Banks operating in Pakistan have formally requested the government to restore the original tax treatment on bad debts, submitting their proposals for the upcoming federal budget 2025–26. The banking sector is seeking a re-evaluation of recent amendments that they argue limit tax deductions related to loan losses and bad debts, particularly in the context of the newly implemented International Financial Reporting Standard 9 (IFRS 9).
Effective January 1, 2024, the State Bank of Pakistan (SBP) mandated the adoption of IFRS 9 for all banks. This new framework introduced significant changes in how financial instruments, including bad debts and credit losses, are recognized and measured. In response to this, the Finance Act 2024 introduced amendments aimed at maintaining the pre-existing tax status quo by disallowing certain deductions under the new accounting standard.
Current Tax Law vs. IFRS 9
Under the current tax law, provisions for bad debts classified as ‘sub-standard’ and ‘doubtful’ under SBP’s Prudential Regulations are not eligible for tax deductions until those debts are officially reclassified as ‘loss’. Furthermore, any provisions for advances, off-balance sheet items, or financial assets—whether performing or non-performing—classified under Stage I, II, or III of the Expected Credit Loss (ECL) model in IFRS 9 are not deductible for tax purposes.
Banks argue that this current tax treatment creates a significant discrepancy between internationally recognized accounting standards and domestic tax regulations. While IFRS 9 requires timely recognition of credit risk and expected credit losses, the existing tax laws effectively delay the recognition of these bad debts for deduction purposes, impacting their taxable income.
Call for Harmonization and Reduced Litigation
Consequently, the banking sector has proposed that any loan losses recorded through the Profit and Loss account or directly in equity under the IFRS 9 framework should be treated as allowable expenses for tax purposes.
The sector believes that aligning the tax treatment with the actual financial reporting of bad debts will significantly reduce administrative hurdles and ongoing litigation between banks and tax authorities. Given that the banking industry operates under a schedular tax regime based on audited financial statements prepared in line with SBP guidelines, the current system is seen as introducing unnecessary complexity and compliance burdens.
By restoring what they refer to as the original tax framework for bad debts, banks argue that they will be better positioned to reflect their true financial health and efficiently manage credit risk. This alignment, they contend, would also enable them to contribute more transparently to the national tax system. If accepted, this proposal could lead to fewer disputes and a more predictable tax environment for Pakistan’s crucial banking sector.
