The government has enhanced the burden of taxes on the common man to generate revenues for the economy but its measures such as imposing high withholding tax rate, on the banking transactions of more than Rs. 50,000, have become useless and counterproductive for the economy.
The target of enhancing tax rate on non-cash transactions (interbank fund transfer) was improving revenue streams, encouraging people to file income tax returns, and discouraging cash economy.
On the other hand, the currency in circulation has been increased markedly, the deposit growth of the banking industry witnessed a drop, and alternate methods were introduced by traders to avoid taxes such as opening of multiple accounts and trading Dollar and Prize Bonds.
To recall, the government imposed a withholding tax on non-filers of income tax returns through the Finance Bill 2015, initially at the rate of 0.6 percent on all non-cash banking transactions and on cash withdrawal. Later, the tax rate was lowered to 0.4 percent after opposition from some circles of the society.
For FY18, a WHT of 0.3 percent and 0.6 percent applies on filers and non-filers, respectively, on cash withdrawals exceeding Rs. 50, 000 per day. However, filers can claim for refund of the amount paid in this tax.
Negative Aspects of WHT on Banking Transactions
While the withholding tax on non-cash banking transactions seems to have had a negligible impact on revenue collections and incentivizing tax filing, it instead led to an increase in currency in circulation and a decline in private business deposits, according to a study by State Bank of Pakistan (SBP) titled “The State of Pakistan’s Economy”.
Currency in circulation grew by 21.5 percent on average during July 2015 to June 2017 against an average growth of 14.0 percent recorded in the past 11 years (between July 2004 to June 2015) prior to its imposition.
It was expected that this tax would help expand the tax base by encouraging more people to file income tax returns and come under the tax net. The introduction of the transaction tax led to some increase in the number of income tax filers but not to sales tax filers. The reason is that many salaried persons who were already paying income tax but were not filling tax returns started to do so to qualify for the adjustment against the advance tax payments.
Despite this, the number of non-filers as a percent of the registered income tax payers remained high at around 70 percent in FY16.
Moreover, the private business deposits, as a percentage of total deposits, declined from 27.6 percent to 25 percent after imposition of the WHT on banking transactions.
This shows that the imposition of the WHT on banking transactions apparently defeated the very purpose for which it was imposed i.e. to discourage the cash economy.
It is pertinent to mention here that the WHT on cash withdrawals and on banking transactions respectively has contributed on average 0.9 percent and 0.6 percent annually to the FBR tax revenue, since July 2015.
In effect, this analysis suggests that the economic cost of imposing WHT on non-cash banking transactions needs rethinking, SBP report added.
In case of revenue, however, WHT on cash withdrawal has a strong positive impact compared to the tax on non-cash banking transaction. In particular, a 0.1 percent increase in the WHT on the cash withdrawals leads to 0.13 percent increase in the FBR tax revenue, while similar increase in the tax on banking transactions leads to only 0.009 percent increase in the FBR tax revenue.
The imposition of WHT on cash withdrawal has a negative but statistically insignificant impact on currency in circulation growth. As the objective of the WHT on cash withdrawals was to discourage the cash economy, the negative coefficient of WHT on cash withdrawals was expected, SBP report added.