Revisiting advance/withholding taxes
Huzaima Bukhari & Dr. Ikramul Haq
After the Second World War, the provision of advance income tax was provided in the then prevalent Income Tax Act, 1922 for the first time by inserting section 18A vide section 5 of the Indian Income Tax (Amendment) Act, 1944. We inherited this law on independence and retained it till 1979 when the military dictator, General Muhammad Zia-ul-Haq repealed it and replaced with Income Tax Ordinance, 1979. It survived till 2001 when another military ruler, General Pervez Musharraf on the dictates of International Monetary Fund replaced it with Income Tax Ordinance, 2001, made effective from tax year 2003. In the Income Tax Ordinance, 1979, advance tax was charged under section 53 and now encased in section 147 of the Income Tax Ordinance, 2001. What a farce that a provision, introduced as a measure to combat inflation and to squeeze large part of the unprecedented amount of money then in circulation in British India is still existing after 76 years!
The famous Indian tax scholars, Mr. N. A. Palkhivala and B.A. Palkhivala, in their classical work, The Law and Practice of Income Tax [Seventh Edition, page 1063] very aptly observed: “Like many other innovations in tax legislation it [advance tax] has outlived the exigency which gave it birth”. In Pakistan, we and many others have written repeatedly about its obsoleteness and negative impact as well as malpractice of the Federal Board of Revenue (FBR) to show it as part of current year’s collection, but no elected government after General Musharraf’s exit paid any heed to it and even the coalition Government of Pakistan Tehreek-i-Insaf (PTI) is no exception. By taking credit of advance tax relating to the nest tax year, during the current tax year, FBR has not only been overstating collection figures since 1996, but also not paying back the excess amount received as withheld or advance tax. What makes the situation more excruciating is the fact that the government pays no compensation to the taxpayers for using their funds received in advance and retained though prior to 1996 the same was paid at the time of assessment.
It needs to be highlighted that since its inception and until assessment year 1995-1996, section 53 dealing with advance tax under the repealed Income Tax Ordinance, 1979, had the following three specific:
- Advance tax was paid by the taxpayer on the basis of latest declared/assessed/estimated income for that assessment year;
- Credit for any advance tax collected for an assessment year was accounted for in the related year and not the year of collection; and
- 6% mark-up on the amount retained as advance tax was paid to the taxpayer at the time of assessment thereby compensating his cost of funds or opportunity cost for the period his money (not yet due) remained with the government.
With increasing pressure on FBR for achieving assigned (inflated) targets (fixed with utter disregard to ground realities), panic-struck measures were adopted to display a high level of efficiency by foolhardy bureaucrats and one by one the following features started unfolding:
- Credit for advance tax was being taken in the year of collection;
- Calendar year as income year was done away with in 1995 amending the repealed Income Tax Ordinance, 1979, resulting in many taxpayers having to pay tax for a period of 18 months for assessment year 1995-96;
- Basis for determining tax shifted from income to ‘turnover’; and
- Compensation was no longer payable.
These measures made more stringent by amending section 147 on numerous occasions through various Finance Acts. FBR’s pride in achieving collection targets is not based on the figures for the past closing year alone but inclusive of the future closing year or years as well e.g. during 2020, the banks are paying advance tax on monthly basis for tax year 2021! The credit of advance tax being paid for tax year 2021 every month till 31st December 2020 will be given credit when banks file returns in 2021—due date under the law is September 30, 2021 but every year extension of many months is given. In this way, the federal government keeps on utilising billions of rupees of the banks paid as advance tax against their future liabilities [now highly uncertain and will be much lower due to economic toll of lockdown in the wake of Covid-19]. The banks will have unprecedented write-offs and deferments of payments from borrowers due to prevalent crisis. According to a press report, Pakistan Banks Association (PBA) in its budget proposals for fiscal year 2020-21, submitted to the Ministry of Finance, has demanded that the banks should be given Karachi Inter Bank Offer Rates (KIBOR) based compensation on utilisation of money taken in the form of monthly advance tax.
Any hope of positive changes regarding revisiting advance tax and dozens of withholding tax provisions, through the introduction of the Ordinance, 2001 were shattered in that all existing ailments at that point of time were merely repackaged with new terminology and concepts that remain tantalizing for the minds of both the taxpayers as well as officials. All provisions of the repealed Ordinance regarding basis of computing advance tax first? stand as before but then made confiscatory shifting from income-based to turnover-based with no option of downward revision and many other aberrations, including non-payment of compensation.
The concept of advance tax clearly envisages a pre-assessment situation in the case of a taxpayer. Thus, if at the time of filing a return under section 120 of the Ordinance (incidentally resulting in automatic assessment under the universal self-assessment scheme), the law specifically provides for taking credit for all taxes paid until the date of filing the return. This implies that if any outstanding balance of tax remains, it should be either refunded or adjusted in the subsequent installments of advance tax for the next tax year. However, the FBR stalwarts have always interpreted this law negatively in case of taxpayers and much to their own advantage since 2004. Para 4 of Circular No. 2 of 2004 dated 25.5.2004 reads as under:
“4. It is also clarified that in case of taxpayers having special *income year, the credit for payment of advance tax, shall be allowed in respect of the quarters falling within such income year e.g. in case of a company closing its accounts on December 31, 2004, the credit for advance tax shall be allowed for tax year 2005 in respect of advance tax paid for the quarters, ending March 31, 2004, June 30, 2004, September 30, 2004 and December 31, 2004.”
(Emphasis is ours)
*Should have been ‘tax year’
Under which law have these instructions been issued? In the first place, ‘income year’ no longer exists in the new law, and secondly, there is clear indication of straining the law to the extent of distorting the very basis of giving credit for advance tax payments. These instructions are totally in disregard of the actual law. Why should a company allow credit to be taken (of the three quarters falling in any calendar year) for a tax year that is yet to come? This merely proves that:
- the term ‘tax year’ is a definition subject to the whims of FBR;
- in reality, the Department failed to grasp its meaning as laid down in the statute;
- the taxpayer will have to adjust his accounts according to the defective language of the circular;
- there will always be overlapping of two or more tax years; and
- there is no relevance of tax year as it will be the Department deciding for which tax year, credit may be taken.
If this has been the position since 2004, then what is the sanctity of allowing a taxpayer to maintain so-called special tax years ending on dates other than 30th June because according to his understanding, his accounting period, both for maintaining accounts and assessment of income, will remain a period of twelve months distinct from the financial year. And above all, why should he let the department exploit his advance tax paid on, say 15.03.20 and 15.06.20 for a period of 18 and 15 months respectively? It is quite surprising that FBR, in total contravention of existing law has the audacity to suggest which quarters’ credit would be allowable despite the non-relativity of an advance payment with the tax year in question.
FBR’s interpretation is patently unlawful as it gives the Department an opportunity to retain a taxpayer’s money beyond twelve months’ period. The concept of advance tax in itself is tortuous as businessmen are out of money, hampering their cash flow and depriving them of circulating the amount to earn more profits. This has become even worse due to lockdown in the wake of Covid-19 pandemic. Adding insult to injury, FBR wants to utilise that money without paying any compensation. Before 1997, under the law FBR was bound to pay 6% compensation on deposit of advance tax. Not only has the 6% compensation been withdrawn but on top of that in case of a taxpayer maintaining calendar year as tax year, the last two installments of March and June would be retained for 18 and 15 months respectively till the return becomes due on 30 September next following. There cannot be a worst scenario than this that a person is deprived of his money in the name of advance tax for such lengths of time and that too without any compensation. It is further burdensome for the banks as they are required to pay advance tax on monthly basis whereas others on quarterly basis!
Advance tax was a temporary measure in the wake of the Second World War as British imperialists were running short of money. Unfortunately, this has been made a permanent feature of our income tax law since independence, courtesy our local ‘gora sahibs’ who believe in utilising citizens’ money without any return to them. This has changed the face of income tax into bhatha (extortion) forcefully recovered by modern day dacoits who call themselves “tax collectors”!
What would be the position of adjustment of tax liabilities against excessive payment of advance tax? Does it mean that there will be point-blank refusal to adjust such payments on the grounds that they are not related to the immediately succeeding year but a subsequent one? Suppose if a deduction of tax is made from payment of a future contract (assuming it does not fall in the presumptive tax regime) to be executed after two years, the taxpayer has no right to claim its credit after a lapse of two years and must take credit in the year in which the deduction is made? What would be the position if instead of income he incurs loss in a return filed two years later? How would he justify his entitlement to the refund?
FBR has proved again and again that it merely wants to extort money that is not due but gives tax amnesties, immunities and waivers to tax evaders and looters of national wealth, creates confusion and utter uncertainty. This practice should end now when all the businesses, big or small, are on the verge of collapse after prolonged lockdown and struggling to escape medical and other disastrous consequences of coronavirus outbreak.
Their own (mis)understanding about the new Income Tax Law is complicating matters rather than simplifying them. There was nothing in the repealed Ordinance to give rise to such interpretation although even then, we had strongly agitated the amendment in law where credit for advance tax was taken by FBR in the year in which it was received rather than carrying it forward to the relevant assessment year. History is witness that a few high-ups in the bureaucracy serving their own self-interests have played havoc with the income tax law and procedure creating gaping lacunae and unleashing a reign of mismanagement just to show that they have proved ‘more than efficient’ in achieving given targets—or was it just to cover up their own incompetence?
Presently, FBR is depending heavily on advance tax collections and has started pressurizing taxpayers to make payment of advance tax even for more than one year. It is now a major source of FBR collection (sic). If old practice is revived, taxpayers will be relieved of the pressure of FBR to pay “advance tax” [which otherwise needs to be deferred till the time businesses and individuals liable to pay recover from the economic toll of coronavirus led lockdown] for more than one year. In the coming budget, the Government must make amendment in law requiring FBR to:
- Account for advance tax under section 147 of the Income Tax Ordinance, 2001 as collection of the year to which it actually relates. This procedural change will not have any adverse effect on revenue of FBR, except that the advance tax will be accounted for as collection at the time of assessment that is the tax year to which it actually pertains, rather than taking its credit during the ongoing tax year to which it does not pertain though collected in anticipation. Ideally, the government should abolish it once tax base is widened and people start paying taxes with returns. The money they have to part away in advance can be utilised for business growth and expansion that will ultimately yield more revenue for the State and creation of much-needed jobs.
- The existing 66 withholding tax provisions from out of 47 related sections [WHT regime] in the Income Tax Ordinance, 2001 are destroying the already collapsed economy due to Covid-19 pandemic as well as resulting into heavy refunds which the FBR appears incapable of paying. The number of withholding taxes should be drastically reduced and confined to salary and incomes taxed as separate blocks or payments where taxable, to non-residents. As an emergency measure, till the time the country recovers from Covid-19 pandemic, rates of all adjustable withholding taxes should be reduced to 1% or even less.
- The withholding tax provisions in the Sales Tax Act, 1990 and all provincial sales tax on services should be suspended, rather withdrawn as nowhere in the world these kinds of erratic withholding tax rules exist in value-added tax or simple general sales tax enactments.