The financial services sector is one of the most critical pillars of Pakistan’s economy, encompassing banks, insurance companies, mutual funds, leasing firms, investment companies, microfinance institutions, and non-banking financial companies (NBFCs). Given its central role in economic development and monetary policy execution, the taxation of financial services in Pakistan is governed by a complex framework of federal and provincial tax laws. This article provides an in-depth look at how financial services are taxed in Pakistan, including income tax, sales tax on services, withholding obligations, minimum tax regimes, and sector-specific exemptions or incentives.

Regulatory Framework Governing Financial Services

The taxation of financial services is rooted in multiple regulatory and legal sources:

• Income Tax Ordinance, 2001

• Sales Tax Act, 1990

• Federal Excise Act, 2005

• Provincial Sales Tax on Services Laws such as:

  • Punjab Sales Tax on Services Act, 2012

  • Sindh Sales Tax on Services Act, 2011

  • Khyber Pakhtunkhwa Finance Act, 2013

  • Balochistan Sales Tax on Services Act, 2015

• SECP Rules for NBFCs and insurance companies

• State Bank of Pakistan (SBP) Prudential Regulations

• Insurance Ordinance, 2000

Financial service providers are typically subject to both federal and provincial taxation, depending on the nature of their services and jurisdiction.

Income Tax Treatment of Financial Services

Under the Income Tax Ordinance, 2001, financial institutions are treated as corporate taxpayers and are subject to corporate income tax as follows:

1. Banks and Banking Companies

• Taxed at a flat rate of 39% on taxable income under Division II, Part I, First Schedule of the Ordinance (Finance Act 2023)

• No separate slab-based taxation; the flat rate applies to all banking profits

• Banks are required to maintain books on accrual basis and prepare IFRS-compliant financial statements

• Expenses are allowed as deductions, except for provisions for bad debts not written off

• Taxable income includes interest income, fees, forex gains, investment returns, and treasury operations

2. Insurance Companies

• Taxed under the Fourth Schedule of the Income Tax Ordinance

• Life insurance companies are taxed on shareholder funds only

• General insurance companies are taxed on net underwriting profit

• Special rules apply for determining tax liabilities for investment-linked policies

• Tax rate: 29% on profits of insurance companies, as per corporate rate

3. Non-Banking Financial Companies (NBFCs)

• Include leasing, modaraba, mutual funds, and investment finance services

• Taxed as companies at the general corporate tax rate of 29%

• Modarabas enjoy special exemption on income distributed to certificate holders

4. Microfinance Banks and DFIs

• Taxed as companies

• Subject to standard income tax regime unless exempt under special provisions or SROs

Sales Tax on Financial Services

Unlike goods which are taxed under the Sales Tax Act, 1990, services including most financial services fall under provincial jurisdiction due to the 18th Constitutional Amendment. However, there are specific exceptions.

1. Sales Tax by Federal Government (FBR)

• FBR does not charge sales tax on most core financial services

• Only applies FED or sales tax on certain fee-based services like SMS alerts or leasing

2. Provincial Sales Tax on Services
All provinces impose sales tax on various fee-based financial services:

Services exempt from provincial sales tax typically include:

• Interest and markup on loans

• Profit from debt instruments

• Insurance premium (in some cases)

• Treasury and capital market investments

3. Key Point: Sales tax is charged only on fee-based services such as:

• ATM and transaction charges

• Safe custody and locker charges

• Issuance of financial certificates

• Advisory and portfolio management services

Federal Excise Duty (FED) on Financial Services

The Federal Excise Act, 2005 imposes FED at 16% on specific financial services if they are not already subject to provincial sales tax. However, FED generally does not apply if provincial sales tax has been paid, due to the principle of single incidence of taxation on services.

Example:

• If a bank is based in Islamabad (ICT), then FED at 16% is applicable on services like ATM fees, advisory charges, etc.

• If in Karachi or Lahore, then SRB or PRA sales tax applies instead.

Withholding Tax Obligations of Financial Institutions

Financial institutions are major withholding agents under Pakistan’s tax law. Some key withholding obligations include:

• Section 151: Deduct tax on profit on debt (rates: 15% for individuals, 20% for companies)

• Section 153: Deduct tax from payments to service providers and contractors

• Section 152: Deduct tax from payments to non-residents (royalty, fee for technical services)

• Section 149: Deduct tax on salaries of employees

• Section 233: Deduct tax on brokerage and commission

• Section 231A: Deduct tax on cash withdrawals above prescribed limits (for non-filers)

Failure to comply with withholding obligations can lead to disallowance of expenses, penalties, and additional tax.

Minimum Tax Regime

Like other corporate taxpayers, financial institutions may also fall under the minimum tax regime under Section 113 of the Income Tax Ordinance, which requires payment of 1.25% of turnover if tax liability is less than this amount. However:

• Banks are generally exempt from Section 113 because of their regulated nature

• NBFCs and insurance companies may fall under this regime depending on profitability

Taxation of Islamic Financial Institutions

Islamic banks, takaful companies, and modarabas are governed by similar tax principles but with recognition of Shariah-compliant instruments. Key features include:

• Murabaha, Ijarah, Musharakah, and Mudarabah returns are treated like conventional income

• Income distributed by modarabas is exempt if 90% of profits are distributed

• Takaful companies are taxed similarly to insurance firms, with separation of participant and shareholder funds

There is no differential tax rate for Islamic financial institutions, but the accounting treatment and contract structures are different.

Filing Obligations and Returns

All financial service providers are required to file the following:

• Income Tax Returns (annually on IRIS)

• Sales Tax Returns (monthly with PRA, SRB, KPRA, or BRA)

• Withholding Statements under Sections 149, 153, etc.

• FED Returns (where applicable)

• SECP Filings for NBFCs, mutual funds, and insurance firms

Banks and insurance companies are also subject to:

• SBP and SECP audit requirements

• Regular reporting to Pakistan Stock Exchange (if listed)

• Quarterly and annual financial statement submissions

Tax Incentives and Exemptions

The government has provided certain incentives to the financial sector:

• Reduced tax on microfinance institutions under certain SROs

• Profit on government securities exempt under specific SROs

• Mutual funds and REITs benefit from reduced tax rates or exemptions if 90% of income is distributed

• Export refinance and SME lending incentives for banks with favorable tax treatments

Modarabas are also provided a favorable tax regime to encourage Islamic financial development.

Challenges and Tax Disputes in the Sector

Despite clear laws, the financial sector faces multiple challenges:

• Double taxation between FED and provincial sales tax

• Ambiguity in distinguishing taxable vs non-taxable services

• Frequent changes in tax rates and SROs

• Litigation on input tax adjustment and apportionment under provincial laws

• Sector-specific audits by FBR and PRA causing compliance costs

Regular coordination with tax consultants and updated legal opinions are necessary to mitigate these risks.

Digital Financial Services and Emerging Trends

The taxation of fintech and digital financial services such as e-wallets, branchless banking, and mobile payment apps is an evolving area. As of 2025:

• Services by telecoms (e.g., Easypaisa, JazzCash) are subject to provincial sales tax

• SBP-licensed fintechs are regulated like NBFCs and face standard taxation

• Commission-based earnings from payment gateways are taxable

• Cross-border digital payments are under increased scrutiny for taxation

The FBR is also working on digital economy taxation, including rules for foreign digital services, in coordination with OECD BEPS frameworks.

Best Practices for Financial Institutions

To ensure smooth compliance with tax regulations:

• Maintain real-time tax dashboards and transaction tagging

• Reconcile tax deductions with GL accounts monthly

• File withholding statements accurately and on time

• Segregate taxable and non-taxable revenue streams

• Conduct quarterly internal tax reviews or audits

• Stay updated with provincial SROs and amendments

Engaging a specialized tax advisor with experience in financial services is highly recommended.

Conclusion

The taxation of financial services in Pakistan is shaped by a complex interplay of federal and provincial laws, evolving regulatory frameworks, and dynamic financial instruments. Understanding the income tax structure, sales tax on services, and specific compliance requirements is essential for banks, insurance companies, NBFCs, and fintechs. As digitalization accelerates and tax authorities become more vigilant, proactive tax planning and regulatory awareness are key to managing tax risks and ensuring smooth operations in Pakistan’s financial sector.