Are withholding taxes holding back businesses?
P
By Ahtasam Ahmad
akistan’s Federal Tax System is a huge puzzle that seems to get more complicated as the time passes. In the last 2 years, 5 different individuals have served in the role of Chairman of the Federal Board of Revenue (FBR) as the institution struggles to catch up with the consistently rising revenue collection targets set by the IMF.
A brief introduction of Pakistan’s withholding regime
P
akistan’s tax system is by design dependent on indirect taxes as the direct tax filing ratio is just around 1% of the total population. To facilitate the process of collecting direct as well as indirect taxes, the Federal Board of Revenue (FBR) implements its withholding tax regime in which taxes are deducted at the source of transaction rather than at filing of the returns. The withholding tax laws of Pakistan state that Companies and other prescribed persons, known as withholding agents are required to deduct taxes, on behalf of FBR, while paying to their suppliers, vendors, service providers and employees. The tax regulator has devised this mechanism to ensure that tax revenue is collected even if the majority of individuals required to file tax returns are not filing. However, this system is a matter of contention between the Industry and the Regulator. A wide base of withholding tax regime is a recurring feature in the developing world as conventional tax collection is low due to majority of taxable activity originating from undocumented sectors primarily agriculture, small and informal. Therefore, to meet the revenue targets, tax is collected through withholding tax agents in order to encourage the population to get themselves documented.
Why are businesses so averse?
T
he industry in general is not content with the system devised for withholding tax deductions and the majority see it as a deterrent to the ease of doing business. One of the reasons for this is the complication of the system. The rules for withholding tax are complicated and
28
the fact that the majority of our population has very low financial literacy doesn’t help. Furthermore, it should be noted that sometimes, the FBR laws just don’t make sense from a business perspective. A reputed tax practitioner from Islamabad, told Profit that once they were confronted by a client on why FBR requires them to deduct withholding sales tax on a made-up amount when the actual receipt is less than that. The practitioner couldn’t justify the business sense behind it, because there wasn’t any. (E.g If a withholding agent purchases good worth Rs. 100 from someone whose tax should be withheld, in that case the person would gross up the invoice amount of Rs.100 to Rs. 117 (17% Sales Tax) and then charge the applicable withholding tax rate of 5% on the grossed-up amount of Rs. 117.) Furthermore, the business community just cannot trust the FBR. The board of revenue has a history of going after businesses in a draconian manner to meet their targets (Last year FBR sealed the headquarters of Jazz, Pakistan’s biggest telecommunication company, in an attempt to recover outstanding taxes). The distrust coupled with the intricate tax systems lays the ground for a cat and mouse game between the taxpayer and the regulator, each trying to get one up but ends up exhausting valuable resources that could have been put to much more productive use.
Methods of tax evasion
T
his situation ultimately propels the taxpayer to find ways to hoodwink the board of revenue and evade taxes payable. So what are the general practices to evade the withholding? Actually, there are many, some include transacting below prescribed thresholds in order to go under the radar and others are more blatant practices that have become a norm. Some common examples include breaking down transactions into smaller ones so that they fall within limits for cash-based transactions, thus withholding deductions are not required. Furthermore, the businesses especially those in the construction sector use ghost employees as a way to break up the salary and wages expense into cash permissible limits of Rs.25,000. Some business owners have multiple registered companies, some that qualify as withholding agents while others that don’t. This way they are able to divide up transactions and
get a discount from suppliers and vendors as a reward for not withholding their taxes. Furthermore, it is a practice to disguise employees for service providers as there is a flat rate of withholding tax for contractual agreements compared to higher end of salary taxation.
Consequences
A
s a result of these activities the revenue collection has become difficult and the burden of tax targets is borne by those taxpayers who diligently try to adhere to the tax framework. This is something that can not last long as the taxpayer community will sooner or later confront FBR about the detrimental effects of the excessive tax burden on their business.
Solution
T
he solution to this is not simple but is necessary. What the board needs to do is streamline the process of revenue collection and make it easy for taxpayers to understand the withholding tax regime. Furthermore, digitization is something that can resolve a lot of tax evasion issues. However, it is necessary to understand that Pakistan still has a long way to go given that the majority of our SME sector businesses lag behind in the effective use of technology (A recent example is the resistance faced for Tier-1 retailer integration). Moreover, there needs to be trust building between the regulator and Industry as the latter always views the board’s reforms with suspicion. One of the most important and inevitable changes that FBR needs to implement is in its resource building department. The Board’s staff is not adequate to deal with complex matters of taxation as they neither have the technical expertise in the field nor do they have any professional experience. Hiring BA’s and equivalent instead of individuals that understand finance isn’t working for the department. Furthermore, there needs to be a transfer of resources from the private sector. Professionals practicing tax and individuals holding professional qualifications like Chartered Accountancy need to be made a part of the mix and for that the board must reconsider its payscale. At the end of the day, whatever the goal might be for the regulator, its tax regime should be based on rational grounds and possess the characteristics of being equitable, certain, convenient and economical. n
ANALYSIS
