Pakistan - The withholding tax: some disturbing facts

According to a Business Recorder exclusive, the federal government is reviewing the adverse impact of the withholding tax (WHT) regime on the sale/purchase of immoveable properties and on the imposition of capital value tax (CVT) by provinces on property with the objective of determining whether to continue imposing this tax in the budget for the forthcoming fiscal year. With a specific reference to the tax on immoveable properties, it is relevant to note that it is a provincial subject and to impose a WHT tax on top of the CVT imposed by the provinces would normally imply lower revenue collections by the provinces mainly because the levy of higher taxes would become a challenge to meet for a small businesses/buyer of property. 

The issue of the negative impact of WHT on provincial revenue was raised by Khyber Pakhtunkhwa (KPK) Legal Advisor who gave the example of imposing WHT on immoveable properties in addition to the provincial levy of CVT on sale/purchase of immoveable properties as the reason behind a greater number of transactions in grey areas. The Chairman Federal Board of Revenue (FBR) working under increasing pressure from the Finance Ministry to meet the newly downward revised revenue targets promised that he would examine the KPK proposal once a plausible case based on empirical evidence is presented. It is unclear whether the evidence would be provided on time to the FBR to enable a timely decision with respect to the WHT imposition in the next fiscal year's budget. 

First off, it is necessary to acknowledge that almost 50 percent of our economy operates outside the ambit of the FBR. This does not only include the large number of extremely small businesses run by the vulnerable but also a large number of traders/business houses who claim that the reasons for their resistance to becoming filers is attributable to the misuse of discretionary powers of the FBR officials. Or in other words, these non-filers would rather pay a higher WHT instead of filing their tax returns, which as per the current budget has a higher applicable tax rate, but importantly from their perspective, disable the FBR from examining their books. For the government to enhance reliance on withholding tax, therefore, is a measure of its sustained failure to enhance documentation of the economy. It is also relevant to acknowledge that Pakistan has the lowest tax to Gross Domestic Product ratio or disturbingly the tax generated as a consequence of economic growth is much lower than in other countries. 

To further compound the complexity of our WHT tax regime the government also imposes a WHT on the sales tax paid. Taxpayers in the country operating in the legal economy have to withhold a portion of the sales tax charged to them and deposit it in the treasury. More often than not, businesses are offered two set of prices - one where the sales tax is charged and another where it is not. Those who lay the blame squarely on small units must acknowledge the complexity of our WHT regime and the fact that a full-time accountant is required for compliance that includes filing of monthly returns of withheld tax that is an added expense that would simply push the small entity into losses. Thus in Pakistan income which is a direct tax has been transformed through an all-encompassing WHT regime into an indirect tax where businesses build it in their cost of products leading to price inflation. This is so because of the cumbersome procedure to get credit for tax deducted at source and an ordeal if refund is to be claimed in case the tax deducted is more than the tax due at the end of the financial year. To exacerbate matters further, the rates of WHT have steadily increased fuelling higher price inflation and tax evasion.

The incidence of a direct tax is greater on the rich than on the poor because higher the income the higher the tax not only in terms of its quantum but also in terms of applicable rate. This is not so in the case of an indirect tax because incidence of an indirect tax is greater on the poor than on the rich. 

To conclude, in the long run the government must focus on substantially lowering the WHT rates but given the focus of the PML-N government to generate greater revenue through the distinction between filers and non-filers, it is unlikely that withholding rates of tax would be reduced in the near future.