The banking sector in Pakistan is not only a cornerstone of the financial system but also one of the most significant contributors to tax revenues at both federal and provincial levels. The taxation of banking services is governed by an intricate framework involving income tax, sales tax on services, federal excise duty (FED), withholding obligations, and sector-specific rules and exemptions. This article provides a comprehensive overview of the taxation of banking services in Pakistan, highlighting applicable laws, rates, compliance requirements, and the latest regulatory trends.

Regulatory Framework Governing Banking Taxation

Taxation of banks and financial institutions is derived from several key legislations and regulatory frameworks including:

• Income Tax Ordinance, 2001

• Federal Excise Act, 2005

• Sales Tax Acts of provinces (PRA, SRB, KPRA, BRA)

• State Bank of Pakistan (SBP) Prudential Regulations

• Banking Companies Ordinance, 1962

• SECP Rules and SROs for listed banks

• Foreign Exchange Manual by SBP

These laws impose multiple tax obligations on banks as corporate entities, service providers, and withholding agents.

Income Tax Treatment of Banks

Banks in Pakistan are taxed as corporate entities under a separate tax regime defined in Division II, Part I of the First Schedule to the Income Tax Ordinance, 2001.

Applicable Tax Rate
As of tax year 2025, the corporate tax rate for banking companies is 39% on their taxable income. This rate is significantly higher than the standard corporate tax rate of 29% applicable to other companies.

Scope of Taxable Income
Taxable income for banks includes:

• Interest or markup on advances and deposits

• Fee-based income from account maintenance, ATM, locker charges

• Commission income from remittances, guarantee issuance, and LC services

• Treasury operations and investment income

• Foreign exchange gains and derivative trading profits

• Rental and service charges

Special Provisions for Banks

• Section 100A and Seventh Schedule of the Income Tax Ordinance govern computation of income, deductions, and tax credits specifically for banking companies.

• Provision for bad debts is only allowed if the loan is written off and satisfies the prudential criteria laid out by SBP.

• Unrealized gains on revaluation of investments are excluded from income.

• Deferred tax asset/liability accounting follows IFRS but is treated differently for tax purposes.

Minimum Tax and Alternative Corporate Tax

Banks are exempt from Minimum Tax under Section 113. However, Alternative Corporate Tax (ACT) under Section 113C may apply if tax payable under normal provisions is less than 17% of accounting income.

This provision has been largely inactive for banks in recent years due to consistently high tax obligations, but banks must still calculate ACT for compliance.

Sales Tax on Banking Services (Provincial)

After the 18th Constitutional Amendment, sales tax on services was devolved to provinces. Each province levies sales tax on banking and financial services through its own revenue authority:

Exemptions

• Markup or interest on loans, deposits, or bonds is exempt from sales tax

• Forex transactions (if not commission-based) are generally exempt

• Utility payments and taxes collected on behalf of the government are not taxable

Sales Tax Compliance for Banks

• Register with each provincial authority where services are provided

• File monthly sales tax returns separately for each province

• Maintain STRN-enabled invoices for all taxable services

• Track input tax and ensure its apportionment where services are partly exempt

Federal Excise Duty (FED) on Banking Services

For branches operating in Islamabad Capital Territory, Federal Excise Duty (FED) at 16% is levied under Serial No. 8 of Table-II of the Federal Excise Act, 2005 on:

• ATM transactions

• Locker rentals

• Issuance of financial instruments

• Consultancy and advisory charges

• Consumer finance processing charges

This is an exclusive tax where applicable. If sales tax is paid to a provincial authority, FED is not imposed to avoid double taxation.

Withholding Tax Obligations

Banks are considered major withholding agents in Pakistan under the Income Tax Ordinance. Some key withholding tax obligations include:

Banks must deposit withholding taxes by the 7th of the following month and file withholding statements (monthly and annually) via FBR’s IRIS portal.

Taxation of Digital and Foreign Transactions

With the increase in digital banking, internet banking, and card transactions, the tax treatment of certain services has evolved:

• SMS alerts, debit/credit card issuance charges, and mobile app subscriptions are taxable under provincial sales tax

• Payments made abroad for cloud services or software are subject to withholding tax under Section 152 and may attract sales tax on imported services

• Transactions using third-party gateways (e.g., PayPal, Stripe) through bank-issued cards fall under increased SBP scrutiny

Banks providing merchant services must deduct and remit applicable taxes on each transaction and reconcile with SBP’s foreign exchange regulations.

Financial Reporting and Tax Disclosures

Banks must maintain financial records in accordance with IFRS and SBP’s Prudential Regulations. Key reporting obligations include:

• Annual Income Tax Return (Form 114)

• Monthly and Quarterly Withholding Statements (Form 184, 186, 187)

• Monthly Provincial Sales Tax Returns

• Quarterly and Annual Financial Statements with tax reconciliation

• Tax provisioning and disclosures in published financial reports

Listed banks must also comply with SECP disclosure requirements, PSX reporting standards, and submit Director’s Reports including tax compliance statements.

Taxation of Islamic Banks

Islamic banks are subject to the same tax laws, with adjustments for Shariah-compliant instruments:

• Profit from Murabaha, Ijarah, Musharakah, and Mudarabah is treated as taxable income

• Islamic banks use Shariah-compliant accounting standards but file income tax like conventional banks

• Takaful contributions paid are deductible, but only if not capital in nature

• Zakat deductions are separate from income tax and governed by Zakat and Ushr Ordinance

There is no preferential or reduced rate for Islamic banks; however, their structure of transactions impacts timing and method of revenue recognition.

Common Tax Disputes and Audit Issues

Banks often face tax audits and litigation over:

• Disallowance of provisioning for NPLs not written off

• Input tax adjustment mismatches across provincial sales tax filings

• Double taxation where both FED and provincial sales tax are inadvertently charged

• Underreporting of fee-based income on treasury or forex operations

• Disputed classification of income as capital vs. revenue (especially in case of investments)

To mitigate these risks, most banks establish in-house tax units and hire Big 4 firms or tax advisors for audit handling.

Tax Incentives and Concessions

Although no industry-wide tax holidays apply to banks, the following may be available:

• Reduced rate for exporters using banking channels for remittances

• Exemption on income from government securities in specific cases (SRO-based)

• Credit for advance tax payments and foreign tax credit under Section 103

• Deduction for donations, CSR, and community support programs under Section 61

• Tax loss carryforward for up to six years in case of business losses

Some small finance and microfinance banks may receive concessional treatment under SBP and FBR’s SME promotion initiatives.

Compliance Best Practices for Banks

To ensure smooth tax operations and audit readiness, banks should:

• Implement ERP systems integrated with tax reporting modules

• Conduct monthly reconciliation of STRN, WHT, and input tax

• Automate withholding and invoicing processes

• Engage external advisors for tax health checks and internal audits

• Stay updated with changes in provincial SROs and FBR circulars

• Maintain real-time dashboards to monitor tax payments and filing schedules

Conclusion

The taxation of banking services in Pakistan is a complex yet well-structured regime covering income tax, sales tax, federal excise, and withholding provisions. As financial intermediaries, banks play a crucial role in tax collection, documentation, and compliance enforcement. With high tax rates, evolving digital transactions, and growing regulatory scrutiny, banks must maintain robust internal systems, strong tax governance, and timely compliance with all federal and provincial authorities. A proactive tax strategy and expert advisory can help banks optimize their tax position, reduce risk, and contribute effectively to Pakistan’s revenue ecosystem.