Concerns and Implications of Proposed Restoration of Withholding Tax on Cash Withdrawal and Banking Transactions

Authors: Mr. Usman Azmat (Advocate High Court) and Mr. Muhammad Anas Farhan (Vice President, Tax Department, ZTBL)

The Annual Federal budget is scheduled to be presented to the National Assembly on the 9th of June. Recent news regarding potential tax proposals from the Ashfaq Tola-led Revenue and Resource Mobilization Commission has been generating headlines for the past two weeks.

One of these proposals is the reinstatement of withholding tax on cash withdrawal, banking instruments, and other banking transactions. This reinstatement involves the revival of sections 231A, 231AA, and 236P of the Income Tax Ordinance 2001, which were abolished two years ago in the Finance Act of 2021.

The withholding tax on banking transactions was initially introduced in the Finance Act 2005 through the inclusion of section 231A in the Income Tax Ordinance 2001. It served as a significant source of revenue according to the Revenue Division’s Year Books.

The primary objectives of imposing withholding tax on cash withdrawal were: a) discouraging the cash economy, b) improving documentation, and c) broadening the tax base.

The rate of withholding tax on cash withdrawals started at 0.1% and, before its removal in 2021, stood at 0.6% for non-filers.

FBR’s Circular No. 02 of 2021-22 dated 1st July 2021 explained the rationale behind removing the withholding tax on banking transactions: “There were 38 withholding tax provisions in the Income Tax Ordinance 2001. This high number of provisions adds to complexity and creates undue burden of compliance on different withholding agents. It also impacts the country’s rating on the ease of doing business index.”

FBR’s overall tax revenue experienced significant growth of 30% during FY2021-22, surpassing Rs. 6 trillion for the first time in Pakistan’s history. This growth can be largely attributed to the elimination of withholding tax on cash withdrawal, banking instruments, and banking transactions.

Cash flowed freely within businesses, leading to flourishing economic activities, and withholding tax on business activities became a significant revenue driver. People’s confidence in the banking system improved, prompting those who were hesitant to keep their money in banks to start utilizing them.

Overall, there was a boost in economic activities, resulting in increased earnings for taxpayers and naturally leading to an increase in tax revenue. Bank deposits also saw an extraordinary surge (Rs. 23.4 trillion as of April 2023, as reported by SBP), and bank earnings found their way into the Government Exchequer in the form of corporate income tax.

However, an analysis of FBR’s revenue collection from withholding tax on cash withdrawals reveals a dismal performance and negative growth in recent years. The compound annual growth rate (CAGR) of this tax remained at only 2%, which is an unhealthy sign.

Table 1: Collection of withholding tax on cash withdrawal

(Source: Revenue Division’s Year Books 2007-08 to 2020-21)

The State Bank of Pakistan (SBP) findings on the imposition of withholding tax on cash withdrawal, banking instruments, and banking transactions are not encouraging. According to SBP’s Annual Report 2016-17: “… the imposition of withholding tax on banking transactions apparently defeated the very purpose for which it was imposed, that is, to discourage the cash economy,” and “… the economic cost of imposing withholding tax on non-cash banking transactions needs rethinking.”

The forthcoming withholding tax on cash withdrawal, banking instruments, and banking transactions is justified on the basis that it will only apply to non-filers. However, being a non-filer does not necessarily mean being a tax evader. Instead of imposing taxes on non-filers, mechanisms should be devised to penalize tax evasion.

If someone files their tax return with nil income and the government receives no tax revenue from their return, or if the reported figures are manipulated, what benefit can be expected from converting their status from non-filer to filer?

Section 115 of the Income Tax Ordinance 2001 lists individuals who are not required to furnish their annual income tax returns. When the law itself designates them as non-filers, it is unfair for the government to label them as such solely based on the actual non-filing of their returns. The provision allowing individuals not to file their tax returns already categorizes them as “deemed filers.” Other means should be explored to include individuals from both categories in the Active Taxpayers’ List (ATL) and at least provide them with the benefits of withholding tax provisions—those who file their annual income tax returns and those who are not required to file their annual income tax returns.

If the government plans to reinstate provisions regarding withholding tax on cash withdrawal, banking instruments, and banking transactions solely to broaden the tax base, it may prove ineffective in the current economic environment. People may once again resort to keeping their cash outside of the banking system. To broaden the tax base, the FBR can explore alternative measures and make informed policy decisions while maintaining taxpayers’ confidence by excluding withholding tax on cash withdrawal, banking instruments, and other banking transactions.

There are other means to identify taxpayers engaging in cash transactions. Banks are also required to file statements under section 165A of the Income Tax Ordinance 2001, where Form-C entails reporting cash withdrawal transactions to the FBR if the aggregate monthly volume of cash withdrawal exceeds Rs. 1 million. This can serve as a useful tool to monitor cash transactions carried out by taxpayers.

Additionally, the concept of SWAPS (Synchronized Withholding Administration and Payment System), introduced in the Finance Act 2022, is part of the same series and, once fully implemented, will facilitate real-time reporting of such transactions through banks’ synchronized/integrated systems with the FBR, further contributing to the broadening of the tax base.

Reintroducing withholding tax on cash withdrawal can have negative repercussions on the economy, financial inclusion, and could potentially lead to the emergence of a parallel banking system. When withholding tax is imposed on cash withdrawals, individuals may seek alternative methods to evade the tax, leading to an increase in parallel banking activities.

Policymakers should focus on alternative measures that can achieve the desired objectives of curbing corruption, tackling black money, and reducing tax evasion while also promoting digital transactions to curb the shadow economy. Measures like the demonetization of high-denomination currency notes, such as the Rupees five thousand note, can be considered. Although this may cause temporary disruptions and have a slight impact on the GDP growth rate in the short term, it can lay the foundation for long-term economic sustainability.

To strike a balance between revenue generation and the long-term goals of financial inclusion and stability, it is crucial to strengthen existing tax frameworks, promote digital payments and banking, and enhance financial literacy. Effective policies and collaborations among stakeholders can contribute to a robust financial ecosystem that minimizes risks and encourages sustainable economic development.

PRIME has always advocated for progressive, equitable, and fair taxation. In the Federal Budget 2023-24, PRIME has strongly recommended and proposed to the FBR to simplify the existing withholding tax regime and introduce measures that can reduce the compliance burden on withholding agents. The institute is also in the process of publishing a working paper titled “Withholding Tax Regime: Doing Business Perspective,” which highlights the problems associated with the existing withholding tax regime and proposes measures to effectively address these issues.