The central bank’s latest State of Economy report finally brings home a point that this column has been writing about in its coverage of FBR’s annual tax directories for the last three years: the WHT-isation of tax policy is not the right foot forward. It only reflects short-cut economic thinking, and as is the case in life, there are no short-cuts to economic reforms; the fall out of short-cuts being usually negative.
Recall that direct taxes grew by Rs140 billion in FY17. Of that Rs109 billion or 78 percent came from the increase in withholdings taxes, pushing up the contribution of WHT to total direct tax collection to 66.7 percent from 65.5 percent in FY16.
The consequences of such excessive WHT-isation come in various forms. At one end, businesses have been shying away from formalizing because they don’t want to get entangled in the web of WHT and other difficulties that even box standard salaried class filers face while filing tax returns.
At the other end, formal sector players have no option but to either increase prices to pass on the impact of WHT or take a hit on their margins. This is because they have been tasked to become withholding agents and deposit the same to the FBR, regardless of whether they are deducting it from their supplier or not. And given the informal nature of Pakistan’s economy, formal sector players eventually have no option but to purchase many their supplies and services from informal players.
Is the reward worth this pain? Turns out, the reward itself is too little to write home about.
“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 around 70 percent in FY16,” so notes the SBP in its latest annual report.
The SBP added that though the incentive of tax adjustment is also available for sales tax payers, delays in processing of refund claims may have discouraged potential and current sales tax filers from filing their returns.
There is no denying that a culture of filing tax returns may have picked up in the salaried class; but if the purpose of WHT-isation, especially differentiation of filers/non-filers, was to rope in those who are outside the tax net, especially the countless AoPs and informal players, it has not reaped fruits. If it were so, collection on demand would have increased much higher than 5.6 percent (as against 13% growth in WHT).
Consider also the fact that the WHT on cash withdrawals and on banking transactions has contributed on average 0.9 percent and 0.6 percent respectively to annual FBR tax revenues since July 2015, according to SBP’s analysis. While the revenue impact has been negligible, the WHT-isation has led to an increase in currency-in-circulation and a decline in private business deposits. For a government that says it wants to increase financial inclusion in the country, the rise in CIC and fall in deposits are not exactly agreeable consequences of WHT-isation.
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