Withholding tax gives rise to undocumented cash economy: SBP report

Islamabad

Although the imposition of 0.6 percent withholding tax on bank transactions may broaden the tax base in the long run. However, the official data suggests quite opposite to the government expectations as it has caused undocumented cash economy in the form of gradual decline in deposits rates and high currency circulation, reveals the report of State Bank of Pakistan.

Whereas the imposition of withholding tax has also caused a sharp rise in prize bonds, which increased by Rs94.1 billion during July to March fiscal year 2015-16 compared to Rs49.8 billion in the same period of FY 15. The banking regulator has warned that this situation does not bode well for financial deepening and effectiveness of the monetary policy.

Finance Secretary Dr Waqar Masood Khan while talking to The News said the impact of imposition of withholding tax on bank transactions was short-term and now the situation has improved.

“How can one play with the cash for long time. Therefore, I can say the impact of withholding tax on bank transaction was for a very brief time and now the figures have improved,” commented the finance secretary.

The quarterly report of the State Bank suggests that imposition of withholding tax on bank transactions could be a major reason of this high currency in circulation and lower growth in bank deposits.

The report further said the imposition of withholding tax also caused a sharp rise in prize bonds, which increased by Rs94.1 billion during Jul-Mar FY16 compared to Rs49.8 billion in the same period of FY15, also lends credence to this assertion. Moreover, gradual decline in weighted average deposit rates since FY10 could be another contributory factor. Regardless of the reason, this situation does not bode well for financial deepening and effectiveness of the monetary policy.

“The private sector deposits increased by Rs149.4 billion during Jul-Mar FY16 – less than half of the rise recorded during the corresponding period of FY15.

“This trend, which can be explained by a gradual decline in deposits rates and imposition of withholding tax on financial transactions, does not bode well for financial deepening,” the report said.

The report further said besides low deposit growth, a higher government borrowing from commercial banks (and retirement to SBP) also required an increase in outstanding OMO injections by the central bank. To put this in perspective, during Jul-Mar FY16, the budgetary borrowing from commercial banks reached Rs1.1 trillion, whereas the government retired Rs525.5 billion to the SBP.

The State Bank in its report said although the high growth in tax collection was encouraging, this required frequent changes in tax policy, particularly after the announcement of the annual budget – a practice that may lead to uncertain business environment.

While the increase in tax revenues is a welcome development, the country still needs considerable effort to improve the efficiency and equity of the tax system.

The report has also highlighted the issue of lack of efforts to increase the direct tax collection as the country’s economy is being run mainly through indirect taxes. The report said the taxation regime relies too much on indirect and transaction-related withholding taxes – both are regressive in nature. 

In fact, the withholding tax contributes 67 percent of the direct tax collection. The banking regulator in its report has stressed for increasing efforts to increase direct tax collection. 

“The efforts to improve direct taxation are reflected in amount of income tax collected on demand. According to available data, collection on demand contributed only 5 percent of the direct taxes – indicating a considerable room for improvement. The government also launched Voluntary Tax Compliance Scheme (VTCS) to bring traders into the tax net. This initiative could not fetch the desired results,” said the report.

It is pertinent to mention that withholding tax on financial transactions for non-filers was revised upward from 0.3 percent to 0.4 percent during quarter three of FY16. This tax had been reduced from 0.6 percent to 0.3 percent in quarter two of FY16.

The SBP report while reflecting the tax collection figure suggests that a major chunk of direct tax was collected through withholding tax and the banking regulator has stressed for enhancing the scope of direct tax collection.

According to this report, FBR collected Rs809.8 billion through direct taxes during Jul-Mar FY16, which is Rs 108.2 billion higher than the revenue collected during the corresponding period last year. Most of this collection came from withholding taxes (67 percent) and voluntary payments (27percent). On the other hand, tax collection on demand hovered around 5 percent of direct tax collection, depicting lower efforts to mobilise direct taxes.