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The local banks in Pakistan have reportedly been involved in a tax evasion scam by manipulating the Advance-to-Deposit Ratio (ADR). At present, a banking company’s income, profits, and gains are taxed at the standard rate of 39%. Additionally, banking companies are subject to a Super Tax at progressive rates ranging from 1% to 10%, depending on income slabs between Rs. 150 million and Rs. 500 million or more.
From the tax year 2022 onwards, banking companies’ income, profits, and gains from investments in Federal Government securities were subjected to higher tax rates of 55% or 49% if the gross ADR was up to 40% or between 40% and 50%, respectively. When the ADR exceeds 50%, the income, profits, and gains from these investments are taxed at the standard rate of 39%.
The higher taxation based on ADR ratios has incentivized banks to manipulate the ratio, creating economic inefficiencies and deadweight losses. After the enactment of these provisions, banks approached the courts and obtained stay orders against the ADR tax for the tax year 2022.
In the tax year 2023, banks reportedly manipulated advances and deposits to maintain an ADR ratio above 50%, thereby avoiding the higher tax rates. In the tax year 2024, the ADR tax was rescinded through the Finance Act, 2023. However, the same taxation rates were reinstated for the tax year 2025, based on ADR ratios as of September 30, 2024.
To avoid higher taxes for 2025, banks not only challenged the ADR regime in court but also manipulated their ratios during the fourth quarter of 2024, ensuring the ADR remained above 50%. This interpretation allowed them to bypass the incremental taxes.
The country’s current economic situation may necessitate the Federal Government borrowing heavily from banking companies to manage fiscal challenges. Such borrowing could adversely impact ADR ratios, subjecting banks to higher tax liabilities of 49% or 55%.
Amid this scenario, banks worked strategically to avoid the ADR tax. By December 31, 2024, they had nearly achieved the 50% ADR benchmark. While reducing deposits on a large scale was not feasible, they managed to increase advances by 27% within just four months.
This achievement came despite significant challenges. When the ADR tax was imposed for FY25, the policy rate stood at a high 22%, and the average ADR hovered slightly above 38%. Nevertheless, banks’ lending to the private sector surged to record levels. According to the State Bank of Pakistan (SBP), banks lent Rs. 1.35 trillion to the private sector between July 1 and December 6, 2024, significantly higher than the average over the previous three years.
Simultaneously, banks parked Rs. 1.33 trillion in non-bank financial institutions (NBFIs) during the same period, further boosting their liquidity management efforts. This aggressive lending allowed banks to improve their ADR ratios and comply with government-imposed thresholds before the year-end.
