Understanding Withholding Tax in Pakistan: A Detailed Guide

Withholding taxes play a vital role in Pakistan’s taxation system, ensuring that taxes are collected at the source before income reaches the taxpayer. Understanding how withholding taxes work, their types, rates, and implications can help taxpayers comply with regulations while minimizing financial and administrative burdens.

This article provides a comprehensive overview of withholding taxes in Pakistan, including their calculation, benefits, and specific applications in various contexts.

What Are Withholding Taxes?

Withholding tax is a system in which a portion of income is deducted at the source by the payer and remitted directly to the government. This system is primarily used to streamline tax collection and reduce the chances of tax evasion. In Pakistan, withholding taxes apply to both individuals and businesses, covering various types of income, transactions, and payments.

Types of Tax Withholding in Pakistan:

Pakistan’s tax framework encompasses two primary types of withholding tax:

• Final Withholding Tax: This is a one-time, conclusive deduction. The amount withheld is considered the final tax liability on that particular income, and it is not subject to further adjustments or refunds when the taxpayer files their annual tax return. Examples include tax withheld on certain dividends or specific types of income for non-residents. �
• Adjustable Withholding Tax: This is a preliminary deduction that is credited against the taxpayer’s total tax liability at the end of the fiscal year. If the amount withheld exceeds the final tax due, the taxpayer is eligible for a refund. Conversely, if the amount withheld is less than the final liability, the taxpayer will need to pay the remaining balance. Salary income is a prime example of income subject to adjustable withholding tax.�

Who is Withholding Agent?

In Pakistan, a withholding agent can be a company, the federal government, an Association of Persons with a turnover of 100 million or above in any preceding tax year, an individual with a turnover of 100 million or above in any preceding tax year, a person registered in Sales Tax, or a non-profit organization.

The person deducting the tax at source is required to deposit the tax with the government within 15 days of withholding. The tax can be deposited online or through a bank.

Responsibility of Tax Withholding

The responsibility for withholding tax depends on the nature of the income and the relationship between the payer and the recipient:

• Salaried Individuals: Employers are legally obligated to deduct adjustable withholding tax from their employees’ salaries based on the prescribed tax rates and the employee’s declared exemptions and allowances.
• Self-Employed Individuals and Businesses: While not subject to withholding at source on their overall business income, self-employed individuals and businesses often act as withholding agents when making payments to their own suppliers and service providers, depending on their turnover and legal structure.
• Companies and High-Turnover Entities: Companies, by default, and other entities exceeding a specified annual turnover (currently Rs. 100 million) are designated as withholding agents. They are required to deduct adjustable withholding tax on payments for goods, rent, and services exceeding certain annual thresholds.

Section wise Explanation:

Section 149 of the Income Tax Ordinance deals with the payment of salary. If a business individual or an Association of Persons pays an amount of salary that falls under the slab rate of tax deduction, the employer is liable to deduct and deposit the due taxes in the government treasury, irrespective of the turnover amount.

Section 155 of the Income Tax Ordinance deals with the payment of rental income. Individuals will deduct tax from the payment of rental income if the aggregate of the rental income is more than 1.5 million. The condition of minimum turnover does not apply in this case.

All withholding agents are liable to submit quarterly withholding tax statements in the prescribed formats under section 165 of the Income Tax Ordinance. In addition to that, annual employer statements are also submitted to the tax authorities.

It’s important to note that if a withholding agent fails to deduct or deposit the withholding tax, they will be liable to pay a penalty equal to the amount of tax that was required to be deducted or deposited. This penalty can be as high as 100% of the amount of tax that was required to be deducted or deposited.

Here’s a breakdown of the steps a withholding agent should take when dealing with someone not listed as an active taxpayer:

Exemption Assessment: The withholding agent first needs to determine if the individual, despite not being on the active list, qualifies for exemption from filing a tax return under specific sections (114 or 1) of the Income Tax Ordinance.

Notification to Commissioner (if applicable):

• If the withholding agent believes the person is exempt, they must electronically notify the Commissioner (tax authority) with details about the individual and the transaction.
• This notification includes the individual’s name, ID (CNIC or NTN), address, transaction details (nature and amount), and the reason for believing they are exempt.

Commissioner’s Response: The Commissioner has 30 days to respond to the notification:

• Acceptance: If the Commissioner agrees with the withholding agent’s assessment of exemption, no further action is required.
• Tax Deduction Order: If the Commissioner believes the individual should file a return, they can order the withholding agent to collect tax at the source.
• No Response: If no response is received within 30 days, the Commissioner’s silence is considered acceptance of the withholding agent’s assessment. This means no tax needs to be collected.

Rates and Calculation of  Withholding Tax:

The rates at which tax is withheld vary significantly based on the type of income and the recipient’s tax status (e.g., filer vs. non-filer, resident vs. non-resident). �

• Salaries: Tax deduction from salaries follows a graduated scale, with higher income brackets subject to progressively higher tax rates. Employers use tax tables provided by the FBR to calculate the applicable withholding tax.
• Dividends, Interest, and Royalties: These income streams are subject to specific withholding tax rates, which can differ based on the recipient’s residency and filer status.
• Rental Income: Withholding tax on rental income is also determined by specific rates based on the gross rent amount and the recipient’s tax status.
• Payments to Suppliers and Service Providers: Withholding tax rates on payments for goods and services u/s 153 vary depending on the nature of the transaction and the supplier’s/service provider’s filer status.
• Payments to Non-Residents: Payments made to non-residents are subject to withholding tax under Section 152 of the Income Tax Ordinance, 2001, with rates varying based on the type of income (e.g., royalties, fees for technical services,) and the existence of Double Taxation Agreements (DTAs).
• Online Advertising Payments: One critical scenario is when payments are made to non-resident entities for online advertising. Under Section 152(1A) of the tax law, payments remitted to a non-resident for advertising services are subject to a 10% withholding tax. This means that if you are classified as a prescribed person and you are running advertisements on digital platforms, you must ensure compliance with withholding tax requirements.

Tax Withholding on Petty Expenses

Tax withholding does not apply to petty expenses below specified thresholds. For instance, payments under Rs. 75,000 per year for goods or Rs. 30,000 per year for services are exempt. Additionally, expenses considered petty, generally ranging between Rs. 5,000 and Rs. 10,000, are not subject to withholding tax due to the minimal impact compared to administrative efforts.

How to Apply for Reduced Withholding Tax Rates

Benefits of Withholding Taxes

The withholding tax system benefits the government by ensuring timely tax collection and minimizing evasion. For taxpayers, it simplifies the payment process and reduces the risk of penalties. Moreover, compliance with withholding tax regulations can improve cash flow and financial transparency for businesses.