In an effort to broaden an exceedingly narrow tax base, the government’s tax commission has proposed reinstating the withholding tax on cash withdrawals and banking transactions and eliminating hard dollars from the market.
The Federal Board of Revenue (FBR) is actively contemplating recommending the re-imposition of a 0.6% tax on cash withdrawals, banking instruments, and banking transactions beginning in July of this year, according to government sources.
However, the two proposals presented by the Reform and Revenue Mobilisation Commission (RRMC), led by Ashfaq Tola, appear to be mutually exclusive.
The tax on cash withdrawals by non-filers of tax returns may encourage the growth of the informal economy, as individuals have historically been able to successfully keep cash outside of banks.
The RRMC proposed that the government investigate ways to reduce the circulation of cash and eliminate all hard dollar cash from circulation. The plan is to eliminate foreign exchange companies’ dollar transactions and transfer the foreign currency business to commercial institutions, which will document these transactions.
According to a report prepared by the RRMC, all foreign currency transactions should be conducted through the banking system, with the exception of providing dollars to departing passengers at airports, which can be done at airport counters.
Pakistan’s tax system and administration continue to be feeble and fragile. Only 3.6 million of the 7.6 million individuals registered with the FBR file tax returns, which speaks volumes about the inefficiency of the tax system.
Dollars are brought into and out of the country by foreign exchange companies, but some of them have been implicated in money laundering in the past.
According to government sources, the imposition of a withholding tax on banking transactions and currency withdrawals is on the agenda for the upcoming budget, and the government’s “hands have been strengthened” by the RRMC report.
Numerous withholding tax provisions had been eliminated in the past, including the withholding tax on cash withdrawals, banking instruments, and other banking transactions besides currency. According to the report, as a result, the contribution of withholding tax to direct taxes decreased.
Nonetheless, RRMC recommended restoring the withholding tax on currency withdrawals, other banking instruments, and banking transactions for non-filers.
Except for 3,6 million individuals and businesses, all 246 million inhabitants of Pakistan do not file income tax returns.
RRMC believed that the reinstatement of withholding tax would provide actionable information about non-filers, who are responsible for revenue loss to the government. Previously, the FBR was unable to use the information when the tax had been in effect for more than six years.
In February of this year, the government attempted to reinstate the tax on currency withdrawals, but was met with stiff opposition from the International Monetary Fund (IMF) and the World Bank.
Pakistan and the IMF have been unable to reach an agreement at the staff level regarding the conclusion of the ninth review of the loan programme. The government may be able to proceed with its plans to reimpose the withholding tax due to the strained relations.
The government has also not yet accepted the IMF’s demand to debate the budget for the following fiscal year, as the finance ministry believes the budget cannot be tied to the approval of the ninth review alone.
However, the reimposition of withholding tax may jeopardise Pakistan’s efforts to secure a $450 million budget support loan from the World Bank, which it needs to replenish its dwindling foreign exchange reserves.
Taxes on cash withdrawals and deposits are regressive and contrary to the principle of equitable and reasonable taxation.
The 0.6% withholding tax on deposits may also enhance the amount of currency in circulation. According to SBP statistics, as of the end of December 2022, total deposits in the banking system were approximately Rs22,5 trillion. Included among these are Rs10.5 trillion in personal deposits held by salaried individuals, merchants, and others.
It appears that the primary objective is to increase tax collection at the expense of massive consequences for various economic sectors.