KARACHI: The Reform and Revenue Mobilisation Commission (RRMC), the government’s tax commission, chaired by Ashfaq Tola, has put forth intriguing proposals. It proposed the re-introduction of withholding tax on cash withdrawal and banking transactions and the elimination of hard dollars from the market. These recommendations aim to address the country’s narrow tax base and strengthen tax administration, which has long been regarded as weak and inefficient.
Tax on cash withdrawals
Pakistan’s tax system suffers from a significant disparity: despite 7.6 million individuals being registered with the Federal Board of Revenue (FBR), only 3.6 million actually file tax returns, which amounts to less than 50% of the registered taxpayers. Pakistan has a population of 246 million, yet only 7.6 million pay taxes which means that 96% of the population does not pay taxes which reflects the inefficiency of the system.
Government sources have indicated that the FBR is actively considering re-imposing a 0.6% tax on cash withdrawals, banking instruments, and banking transactions, with the potential implementation starting in July of this year. The RRMC report has significantly strengthened the government’s stance on the imposition of withholding tax, as it supports the revival of these taxes for non-filers.
It is worth noting that this is not the first time such a withholding tax has been introduced. Initially implemented through the Finance Act of 2005, the tax targeted withdrawals of Rs 25,000 or more at a rate of 0.5%. However, subsequent amendments increased the threshold to Rs 50,000, while also reducing the withholding tax rate to 0.3% for income tax return filers and increasing it to 0.6% for non-filers. In 2019, the tax for tax filers was abolished, but non-filers were still required to pay 0.6% on cash withdrawals exceeding Rs 50,000 per day.
Finally, In 2021, this withholding tax on cash withdrawals was completely abolished through the Finance Bill 2021 for non-filers as well.
Unfortunately, the elimination of this withholding tax has resulted in a decrease in its contribution to direct taxes. Therefore, the RRMC has recommended restoring the withholding tax on cash withdrawals and other banking instruments and transactions for non-filers in the upcoming fiscal year.
However, these proposals given by the RRMC could turn out to be counter-intuitive.Â
While taxing cash withdrawals by non-filers may seem like a revenue-generating measure, it could inadvertently encourage the growth of the informal economy. History has shown that individuals have successfully avoided taxation by keeping their cash outside the banking system. This, in turn, could increase the amount of currency in circulation. As of the end of April 2023, the total banking industry deposits in Pakistan amounted to a staggering Rs 23.4 trillion, according to the State Bank of Pakistan’s statistics. The introduction of withholding taxes might discourage non-filers from depositing their money in banks, potentially leading to a cash shortage for banks to meet their depositors’ demands.
Furthermore, while the RRMC believes that the restoration of withholding taxes would provide valuable information about non-filers and help address revenue losses, past experiences have shown that the FBR struggled to effectively utilise this information during the previous implementation of the tax.
Additionally, while measures such as taxing cash withdrawals or deposits may increase revenues for the government, they are regressive and contradict the principle of equitable and fair taxation. It appears that the primary focus is to increase tax collection, potentially at the expense of various sectors of the economy.
IMF and World Bank equation
Notably, the government attempted to introduce this tax on cash withdrawals in February 2023 but faced strong resistance from international financial institutions like the International Monetary Fund (IMF) and the World Bank.Â
Pakistan and the IMF have not been able to strike a staff-level agreement on the ninth review of the loan programme. The government has also not yet accepted the IMF’s demand to discuss the next fiscal year’s budget. Given the current friction in relations between Pakistan and the IMF, the government may be more determined to press ahead with its plans.
Nevertheless, the re-imposition of the withholding tax may have consequences for Pakistan’s efforts to secure a $450 million budget support loan from the World Bank. This loan is crucial for the country to address its dwindling foreign exchange reserves. As of May 5, 2023, the SBP’s foreign currency reserves stood at $4.38 billion, down by $74 million as compared to $4.46 billion on April 28. The net reserves held by banks amounted to $5.61 billion. Overall, the liquid foreign currency reserves held by the country stood at $9.99 billion which is sufficient to cover for imports of few weeks only.
Elimination of Hard Dollars in the economy
In order to enhance documentation, and transparency, and reduce the use of physical cash (hard dollars), the RRMC has proposed a significant change regarding foreign currency transactions. They suggested that commercial banks should be entrusted with foreign exchange transactions instead of relying on foreign exchange companies. The only exception would be for outgoing passengers at airports, which can be handled at airport counters, all transactions in foreign currency should be through the banking system, according to a report prepared by the RRMC.
It is important to note that although foreign exchange companies have been involved in facilitating the movement of dollars in and out of the country, some of them have been implicated in cases of money laundering in the past.
