Iran's CB Proposes Deferral of Deposit Interest Tax

The scheme to levy taxes on bank deposit interest has come to the fore again, with a senior official at the Central Bank of Iran saying that under the current circumstances, an interest income tax would hurt the Iranian financial system.

Jafar Mehdizadeh, director of the Economic Research and Policy Development Department, however, acknowledged that the plan also contains many intrinsic advantages.  

The issue of interest income tax had recently been reviewed by Majlis Research Center, the influential research arm of the parliament, with the body coming out in favor of the scheme.

Mehdizadeh enumerated the potential benefits of implementing a deposit interest tax plan, considering it be in line with economic justice, which would expand the tax base and increase government revenues.

"Economic justice rules that interest income be subject to tax like many other activities in the real sector which, unlike bank deposits, involve risks," he said.

The official added that such a scheme would help realize the country's vision of becoming less dependent on petrodollars by boosting its tax revenues.

However, even though levying deposit interest tax might be highly beneficial under normal circumstances, Mehdizadeh said doing so now would be untimely as it would "derail the goals of the policymaker [CBI] and worsen the conditions of banks".

Downsides

Surveying the current landscape of the Iranian banking system, he pointed out that it is now feeling the effects of decades of bad policy, coupled with the country's "special conditions" i.e. being relieved of sanctions only recently.

A significant amount of non-performing loans mainly because of the facilities previously allocated irresponsibly to the government and state-owned companies, and a significant volume of non-liquid assets (e.g. real-estate and bonds) that are currently evident in the balance sheets of lenders were two other major challenges referred to by the official.

As Mehdizadeh outlined, this has caused a large number of depositors to gain an unusually strong hold over the banking system, which has led to higher interest rates.

"Under the circumstances, depositors–especially major depositors–boast a higher lobbying power and can transfer the tax pressure resulting from levying tax on deposit interest to banks or people receiving loans. This would naturally reduce the profitability of banks, which are mostly posting losses, or an increase in lending rates," he said.

According to Mehdizadeh, this would drive up the costs of providing finance, especially since banks bear 90% of that burden in Iran, and undermine macro-policies of the administration revolving around supporting production and job creation.

Even if major depositors fail in their lobbying efforts, implementing a deposit interest tax scheme at present would decrease the relative attractiveness of making bank deposits by reducing the interests gained in the monetary market, which will exert a negative influence on parallel markets, especially the foreign exchange market by increasing the liquidity of bank deposits.

As to what must be done under the circumstances, the CBI official said the monetary regulator and the government are currently pursuing vast banking reforms that began about two years ago.

"Therefore, it is appropriate that the policy of levying taxes on bank deposit interest is postponed until after reforms to the banking system are completed," Mehdizadeh concluded.

In its study published in mid-December, Majlis Research Center evaluated the three ways of implementing the tax scheme and the experiences of other countries in doing so, but finally supported the scheme as it boosts transparency and tax revenues.

The body proposed that the scheme kick off by targeting large depositors and deposits whose owner identity remains unknown.

In assessing both sides of the argument, MRC announced that it has held a joint meeting with officials representing the central bank and the Economy Ministry.

The ministry is reportedly in favor of implementing the tax scheme and notes that other financial entities such as the Securities and Exchange Organization are dissatisfied with bank deposits being exempt from taxes, whereas CBI is opposed citing reasons similar to those put forth by Mehdizadeh, in addition to the potential social backlash of the tax scheme.