Cenbank asks NBR to reconsider 20% tax on foreign loan interests

Highlights:

• The plea from the central bank, communicated in a letter dated 31 August, points out that the NBR had previously waived the tax on interest for foreign loans through a circular in 1976.
• However, this beneficial provision was rescinded with the issuance of a circular in May this year.
• Consequently, interest payments on foreign loans obtained by local banks' offshore banking units and buyers' credit have now become subject to a 20% tax at the source.
• The Bangladesh Bank said that, ultimately, it is the borrowers who will bear these additional costs, not the foreign lenders.
• Thus, when calculated on a gross-up basis, the effective tax rate reaches a substantial 25%.

The Bangladesh Bank has made a formal request to the National Board of Revenue (NBR) to reconsider the 20% "withholding tax" imposed on interest payments for foreign loans in the current budget, arguing that this tax would increase borrowing costs from foreign sources by one-fourth.

The plea from the central bank, communicated in a letter dated 31 August, points out that the NBR had previously waived the tax on interest for foreign loans through a circular issued on 29 November 1976. However, this beneficial provision was rescinded with the issuance of a circular on 23 May this year.

Consequently, interest payments on foreign loans obtained by local banks' offshore banking units and buyers' credit have now become subject to a 20% tax at the source. The Bangladesh Bank said that, ultimately, it is the borrowers who will bear these additional costs, not the foreign lenders. Thus, when calculated on a gross-up basis, the effective tax rate reaches a substantial 25%.

The central bank further says the interest rates on foreign loans have already reached their peak, and the newly imposed tax only serves to make these loans even costlier. "This could lead to discouragement in taking foreign loans by offshore banking units, corporates, and importers, which, in turn, could exert pressure on liquidity and the exchange rate," reads the BB letter.

Md Mezbaul Haque, spokesperson for the Bangladesh Bank, said they have written to the NBR after the Association of Bankers, Bangladesh, a forum of bank chief executive officers (CEOs), alerted them to the challenges arising from the imposition of taxes on foreign loans.

"In response, the central bank has reached out to the NBR, emphasising difficulties faced by banks in securing foreign loans. We have formally requested the NBR to reconsider and withdraw the tax," he told The Business Standard on Saturday.

Mezbaul, also an executive director at the central bank, underscored that a reduced flow of foreign loans would impact the country's financial account and current account balance, both of which are already in negative territory.

The NBR is currently reviewing the letter from the central bank, and the ultimate decision on whether to withdraw or reduce the 20% tax rests with the chairman and the finance ministry, said an NBR official who preferred not to be named as he said he is not authorised to speak to the media.

Why are banks and businesses concerned?

Businesses and bankers said this tax, if not withdrawn, will significantly disrupt the growth of the industrial sector given that many entrepreneurs have relied on these cost-effective loans for business expansions.

For instance, Viyellatex Group, which is one of Bangladesh's leading textile and apparel manufacturers and exporters, used to take foreign currency loans directly from international development finance institutions to meet the demand for foreign currency and expand business activities.

"We take loans from foreign sources as we are not getting dollars in the country," said KM Rezaul Hasanat, chairman and CEO of Viyellatex Group.

He can now breathe a sigh of relief, with only approximately $5 million left unpaid on his foreign loans. However, he expressed strong criticism of the abrupt imposition of the tax asserting that businesses were not given any time to adjust.

According to him, foreign investors lose confidence with such unanticipated tax measures as they typically rely on loans from parent companies and foreign lenders to run their operations.

DBL Group, with diversified interests spanning textiles, garments, ceramics, and pharmaceuticals, experienced significant expansion over the past decade, largely facilitated by low-cost foreign loans obtained from institutions like the International Finance Corporation (IFC), British International Investment, and others.

However, the group, which secured $96 million in loans from international development finance institutions last year, says it will be hesitant to continue taking such loans due to the imposition of the tax.

How this tax measure hikes costs

Interest rates in the international market are now tied to the Secured Overnight Financing Rate (SOFR), replacing the previous LIBOR benchmark. Foreign loans bear an additional interest margin of up to 3.5%. With the recent US Federal Reserve rate hike, SOFR surged to 5.31% as of September 9 from its pandemic low of 0.25%, increasing international loan interest rates.

For instance, a $2 million one-year loan via buyer's credit or offshore banking units incurs roughly $180,000 in interest. With the new withholding tax, borrowers face around Tk39 lakh in interest-related taxes. While foreign firms shoulder this tax, it's passed on to borrowers. Loans from five years ago, with accrued interest, also fall under the tax umbrella.

Before the tax, Bangladeshi borrowers enjoyed a maximum 8% interest rate or less for international loans, compared to a minimum 9% for local loans. Now, dollar-denominated overseas loans command nearly 11% interest, surpassing the 10.10% local loan rate.

Bankers fear the tax will deter dollar borrowing, potentially depleting foreign exchange reserves already dwindling below $23 billion.