Proposed imposition of withholding tax on letters of credit in Pakistan


The Business Recorder (Karachi) contains the following article dated 12 May 2015:


The State Bank of Pakistan (SBP) has expressed concern over the proposed imposition of withholding tax on Letters of Credit (LCs) and further taxes on products and services offered by banks to their customers, in the upcoming budget (2015-16). 

Sources told Business Recorder on Monday that the SBP has shared its concerns over the proposed imposition of withholding taxes on banking products and services with the FBR Chairman undertaking the on-going budget exercise for 2015-16. The SBP has specifically referred to proposed imposition of withholding tax on Letters of Credit saying it will discourage use of formal channels. 

According to the SBP, the apropos to the discussions of Chairman FBR with Governor-SBP, the SBP came to know that FBR is considering imposition of further taxes on products and services offered by banks to their customers. It may be pertinent to mention here that different products and services offered by banks are already being taxed. While SBP do understand the efforts put in by FBR to raise more revenue, yet we also believe that imposition of further taxes on already taxed areas may be counterproductive with unintended consequences for our economy. 

The SBP has also consulted PBA on the proposed imposition of taxes by FBR in budget (2015-16). As per the SBP viewpoint, the advance tax, under Sections 231A and 231 AA, was intended to discourage cash economy, encourage documentation and broaden tax base. On the contrary, it is encouraging cash based transactions, leading to increase in currency circulation in the hands of the informal sector. Similarly, the proposed taxes may further discourage the utilisation of formal channels, resulting in more untraceable incomes and difficulties in tax collection. Furthermore, the proposed imposition of taxes on Letter of Credits can result in increase in cost of doing business and decline in competitiveness in international markets, thus forcing businesses to resort to payments through firm orders or even using informal exchange market. 

It is a matter of concern that Pakistan has one of the lowest saving ratios among its peer countries; imposition of taxes on banking transactions will further discourage and dissuade people from using banking channels for their financial needs. The Financial Inclusion Strategy envisioned and developed by the federal government and SBP in consultation with all stakeholders seeks to strive for more inclusive approach by providing accessibility, enabling and encouraging environment for small savers and ordinary households. However, SBP feel that the measures to be proposed by the FBR may hamper the progress in the sphere of financial inclusion by imposing additional costs of using banking channels, the SBP said. 

The SBP added that the imbalances in imposition and collection of taxes have created unevenness among different sectors of economy, whereby some sectors and taxpayers are overburdened with taxes, while other areas have been relatively less focused by the tax authorities. This has resulted in tax arbitrage for different sectors and transactions. In our view, more efforts should be made to widen tax base by including those sectors which have not been paying taxes up to their potential, the SBP maintained. 

The SBP proposed that it would have been better if the steps to enhance tax collection would have been taken in consultation with the relevant stakeholders and seeking proposals to increase the revenue collection in an efficient manner. 

The SBP proposed that the government may consider a comprehensive and all inclusive approach towards the tax related matters by taking input from different sectors of economy and removing tax imbalances among different sectors of economy. Secondly, the pros and cons of imposition of further taxes on already taxed segments and services may be thoroughly ascertained. 

Thirdly, the revenue collection can be encouraged by simplifying submission of information by taxpayers, while new taxpayers can also be encouraged by incentivising existing tax payers. Meanwhile, Pakistan Banks Association (PBA) has informed the SBP about the introduction of Withholding Tax on Pay Orders, Bank Drafts and Letters of Credit. The PBA has learnt that FBR is considering imposition of withholding tax on bank products like pay order, bank draft, letter of credit. The PBA has failed to understand the basis and logic of FBR considering this, especially as withholding tax is normally levied on income and/or profit, which is not in the case for these banking products. 

The PBA understands and support FBR's efforts to document the economy & increase the tax filers & payers base. Its existing requirement of levying of withholding tax on cash withdrawals (Rs 50,000 & above) & profit on bank deposits & saving accounts is being complied with by all banks. However, imposition of withholding tax on the referred bank instruments will not only be regressive, but also have the following negative effect on the economy, in general and the banking system, in particular. 

The imposition of withholding tax on bank instruments would discourage the financially excluded from coming into the banking system, which will be in conflict with Pakistan's National Financial Inclusion Strategy, which is the most important policy initiative of the government and the SBP and supported by all stakeholders. Similarly, the existing banking customers may consider other/unofficial means to meet their local and international payment and trade requirements. Specifically, for international trade payments, bank customers may opt for payments through firm orders, or even use the informal exchange market, which will be extremely detrimental to the economy. The PBA believe that all efforts must be made to encourage bank customers to use all payment and trade products of banks and to encourage more financially excluded persons/entities to enter the banking system and therefore, become part of the documented economy, the PBA added. 


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