Leaving Zero Coupon Bond out of tax net
Khaled Mahmud Raihan | Sunday, 15 June 2008
THE proposal for withdrawal of SRO on exemption of tax on Zero Coupon Bond (ZCB) is considered to be a big blow to the development of bond market in Bangladesh and thus proving the fact that the government is still in the hose of dilemma on bond market development. The above will put an end to the initiative of a good number of financial institutions to raise fund from the market through ZCB.
The government by dint of power vested in Section 44 (sub-section 4) of the Income Tax Ordinance repealed S.R.O circular no. 159 which gave the privilege of tax exemption of the income derived from Zero-Coupon Bonds (ZCBs) issued by any institution being approved from Bangladesh Bank and the Securities and Exchange Commission (SEC). The above move will have significant adverse impact on the development of bond market as the instrument has become popular due to its attractive and unique feature of creating win-win situation. The issuers were getting the benefits as they were able to use the instrument as a cheap cost funding source while the bondholders were benefited by higher effective interest rate due to tax exemption. The first and foremost affected sector will be the financial institutions which played the pioneering role in introducing zero coupon bonds as a new financial tool heralding a departure from traditional mode of financing and opening a new window in the financial landscape of Bangladesh. During 2004 and 2005, three leading financial institutions of the country issued ZCBs by securitizing part of their lease portfolios. However, due to subsequent change in the income tax structure against income derived from ZCBs, the FIs couldn't further issue any new bonds. Finance Ordinance 2007 reintroduced the income tax exemption on interest earned against investment in ZCBs which once again opened up new avenue to explore cheap cost funding sources. In line with the above, many financial institutions started moving forward to issue ZCBs, a couple of which are awaiting the decision of Bangladesh Bank and Securities and Exchange Commission. However, the initiatives will end in smoke due to the revocation of the S.R.O 159 and the same will through the financial institutions into deep financial crisis. As we all know, financial institutions are mainly dependent on the borrowing from banks that constitutes the major portion of the total funding mix. Along with bank borrowing, many financial institutions mobilize a term deposit which is still costly. The increased market pressure of interest rate will force the financial institutions to operate in a very thin margin. Moreover, budget deficit for the forthcoming fiscal has been estimated at TK 305.80 billion or 4.99 per cent of GDP under the proposed budget and out of this, 2.2 per cent of the GDP will be financed from foreign resources while the other 2.8 per cent will be met from domestic borrowing. The net domestic borrowing of the government, from both banking and non-banking sources, has been estimated at TK 169.98 billion while the net external borrowing has been estimated at TK 72.36 billion under the proposed budget. The over-dependence of the government on domestic borrowing is likely to create "Crowding Out effect" in the private sector which ultimately will adversely affect the financial institutions due to their inherent dependence on the bank borrowing.
The situation has further been aggravated as the Finance Ordinance 2007 withdrew the facility to claim depreciation on leased assets by the financial institutions which will have significant adverse impact on the cash flow which are operating mainly under leasing sector. The cumulative effect of all the factors will pose threat to the survival of the prospective sector which has already contributed significantly to the financial system of the country. Against the above backdrop, the government should review and rationalize the above circular for the greater interest of the bond market in general and the financial institutions in particular.
The writer can be contacted at Email: [email protected]
The government by dint of power vested in Section 44 (sub-section 4) of the Income Tax Ordinance repealed S.R.O circular no. 159 which gave the privilege of tax exemption of the income derived from Zero-Coupon Bonds (ZCBs) issued by any institution being approved from Bangladesh Bank and the Securities and Exchange Commission (SEC). The above move will have significant adverse impact on the development of bond market as the instrument has become popular due to its attractive and unique feature of creating win-win situation. The issuers were getting the benefits as they were able to use the instrument as a cheap cost funding source while the bondholders were benefited by higher effective interest rate due to tax exemption. The first and foremost affected sector will be the financial institutions which played the pioneering role in introducing zero coupon bonds as a new financial tool heralding a departure from traditional mode of financing and opening a new window in the financial landscape of Bangladesh. During 2004 and 2005, three leading financial institutions of the country issued ZCBs by securitizing part of their lease portfolios. However, due to subsequent change in the income tax structure against income derived from ZCBs, the FIs couldn't further issue any new bonds. Finance Ordinance 2007 reintroduced the income tax exemption on interest earned against investment in ZCBs which once again opened up new avenue to explore cheap cost funding sources. In line with the above, many financial institutions started moving forward to issue ZCBs, a couple of which are awaiting the decision of Bangladesh Bank and Securities and Exchange Commission. However, the initiatives will end in smoke due to the revocation of the S.R.O 159 and the same will through the financial institutions into deep financial crisis. As we all know, financial institutions are mainly dependent on the borrowing from banks that constitutes the major portion of the total funding mix. Along with bank borrowing, many financial institutions mobilize a term deposit which is still costly. The increased market pressure of interest rate will force the financial institutions to operate in a very thin margin. Moreover, budget deficit for the forthcoming fiscal has been estimated at TK 305.80 billion or 4.99 per cent of GDP under the proposed budget and out of this, 2.2 per cent of the GDP will be financed from foreign resources while the other 2.8 per cent will be met from domestic borrowing. The net domestic borrowing of the government, from both banking and non-banking sources, has been estimated at TK 169.98 billion while the net external borrowing has been estimated at TK 72.36 billion under the proposed budget. The over-dependence of the government on domestic borrowing is likely to create "Crowding Out effect" in the private sector which ultimately will adversely affect the financial institutions due to their inherent dependence on the bank borrowing.
The situation has further been aggravated as the Finance Ordinance 2007 withdrew the facility to claim depreciation on leased assets by the financial institutions which will have significant adverse impact on the cash flow which are operating mainly under leasing sector. The cumulative effect of all the factors will pose threat to the survival of the prospective sector which has already contributed significantly to the financial system of the country. Against the above backdrop, the government should review and rationalize the above circular for the greater interest of the bond market in general and the financial institutions in particular.
The writer can be contacted at Email: [email protected]