, where the SBP excluded certain advances and included all deposits for the calculation, said Topline Securities in a note. “This time around, we cannot rule out the possibility that the SBP might introduce a similar formula, with the exclusion of lending to non-NBFIs, etc, which could result in a lower ADR and lead to banks paying higher taxes,” it said.

“The committee can change the formula for additional tax on low ADR from a ‘year-end, ie, the specific date of December 31, 2024’ to an ‘average for the year’, it added.

The report estimates any measure targeting Rs100 billion in additional tax revenue from banks may weigh on banks’ profitability by 12-15 per cent.

During the nine months of 2024, listed banks’ pre-tax profits amounted to Rs913 billion, with full-year profits expected to be around Rs1,200 billion, according to the report. Approximately 80 per cent (Rs960 billion) of this profit is derived from government securities. If the ADR of all banks remains in the range of 40-50 per cent, the government could collect an additional 10 per cent tax, ie, Rs96 billion. However, if the ADR of all banks falls below 40 per cent, the government could collect an additional 16 per cent tax, amounting to Rs154 billion. Saad Hanif, head of research at Ismail Iqbal Securities, said the SBP might exclude specific lending categories, such as loans to non-NBFIs, or make other adjustments.

“Such changes would likely aim to broaden the taxable base for banks with low ADRs, potentially increasing their tax burden. This aligns with the government’s intent to generate additional revenue from the banking sector,” Hanif added. “However, the exact formula will depend on the recommendations of the committee and the SBP’s policy objectives,” he said.