Duty on financial services

The budget for 2006-07 to be announced in the first week of June, 2006 (probably June 5, according to an unconfirmed newspaper report) is in the last stages of preparation and tax proposals of various kinds are now being discussed and finalised.
As the reports indicate, certain adjustments in existing taxes and new levies for the financial sector are also under active consideration of the government. As per earlier commitment of the government to equalise the tax rate of the banking sector with the corporate sector in stages, the tax rate on the former would be reduced further by 3 percent.
However, withholding tax of 0.1 percent on cash withdrawals is likely to be maintained. The Central Board of Revenue (CBR) has made a proposal to the Ministry of Finance to levy 7.5 percent excise duty on fee, commission and brokerage income of banks.
In the last budget, the government had levied such a duty on banks, which was later withdrawn. There are also reports about imposition of excise duty on certain other financial services, including loans and advances to the borrowers.
It is encouraging that as per government's tax rationalisation programme, the authorities have continued to reduce the tax rate on financial institutions by 300 basis points every year and in the Budget for FY07 it will come down to 35 percent which would bring them at par with the listed corporate sector in Pakistan.
Only a few years back, the tax rate on the banking sector was as high as 60 percent although there was absolutely no rationale for such a huge difference between tax rates in various sectors of the economy. It goes to the credit of the present government that this anomaly has been finally removed.
Other tax proposals, however, appear to be unjustified and hard to defend. The levy of 0.1 percent withholding tax on cash withdrawals has merely encouraged cash transactions or writing of more than one cheque to withdraw cash from the banks exceeding Rs 25,000. Also, it has discouraged documentation of the economy and banking habit to a certain extent.
We would advise the government to withdraw this measure this time. Other proposals like levying of excise duty on financial services of several kinds would hardly serve any useful purpose and may discourage the growth of business and investment in the country.
The effect of most of the proposals being considered for the next financial sector would ultimately be passed on to the clients of the banks. Any tax on advances would raise the lending rates commensurately and act as a great disincentive for investment and growth, especially at a time when the borrowing rates are already moving up due to the tightening of monetary policy by the State Bank.
The whole philosophy of tax measures, in our view, needs to be revisited and changed. At present, emphasis in tax measures is on convenience of collection rather than on equity in taxation. Of late, the government is also increasingly utilising the services of other organisations to collect levies on its behalf which is rather unfair.
The government needs to curb this tendency by redefining the role of fiscal policy and relying more on the CBR for revenue mobilisation. There are visible sectors reaping windfall gains but mostly outside the tax net. Real estate and shares market business fall in this category. Wealth tax was abolished for very sound economic reasons but there seems to be a strong case for imposing gift tax and inheritance tax because the income from these sources is largely unearned.
Agriculture sector remains grossly under-taxed despite the repeated advice of all the multinational organisations. The growing number of cars and electronic devices like air conditioners shows that no serious efforts have been made to broaden the tax net at a time of rising incomes.
We would advise the government to be more concerned with ensuring equity in taxation in the next budget and avoid measures which could discourage documentation of the economy and are antigrowth. In our environment, this may be an uphill task but that is the only way to move forward.