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AKD Quotidian about — Tax collection: Banks in the firing line

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by January 17, 2012 Brokerage

Karachi: While the FY13 Budget is still many months away, the FBR is reportedly considering a proposal to enhance tax rate on banks to 40% from 35% at present.

According to AKD Securities, news flow to this effect cropped up in the run-up to last year’s budget but fears over enhanced taxation did not materialize. This time around, tax officials are reportedly pointing towards higher banks’ profitability (primarily due to shift towards GoP securities) while the NPL ratio is settling down.

In AKD Securities’ view, considering that 1) the FY12 tax collection target of PKR1.95tn appears on course to be met and 2) smaller banks remain in losses while some of the larger banks are reliant on relaxed provisioning requirements (FSV) to maintain profits, the SBP and representative banking bodies are likely to oppose this move. That said, risks emanate from a potential failure to curb the fiscal deficit which, among others, would depend on release of CSF funds, Etisalat payments and 3G auction proceeds. Ceteris paribus, AKD Securities estimates that an increase in banks’ tax rate to 40% would reduce banks’ earnings post CY12F by up to 7% on average.

Tax collection on target: On a provisional basis, FBR tax collection has totalled PKR812bn, up 27%YoY. At this rate, AKD Securities believes the full-year FY12 target of PKR1.95tn will likely be met which seemingly negates news reports pointing towards increasing taxation for banks. However, this may be a reflection of a continued high fiscal deficit, particularly if anticipated flows (CSF/Etisalat/3G) do not materialize.

Moreover, going by the recent move to reduce GST for tractors, the GoP could look to give further incentives to lock in rural votes in election year (see AKD Stock Smart “A case for broad-based Agri-driven growth” released on Nov 18’11)while increasingly substituting tax collection from banks. If push comes to shove, an alternative could be a one-off higher tax rate for all corporation ala the FY11 flood surcharge.

Banks in the firing line: Following last year’s drive to collect allegedly unpaid withholding tax from banks, the FBR is considering a proposal to increase tax rate on banks to 40% due to their high profitability (high interest income from GoP securities) and claimed stabilization in NPL ratio (systemic NPLs up 24%YoY/6%QoQ in 3QCY11).

In this regard, while profits for some selected banks have grown by more than 20%YoY in QMCY11, most small banks remain in losses while the SBP has recently provided leeway in provisioning to protect banks’ profits. AKD Securities believes reduction in banking sector market cap by 22% over the last 1yr despite high aggregate reported profitability captures these dynamics. As such, the regulator and representative banking bodies are likely to oppose calls for higher taxation on banks, particularly as tax collection remains on target.

Investment Perspective: Considering the FY13 Budget is -6m away, news flow on tax for banks will only pick pace over the next few months. Going by yesteryear’s proposals, the FBR could potentially also consider different tax slabs for various banks (e.g. distinction based on spreads or % of interest income from GoP securities).

While it is early days yet, AKD Securities estimates that if tax rate is increased to 40%, banks’ profit estimates post CY12F could reduce by up to 7% on average. While AKD Securities likes selected banks from in the near-term (run-up to CY11 results), question marks over economic outlook coupled with emergent regulatory risk would warrant a more cautious stance over the medium-term.

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