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SOMETHING very interesting is happening. The withholding tax on banking transactions by non-filers of tax returns has created a storm of controversy, and the real face of informal sector practices is being revealed.
Here’s some background. In its latest budget the government announced a withholding tax on all bank transactions conducted by non-filers of tax returns. The tax would become applicable on any transaction, whether cheque or pay order or online payment or anything else, that was larger than Rs50,000. The rate was set at 0.6pc of the transaction, later negotiated down to 0.3pc, and the funds would be deducted from the account being transacted upon.
The banks were required to use the Federal Board of Revenue (FBR) database to determine all those depositors who have filed tax returns and those who have not. Once they had done this, they were required to automatically start deductions from transactions being made from the accounts of non-filers and deposit the money with the FBR at the end of the day.
The government estimated that it would get Rs35 billion in revenue from this measure. But more importantly, it sought information on those non-filers who are transacting in large amounts for further action.
For most individual depositors who are non-filers, this wasn’t a huge problem. The amount of the tax being levied is very small, and most transactions tend to be below Rs50,000 in any case. The problem came in with businesses, particularly traders and wholesalers, but surprisingly enough, also industry.
I was surprised to see registered owners of large industry protesting this tax. Surely they had filed their returns and the tax would not be levied upon them. So why were they protesting?
Many who do file tax returns conduct a large portion of their business through private bank accounts.
Take a look at who all is protesting. Large-scale industry, such as foreign investors or large-scale manufacturers, are silent. The large textile lobbies are also silent on this measure, although they are pressing ahead with other demands and issuing strike calls of their own, more related to “cost of business” type of concerns.
But many industrialists are protesting the measure, the sort who are indeed filers of returns. What’s their angle? This is where things get a little interesting.
When you ask them, these industrialists will tell you that much of the business dealings are with non-registered parties and therefore the tax impacts them. But how would it impact them if they are filers? Outgoing payments from the account of a tax filer will see no deductions.
The real reason is that over the years many formal sector, registered business owners who do indeed file their returns and are there on the active taxpayers list have taken to the practice of conducting a large portion of their business through private bank accounts opened in the name of miscellaneous individuals. So a large mill-owner might operate a couple of dozen bank accounts, some opened in the name of loyal members of his workforce, some in the name of his driver or cook or chowkidar, and make many of his payments from these accounts to be able to conceal his real turnover.
This practice has become very widespread, and suddenly the new withholding tax has netted these payments, which in some cases can be very large. Not only that, the new tax can now start to generate information which can potentially identify such accounts to tax authorities. So the mill-owner will now have to either move the portion of his business that is conducted through these accounts onto his own books, thereby showing a sharp rise in his turnover and making him liable for additional taxes, or he can increase the number of such accounts to try and keep the turnover in each below the ceiling of Rs50,000, or he can go and file returns for each of these accounts and bring them onto the active taxpayers list.
Each course of action carries risks. A sharp rise in turnover in one year could trigger an alarm bell with the tax authorities, who could then initiate an audit of his past filings to determine if turnovers in the past were understated. Multiplying the number of accounts and spreading your transactions out amongst them is cumbersome. And filing returns for all of the ghost accounts is risky because the tax authorities might again notice high turnovers in the accounts while declared incomes in the returns are below the taxable threshold.
The traders and wholesalers are protesting the tax for clear reasons: they conduct their business through bank accounts but do not file returns and their accounts see very high turnovers, so they are looking at a substantial amount being deducted via this withholding tax.
As a response to this measure, the traders have said they will start conducting all their transactions in cash. This is a bluff. The kinds of turnover that they have on a daily basis would be next to impossible for them to carry on entirely in cash. Foreign exchange companies do report a rush into dollars by many non-filers, which created a short spike in demand for dollar currency in the market, prompting the State Bank of Pakistan (SBP) to allow exchange companies to import dollars from abroad to meet the demand. But the SBP spokesman confirms that in the month of July there is no appreciable decline in rupee deposits, meaning people are not exactly rushing out of the banking system ever since the new tax went into effect.
With a little skill, the government should be easily able to manage the protests against the measure. Traders cannot keep their shops shut for very long, and filing a return is not exactly a very difficult process any more. It would be good to see the government stand its ground in this measure, and the longer it remains in place, the more we will learn about the nature of informal sector activity in the country.
The writer is a member of staff.
Twitter: @khurramhusain
Published in Dawn, August 6th, 2015
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