Karachi, The banking sector in Pakistan is bracing for the impact of Section 99D of the Finance Act 2023, following the Federal Cabinet's approval of a 40% additional tax on income from foreign exchange (FX) for the calendar years 2021 and 2022. This decision marks a significant move in the country's financial regulatory landscape, with potential implications for the earnings and payout capacities of banks.
According to JS Research, the additional tax under Section 99D, titled 'Additional tax on certain income, profits, and gains,' is retrospective, affecting earnings from the past two years. The banking sector, which has already paid an effective tax rate of approximately 47% on FX income during this period, could see an incremental tax of around 3%, considering the current provisions. However, the application of the tax remains unclear, with ambiguities surrounding whether the tax rate is additional to or cumulative with existing rates. There are also questions about how FX income will be categorized between recurring and windfall gains.
The prospective impact on the 2023 estimated earnings per share (EPS) for banks, assuming a 40% additional tax on retrospective earnings and treating all FX income as windfall, is estimated at an average of 9%. This could raise concerns about some banks' ability to maintain their payout capacities for the fourth quarter of 2023, unless they utilize available capital adequacy ratio (CAR) buffers.
Banks are expected to contest the measure, citing the subjectivity involved in its application. While a modified version of the measure on a prospective basis is not ruled out, the open-ended wording of the approved tax could lead to broader interpretations of 'windfall profit,' potentially including favorable movements in other macro variables like interest rates.
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