Increasing reliance on withholding tax

Withholding tax revenue continues to be the leading source of ‘direct tax’ receipts owing to its easier mode of collection through economic agents, and the failure of tax authorities to tap large undocumented segment of the economy.

More than 56.9 per cent of the so-called direct tax revenue comes from the withholding tax (WHT), which relieves the tax authority from its primary responsibility to collect tax.

The revenue collection on demand creation, which involves the efforts of tax officials, has actually declined by around 31 per cent in fiscal year 2012-13 over the pervious year. One of the reasons for this is the lack of audit for several years, and the huge demand that is stuck up in litigation.

The second component of direct taxes is payments with returns and advances. This includes advance tax payments, and payment with returns. The advance tax payment witnessed a paltry growth of 3.5 per cent over 2012-13, while the payment of tax with returns declined by 1.3 per cent.

As a result of this poor direct tax collection, the withholding tax has emerged as the leading tax collection mechanism for the FBR. The WHT revenue rose to Rs436 billion in FY12-13, from Rs420 billion from the previous year, recording a growth of 3.7 per cent. Nine major withholding taxes contributed around 90 per cent to the total WHT revenue.

Despite the WHT’s growing contribution over time, there is ample proof that withholding agents are not depositing the actual amount they deducted at source from the taxpayers. Many such cases were recently detected by the tax authorities.

The highest growth in WHT collection has been from imports (21 per cent), followed by dividends (13 per cent), electricity bills (9.5 per cent), contracts (6.4 per cent) and bank interest (4.5 per cent). The reason for the substantial increase in collection from imports was that the rate of WHT on imports was enhanced to five per cent on certain items and persons that were previously granted the benefit of reduced rates.

On the other hand, collection from salaries, telephone, exports and cash withdrawals declined during the same period. The decline noted in WHT on salaries is because the basic exemption limit was enhanced from Rs350,000 to Rs400,000, and the rate for each slab was also reduced in the budget for FY12-13. The amount of daily cash withdrawal not subject to withholding tax was enhanced to Rs50,000 from Rs25,000 in 2012-13.

To improve collection from these, the government revised the rate of withholding tax on cash withdrawals and revised the slabs for salaried employees. Similarly, the government introduced 10 new withholding taxes in the budget 2013-14, which will not only increase the share of withholding taxes in total collection, but also increase direct taxes.

But the revenue collection function of companies and banks etc. has also created problems for withholding agents, in terms of logistics and record-keeping.

Some studies have pointed out that the ever-expanding withholding tax regime overburdens the corporate sector, which, in order to fulfill its multiple obligations under the WHT regime, has to hire extra staff. This not only adds to their cost of compliance, but also results in duplication of work, at extra cost. And for non-compliance of WHT provisions, the withholding agents face punitive measures.

Documentation issues are beyond the control of withholding agents. And due to a lack of adequate tax education, small taxpayers find it difficult to meet their tax obligations. There are some reports that many businesses treat withholding taxes as expense, and pass on this burden to the consumers. The WHT regime tends to redefine the ‘direct tax’ — if not its mode of collection — in its actual impact.

With all these problems, the tax department is still promoting the collection of taxes through WHT, because the tax officials are not willing to perform their duties and so pass on the responsibility to the businesses.