Income tax withholding is a tax collection method that is used by tax administrations to collect income tax from a person earning income where it is economically not viable to register all the income earners and require them to lodge returns. It is best applied where:
- There exists a large number of income earners from the same source and it makes more economic sense to ask the payer to withhold the tax on all payments and remit the tax to tax authorities, than to allow the payer to make the payments and then require the tax authorities to follow up returns and payments from the individual earners. The latter case would require the tax authorities to spend more administrative resources to collect the same amount of tax.
- It is practically difficulty to enforce payment either because the income earner is foreign and does not have to register for taxes in the country or is highly illusive.
This income tax withholding method has most effectively and logically been applied by many tax jurisdictions on the taxation of employment income (Pay as You Earn), where relatively few employers are registered and required to file returns for purposes of taxing the income of the relatively numerous employees. This way, tax administrations exercise control over fewer entities and spend less administrative resources than they would if it had to register every employee, require them to file returns and follow up payments from them individually.
Other instances where income tax withholding is logically and effectively used are in the case of collecting tax of bank interest earners, where banks are required to withhold the tax and not let the bank pay its customers and then the tax authorities follow up with the customers.
The Case of Rental Income Taxation
It is difficult to understand the reasoning behind the preference to ask the tenants who are more in numbers and more elusive compared to landlords to withhold the tax on rental income. Logically thinking, one would prefer to let a landlord who, for example owns a block of flats to receive all the income from the may tenants and follow up the tax from him/her rather than request the numerous tenants, who are constantly changing, to withhold the tax and then follow up from them. Being the owner of the immovable property, landlords are less likely to go missing and therefore less elusive compared to the tenant who can move from one place to another overnight.
Missing the Target Population Thus Making it a Consumption Tax
Without having to collect and analyze empirical data, one can easily see that the economic tax incidence (on whom the tax burden falls) of withholding tax on rentals falls on the tenant (the consumer) as opposed to the landlord (the income earner). Because of the inelasticity of demand for accommodation, landlords easily shift the entire tax burden of their income to the tenants. They openly include clauses in tenancy agreements such as, “…net of withholding tax…”, when stating the rental amount. There are legality and fairness concerns about this practice because the tenant is made to pay an unlegislated tax, while the landlord’s income goes untaxed. The tax has become a renting tax payable by the tenant, as opposed to an income tax payable by the landlord.
At 10% of gross income, withholding tax on rentals is too high compared to the tax on income from other business income. A person earning K800,000.00 per year on rental income is expected to pay K80,000 in income tax per year, while the one who turns the house into a lodge and earns the same amount will only pay K24,401 tax per year, under the Turnover Tax regime. If ZRA succeeds in enforcing the tax in its current form, one would rather change the use of the house from household to commercial and turn it into a lodge in order to pay less tax and make more profit. A tax with such a distortionary effect is economically inefficient as it causes deadweight loss- an economic loss that is suffered by the whole society.
Need for Review of the Tax as Opposed to Taking a Draconian Approach to Enforcement
The Zambia Revenue Authority (ZRA) has in the recent past issued statements to threaten landlords and tenants that they will soon start applying the full force of the legally available enforcement tools to collect the tax. Such draconian steps to enforce unpopular taxes have seldom worked in the history of taxation. Whenever an administration attempts to apply the full force of the law on a tax that is perceived to be too high and unfair, the response usually is for taxpayers to up their techniques in the evasion and avoidance game and the loser has been the administration and the general citizenry.
We are of the view that income tax on rentals could best be administered as a normal income tax that is taxed under the available income tax regimes, i.e. presumptive and normal income tax with normal tax rates applied. Thus, Turnover Tax can apply for certain categories and normal income tax for others. For example, household rental income earned by individuals could be subjected to turnover tax at the normal progressive rates while commercial rental and household rental provided by companies could be subjected to normal income tax. This would take into consideration the practicality difficulties of maintain records to distinguish business and personal expenses for some individuals in determining income.
ZRA should also think of smarter ways of bringing rental income earners into the tax net, such as placing the onus of proof of not earning rental income on the property owners. This can be achieved by, say, targeting to tax all owners of every property that is appearing on a council cadaster and, or being services by either ZESCO or a water utility company and require the owners that may be occupying their own properties, thus not earning rental income, to indicate so in writing to ZRA, or prove that they are not earning rental income. This way they would cover a larger portion of the tax base for rental income taxes and it would not be so easy to entirely shift the tax burden on tenants.
As the case is the tax fails the “good tax” test on revenue adequacy, equity, economic efficiency and on legality grounds.