Explaining Withholding Tax: Various Types and Their Calculation

Understanding Withholding Tax in Pakistan: A Comprehensive Guide to Saving on Your Tax Bill

Did you know that whether you’re a salaried employee, a pensioner, or earning through commissions or other sources, a portion of your income is withheld as tax? Withholding too little can lead to an unexpected tax bill, while over-withholding allows you to use your money interest-free until you get a refund.

This guide covers everything you need to know about withholding taxes and compliance to help you make informed decisions. Once you understand the concept of withholding tax and how to manage it, you could save thousands of rupees every year.

What is Withholding Tax?

Withholding tax (WHT) in Pakistan is a ‘presumptive’ tax, meaning it’s deducted from your income by your employer and paid directly to the government. Essentially, it’s an advance tax on your income, ensuring tax obligations are met before you receive your earnings. Employers deduct this tax before paying salaries to mitigate the risk of unpaid taxes during tax season.

The Importance of the Withholding Tax System in Pakistan

In Pakistan, withholding tax is a major source of federal revenue. For the financial year, 73% of direct tax collection came from various withholding taxes. These taxes are levied on salaries, imports, bank interests, dividends, utilities, technical fees, cash withdrawals, and more, each with varying rates.

Key benefits of the withholding tax system include:

• Promotes voluntary compliance
• Ensures a steady revenue flow with minimal costs
• Reduces collection efforts
• Expands the tax net
• Provides daily revenue generation
• Prevents tax evasion and revenue loss
• Enhances economic documentation
• Alleviates fiscal shortfalls by providing consistent revenue throughout the year

Who is Required to Withhold Taxes?

Withholding tax, also known as payroll tax, is essential for federal revenue. The following entities are required to withhold taxes:

• Individuals in business or professional practice
• Non-individuals (corporations, associations, partnerships, cooperatives)
• Government agencies and their instrumentalities, including National Government Agencies (NGAs), Government-Owned or Controlled Corporations (GOCCs), and Local Government Units (LGUs), including Barangays

Types of Withholding Taxes

Creditable Withholding Tax

Creditable withholding tax is collected by employers in Pakistan and can be further classified into:

• Compensation: Tax withheld from income payments to individuals in an employer-employee relationship.
• Expanded: Tax on income payments deducted against the income tax due for the taxable year.

Withholding Tax on GMP – Value Added Taxes (GVAT)

Tax withheld by NGAs and instrumentalities, including GOCCs and LGUs, before making payments to VAT-registered taxpayers.

Withholding Tax on Government Money Payments (GMP) – Percentage Taxes

Tax withheld by NGAs and instrumentalities, including GOCCs and LGUs, before making payments to non-VAT registered taxpayers/suppliers/payees.

Final Withholding Tax

Tax on certain income payments not creditable against the income tax due for the taxable year. The payee’s income subjected to final withholding tax is not included in regular tax rates.

Withholding Tax on Compensation

Withholding tax on compensation involves deductions from employee salaries, which can be exempted by the NIRC and relevant laws.

Kinds of Compensation

Regular Compensation:

• Basic salary
• Fixed allowances

Supplementary Compensation:

• Commission
• Profit sharing
• Overtime pay
• Taxable 13th-month pay and other benefits
• Directors’ fees
• Fringe benefits for rank-and-file employees
• Hazard pay
• Monetized vacation leave over ten days
• Sick leave
• Other income from employer-employee relationships

Quarterly Withholding Statement

Tax collectors/deductors must provide a quarterly statement to the commissioner, including:

• Name, CNIC, NTN, address of the person from whom tax was collected/deducted
• Amount of tax collected/deducted
• Total payments made/received from which tax was collected/deducted
• Additional prescribed particulars

Quarterly Compliance Deadlines:

Claiming Back Your Paid Withholding Tax

You can claim a refund on withholding tax if:

• You pay annual tax
• Your income is below the taxable threshold
• You are a tax filer
• You file your tax return on time every year

How to Collect Information for Withholding Tax Refunds

The tax year in Pakistan runs from July to June. To claim a refund, keep track of your receipts and bills for expenditures throughout the year. These documents will serve as evidence of the withholding tax paid and help you get a refund.

Understanding and managing withholding tax effectively can help you avoid unexpected tax bills and save money annually.