You would be aware that the recently enacted Finance Act, 2009 has made significant amendments in the Seventh Schedule to the Income Tax Ordinance, 2001 (the Ordinance) with regard to the allowability of charge for irrecoverable debts in arriving at the taxable income of the banking companies. The provisions of the Seventh Schedule to the Ordinance as amended by the Finance Act, 2009 now allows banking companies a tax deduction in respect of the provisions for advances and off balance sheet items up to a maximum of 1% of total advances on the basis of a certificate from the external auditor to the effect that such provisions are based upon and are in line with the Prudential Regulations of the State Bank of Pakistan. Further, provisioning in excess of above referred limit would be allowed to be carried over to succeeding years.
In this regard, various members of the Institute of Chartered Accountants of Pakistan (the Institute) and the representatives of the Banking Industry of Pakistan have approached the Institute with regard to the impact of the aforesaid changes in tax laws on the following:
(a) the deferred tax asset recognized by the banks in relation to provisions for non-performing advances made in the previous periods and which have not yet been allowed as a tax deduction. As the amendments introduced in the Seventh Schedule does not provide for any transitional mechanism, an ambiguity exist as to whether the same would be allowed as a tax deduction when the amount is actually written off.
(b) deferred tax asset that pertains to the excess of the provisions made by the banks in a particular year over the 1 percent threshold as allowed under the Seventh Schedule to the Ordinance.
With respect to (a) above, the Institute would like to inform the members that this matter has been taken up by Pakistan Banking Association (PBA) and the Institute with the Federal Board of Revenue (FBR) whereby the PBA and the Institute have proposed to the FBR to introduce appropriate transitional provisions in the Seventh Schedule to the Ordinance in order to address this issue. However, pending the final resolution of the matter and considering the fact that the interim financial statements of the banks are due to be issued in the near future, the Institute considers that reversal of deferred tax assets in relation thereto may not be made until the end of the financial year by which time the matter is expected to be decided by the FBR as proposed by the Institute and the PBA.
With respect to (b) above, the Institute would like to draw attention of the members to the requirements of IAS 12 which entail that a deferred tax asset should be recognized for deductable temporary differences when it is probable that the same would be realized in future periods. Accordingly, in respect of carry over provisions for tax purposes, the respective bank should estimate the future pattern of provisioning in addition to its estimates about the availability of sufficient taxable profits, and consequently determine the amount of deferred tax asset that should be recognized in this respect.
Members are advised to take note of the same.