WITHHOLDING TAXES A CURSE OR A BLESSING

By: Dr Muhammad Iqbal

The performance of FBR has come increasingly under the microscope in recent years.
FBR is criticized not only for not collecting enough taxes to meet the governmental needs but
also for using inappropriate policies for whatever collection is achieved. Tax policy is
castigated as being discriminatory, anti-growth and hostage to elitist interests. Such critiques
are not merely a nuisance but lead to narrative-building which ultimately shapes policies. As
an illustration of this phenomenon one can cite the example of withholding taxes. Pakistan’s
taxation system is criticized for its undue reliance on indirect taxes and a wide range of
withholding taxes. The increase in income tax collection in the past is censured as being due
to over 60 types of withholding taxes; both adjustable and non-adjustable. The withholding
taxes are lambasted as being regressive and putting undue burden on the common man and
sparing the rich. The compliance cost borne by the withholding agents is also cited as a
disadvantage of a large number of withholding provisions. It appears that the criticism has
been unwittingly accepted as the gospel truth without being subjected to a stern analysis.

Withholding taxes are neither freakish instruments of tax policy nor were introduced
in Pakistan in recent times only. All over the world certain income streams such as dividends,
royalties, interest, payments to non-residents, income from employment etc are subjected to
withholding taxes which in some cases are treated as final taxes and in others as adjustable
against the final tax liability. However, in Pakistan the scope of withholding taxes did not
remain restricted to income streams but was also extended to cover some items of
expenditure. This has led to the criticism referred above without understanding the rationale
of these taxes. Due to absence of documentation of economic transactions, or not less
importantly, the lack of their visibility to the tax administration, FBR has faced challenges in
assessing actual incomes. Legal fictions were created to treat significant investments and
expenses as income since investment and expenditure are a function of the income. In an
opaque economic environment, the tax machinery is not in a position to collect due taxes on
income so the only alternative is to use proxies and at the same time attempt to make more
significant transactions visible to it. The proliferation of withholding taxes in recent past was
the inescapable consequence of this approach.

In order to appraise the claims regarding regressivity, it would be useful to list the
transactions on which withholding taxes were enforced. Adjustable withholding taxes were
introduced mainly on sale and purchase of real estate, on domestic electricity bills above a
certain monetary threshold, on education expenses of children in expensive schools in
Pakistan and abroad, purchase of international tickets for travel other than in economy class,
domestic air travel, on commercial and industrial electricity connections, on booking and
registration of motor vehicles, purchase of property in auction, on functions and gatherings
held in hotels and marquees, persons remitting money abroad through credit or debit cards
etc. None of the above withholding taxes impacted the proverbial masses but were a tool for
documenting significant economic transactions undertaken by persons who should be in the
tax net and filing their tax returns claiming the withheld amount of tax as adjustable against
their actual tax liability. Yet another group of withholding taxes is collected directly on
purely commercial income generating activities such as on Brokerage or commission
received, Stock exchange transactions by their members, from CNG stations and petrol
pumps, steel melters, cable operators, sales to distributors/ dealers/ wholesalers by
manufacturers, sales to retailers by distributors/ dealers/ wholesalers, from commission
agents/arhtiis by the market committees, on lease of machinery and equipment, on extraction
of minerals, on payments for technical services, royalties and digital services to non-residents
and on purchase of tobacco for cigarette manufacturing. These newer adjustable withholding
taxes were in addition to the withholding taxes that have been in vogue for decades including
withholding taxes on salary, dividend, imports, exports, contracts, rental income etc.

The incidence of the withholding taxes listed above as already mentioned is largely
restricted to persons who otherwise should be paying income tax and the fact that these newer
withholding taxes were adjustable and not final, addressed concerns regarding fairness and
equity. The critics also ignored the fact that these withholdings provided a source of
documentation of the transactions having significant economic worth and not only helped in
identifying potential taxpayers but if backed by robust data analytic tools can also help in
checking under-declaration by existing tax-filers. This wide range of withholding taxes also
enabled a trailblazing measure of creating the distinction between filers and non-filers
whereby the non-filers are subjected to higher rates of withholding taxes thus creating an
incentive for joining the tax net. Even if a person opts to remain out of the tax net and
foregoes the tax withheld, the system at least ensures some contribution from such delinquent
persons in the short term.

However, it has to be admitted that there are certain withholding taxes that are
imposed on persons who are otherwise not liable to payment of income tax and return filing.
The most notorious amongst these and the one that is widely cited to discredit the entire
spectrum of withholding taxes is the withholding tax on mobile phone subscribers. At the
very outset it has to be pointed out that this is not a new withholding tax and was introduced
in 1996 under the Repealed Income Tax Ordinance of 1979 when the mobile phones and their
usage were quite expensive and restricted to upper income groups. However, this became a
source of revenue for the government and even when the mobile phone penetration increased
exponentially and the masses started subscribing to this service, suitable adjustments were
not made to address the equity and fairness concerns. Although the tax is adjustable a vast
section of mobile phone subscribers are not liable to file their returns and cannot claim credit
of the withheld tax. That was precisely the reason that the Apex court in 2017-18 stepped in
and suspended collection of withholding taxes and other levies from mobile phone users. The
withholding tax collected by Banks from profit on debt or markup paid to the account holders
is another tax that can be termed as unjust in its present shape. This is due to the fact that
there is no minimum threshold after which it becomes deductible. Even small accountholders
receiving petty amounts are subjected to withholding and the withheld amount was
previously treated as the final tax and w.e.f 1st July 2019 as the minimum tax in the in the
case of individuals receiving annual profit upto Rupees five million (Thirty six Million till
30th June 2021).
 The few instances quoted above cannot be used to deprecate the entire withholding
regime in view of the purpose it serves in the context of the present stage of economy and the
capacity of the tax administration. But as already pointed out the narratives start shaping
policies and in the last two years withdrawal of more than two dozen withholding taxes on
various transactions has been witnessed. The constraints of space do not permit an analysis of
the pros and cons of each withholding tax that has been withdrawn but suffice it to say that
their withdrawal will result not only in loss of precious revenues but will also have an adverse
impact on the awareness of the tax administration regarding instances of non-reporting and
under-reporting of income. It is also interesting to note that the two withholding taxes on
mobile usage and profit on debt that have a disproportionately larger impact on less affluent
sections of the society have remained intact and the rate of deduction on profit on debt also
witnessed an across the board increase in the Finance Act, 2019 from 10% to 15%.

In the conclusion it needs to be said that Withholding taxes serve useful tax policy purposes
in an undocumented economy as well as fiscal policy. However, there are also disadvantages
that results from favoring of the withholding tax by the government even where they do not
serve these purposes. Withholding taxes allows the government to collect income taxes even
when the capacity of the tax administration is low. Withholding taxes may be regressive if
they are paid by people who are not liable to income taxes and/or if firms treat these as
consumption taxes and they are passed through to consumers. It might have been appropriate
to conduct a study to analyze these factors and categorize different withholding taxes
focusing on desirability of maintaining, amending or phasing out before embarking upon an
exercise of large scale withdrawal.