“In FY 2024-25… WHT collection reached Rs 3,381.5 billion, a significant increase from Rs 2,739.1 billion in the previous financial year, marking a growth of 23.5 percent... Notably, WHT collection from salaries registered the highest increase of approximately Rs 214.2 billion (55 percent growth), primarily due to decrease in number of income tax slabs and increase of corresponding tax rates in each slab. This policy shift resulted in an increase from Rs 391.4 billion in FY 2023-24 to Rs 605.6 billion in FY 2024-25 under withholding tax collection from salaries”—Revenue Division 2025 Year Book, Federal Board of Revenue

Pakistan’s tax system has, over time, evolved into what can best be described as a regime of withholding-isation—a system in which advance deductions or collections at source have ceased to be facilitative instruments of resource mobilisation and have instead become substitutes for bulk income taxation. The problem is not the existence of withholding per se—almost all modern tax systems use it. The distortion lies in its transformation from a creditable advance into a minimum or final liability imposed on gross receipts in a majority of the cases.

The most apt case, for example, is that of professionals. The withholding rate for compliant taxpayers is as high as 15 percent; it is 30 percent for the non-compliant—treated as minimum tax, regardless of actual net income. The high rate may be justified for non-filers. For the complaint taxpayer, this converts what is ostensibly a mechanism for ease of collection into a flat tax on turnover, even where net incomes are substantially lower. Where the final tax liability is lower, no refund is allowed; where it is higher, additional tax must still be paid. The asymmetry is striking: the system guarantees revenue for the state but denies symmetry to the taxpayer.

This hybrid structure—simultaneously taxing gross receipts and net income—has no parallel in well-functioning tax jurisdictions and is a violation of the constitution as elaborated repeatedly by the superior courts.

Comparative perspectives

In most countries, withholding taxes operate under one of two clear principles:

1. Advance, creditable withholding (Global norm)

Countries with similar colonial heritage such as, India, Bangladesh, Sri Lanka, Canada and Australia use withholding primarily as a prepayment of income tax as in the United Kingdom. Any excess deduction is refundable. The final liability is determined strictly on net income. The system is designed to improve compliance, not to replace assessment.

2. Final withholding

(Limited and targeted)

In some jurisdictions, final withholding applies to specific passive incomes—for example, interest or dividends—where administrative simplicity outweighs the need for detailed assessment. Such regimes are typically applied at moderate rates and to clearly defined categories, not across-broad segments of productive economic activity.

3. Turnover-based

(Alternative, not

concurrent)

Some developing economies have experimented with presumptive or turnover taxes, especially for small or undocumented businesses. Such systems are generally designed as alternatives to income taxation, not layered on top of it. Taxpayers are typically given a choice: either remain within a simplified turnover regime or opt into standard income taxation.

A hybrid outlier

Pakistan’s system departs from all three models. It imposes:

withholding on gross receipts,

treats such withholding as minimum or final tax, and

in many cases, simultaneously subjects the same taxpayer to normal income taxation.

The result is a concurrent dual taxation framework:

a turnover-based levy that ignores profitability, and

a net income tax that applies regardless of prior extraction.

This is not simplification. It is duplication and unconstitutional extraction.

Economic consequences

The consequences of this approach are structural rather than incidental.

First, it imposes a severe liquidity constraint. Businesses operating on thin margins—particularly in services and manufacturing—are required to surrender a fixed percentage of gross receipts regardless of actual profitability. This reduces working capital, constrains re-investment and discourages expansion.

Second, it creates perverse incentives. Firms that operate transparently face higher effective tax burdens than those that remain outside the documented economy. The system therefore penalises compliance rather than rewarding it.

Third, it contributes to informality. When taxation is perceived as disconnected from income reality, economic agents rationally respond by avoiding formal channels. The tax base shrinks even as rates rise—a classic illustration of diminishing returns to extractive policy.

Extensive work by practitioners and analysts, including former chairman of Federal Board of Revenue, Muhammad Ashfaq’s examination of withholding-isation, highlights how this model has progressively shifted the tax system away from income-based assessment toward transaction-based extraction.

Constitutional dimension

The constitutional issue is equally significant. Under Pakistan’s constitutional framework, taxation of income must be linked to actual earnings, not gross receipts.

A system that effectively imposes non-refundable tax on turnover while retaining full income tax liability risks crossing the boundary between permissible taxation and arbitrary exaction. The distinction is not merely academic. Constitutional jurisprudence has consistently emphasised that:

income tax must relate to real income, and

alternative bases of taxation (such as capacity or turnover) must operate in lieu of, not in addition to, income taxation.

“If we were to construe Entry 52 of the Legislative List keeping in view the above meanings of the expression “in lieu of”, it becomes evident that the Legislature has the option instead of invoking Entry 47 for imposing taxes on income, it can impose the same under Entry 52 on the basis of capacity to earn in lieu of Entry 47, but it cannot adopt both the methods in respect of one particular tax”—Supreme Court in Messers Elahi Cotton Mills & others v Federation of Pakistan & others [PLD 1997 Supreme Court 582]

A system that combines both, without allowing adjustment or refund, raises serious questions about proportionality, fairness and legislative competence.

Policy implications

Pakistan’s experience suggests that excessive reliance on withholding is not a sign of administrative strength but of institutional weakness. It reflects an inability to assess income properly and a preference for certainty of collection over equity of taxation.

A rational reform path would require:

restoring withholding to its original role as adjustable advance tax,

limiting final or minimum taxation to narrow, clearly defined sectors,

ensuring full refundability where tax exceeds actual liability, and

gradually shifting toward income-based assessment supported by digital documentation.

Conclusion

Tax systems derive legitimacy not merely from their legal authority but also from their economic logic and perceived fairness. When taxation departs from income and attaches itself to gross transactions without symmetry or adjustment, it risks being viewed not as a contribution to public finance but as an extraction from economic activity.

In its current form, Pakistan’s withholdingiisation model reflects such a departure. It secures short-term revenue at the cost of long-term growth, compliance and credibility. Reversing this trajectory requires re-anchoring the system in its foundational principle: taxing income, not merely activity.

A comprehensive remedial roadmap [Towards Broad, Flat, Low-rate and Predictable Taxes (PRIME Institute, October 2024)] exists. Unfortunately, parliamentarians have not made it their priority. They must realise that when taxation extracts revenue to fund the luxuries of the privileged classes, the state loses it credibility.

The writers are lawyers, adjunct faculty at Lahore University of Management Sciences and members of the advisory board of Pakistan Institute of Development Economics