Withholding Tax Deduction on Bank Transactions

Dear all. In our country when you draw a certain amount via cheque from bank, the bank deducts withholding tax on that transaction and it is reflected on the bank statement. Now whenever i make i bank reconciliation, i have to account for that deducted withholding tax as well, which will later on serve as a tax credit at the end of the year during filing of income tax. Also withholding tax deduction on different utility bills also needs to be accounted for and acts as a tax credit. Please suggest me how should u handle withholding tax deduction done by the govt, bank or utility company. Please note, the business is sole proprietary and i am accounting on cash basis, I tried to manage withholding tax by making an asset account for it and posting separate payments (deductions done by different authorities) in it to reconcile the bank statement. The issue with this method is that the withholding tax asset account reflects entries from previous tax years as well which i don’t want. Should i make an equity account for withholding taxes or should i add it to P&L so it discards previous transactions. Kindly guide. Thank You

P.S is there any method to avoid journal entries and make it an automated process? also when i make a journal entry within that Tax year, my assets account get clear due to journal entry and the amount is posted to equity. What i want is that the withholding tax and the income tax should be displayed on the the report separately. Please forgive this lengthy explanation.

You have asked more questions than you may realize. For a general discussion of withholding tax accounting in Manager, see this Guide: https://www.manager.io/guides/12346. However, it applies only to withholding tax on sales and purchases. So it might cover your situation with utility bills. But the information you provided regarding these is insufficient to know with certainty.

In normal circumstances, withholding tax on your purchase of a commodity (such as electricity) from a utility provider would reduce the amount you owe to the provider. Instead of paying your full balance due, you would withhold the tax for later remittance to the tax authority. Is that what is happening? If so, follow the instructions in the second portion of the Guide above. If something else is happening, please describe such a transaction in detail. I note that having small consumers withhold tax from payments to large utility providers, making millions of consumers responsible for remittance to the authority, would be unusual. But that might be how it is done in your jurisdiction. It is also possible that you are mistaking some form of fee or tax on consumption of the commodity as a withholding tax (as the term is used by Manager) when it actually is not.

Your situation with withdrawals from a bank is entirely different. (I am assuming this withdrawal is for your own use, not a cheque written to discharge a debt of the company.) No sale or purchase has occurred. The bank has simply kept a portion of your money for remittance to the tax authority.

How you treat this depends on your income tax laws. In many countries, income of sole proprietors is taxed on the owner’s personal tax filing, not on any business filing. Payment of your personal tax due is not a transaction of the business and is not entered in Manager at all. In that situation, the payment from the business to you is a withdrawal of capital. Simply enter a payment posted to the equity account where your owner’s equity is lodged. This might be a capital account, or it could be a renamed Retained earnings account or some other form of equity account, depending on how you structured your chart of accounts. Records of withheld amounts should be kept separately, outside your business accounts, for use at personal tax filing time.

On the other hand, if local law requires the business to pay income taxes directly, the accounting differs. In that case, you are correct that such a withholding represents an asset, because it can be used to settle your income tax due just like money. So establishing an asset account (I’ll call it Tax withheld) is the right approach. When you withdraw money from the bank, enter a payment with two line items. The bank account you select on the payment form will be posted with a credit for the full amount withdrawn, making your reconciliation simple. The two line items will post the debit side of the transaction. The sum of the two line items must equal the withdrawn amount.

The first line item should be posted to the equity account holding your owner’s equity. (See above.) The amount of this line should be the amount of the withdrawal minus the amount withheld. This line item represents a withdrawal of capital, the same as in the first scenario.

The second line item should be posted to the Tax withheld account. Obviously, the amount of this line item should be the amount withheld.

Now, what happens to the Tax withheld account? When you submit your business income tax filing, you will claim the money withheld and paid on your behalf by the bank. The rest of what you owe will be paid and recorded in Manager with a payment form. Once again, break that payment into two line items.

Post the first line item to a taxes paid expense account. Make it equal to the full amount of income tax owed. Do not reduce it for the withheld amounts.

Post the second line item to Tax withheld. Make it equal to the negative of all money withheld during the tax period by the bank. This will debit the full amount of your taxes to the expense account.

The negative amount on the payment will post a credit to Tax withheld, zeroing its balance. It will also reduce the amount of the credit posted to the bank account by the amount of the previous withholdings. Make your payment to the tax authority for this reduced amount.

You will notice that no journal entries are involved in any of the processes for bank withholding or utility payment withholding, only payment forms. The only time journal entries are required in accounting for withholding tax is when your customers withhold tax on sales invoice remittances to you and instead remit tax to the authority. That is described in the initial portion of the Guide referenced above.

Thank You dear for such a comprehensive reply. No that is not happening. Let me describe a bit:

I paid my landline bill for the whole year and the service provider deducted tax withheld on each bill (each month). Now at the end of the year when i pay my income tax, that deducted withholding tax by the service provider will be considered as a tax credit. The service provider provides me a certificate of deducted tax withheld which then gets adjusted in my Income tax.

Similarly, whenever i pay a certain amount say PKR50,000 via cheque to anyone whether an employee or any payee, whenever that cheque gets cleared and the amount is drawn out, my bank deducts a withholding tax say PKR357 from me upon that withdrawal. Just as the first case, this withheld tax also gets adjusted in my income tax paid in advance upon filing my return.

According to my knowledge of sole proprietorship, the business is not dealt separately from the owner. Its simply owner’s income from business which is taxable. Owner and business act as same entity, which is why owner is responsible for all the taxes on behalf of the business.

Yes that is the case

i get this but this can only be done when i am withdrawing myself. In the case of cheques withdrawn by other people, i have to clear the pending transactions after periodically getting statement from the bank. Then i go through the statement and clear out pending transactions. Afterwards i look for W.H.T deducted and i separately make its payment to my Tax Withheld Asset account which debits it. So, the thing is, W.H.T is not deducted from the cheque, its deducted from the bank balance, if i use second line item, that will make the total transaction amount differ from the actual amount of the checque.
for example:

I pay someone through cheque PKR50,000. In first line i will debit my bank account. I know bank will deduct PKR350 whenever the cash is withdrawn so i add a second line item and in that i debit my W.H.T asset account with PKR 350. So, the total transaction will become 50,350. Is that correct?

i am doing this already, in my P&L i have made a subtotal “Net profit before tax” and then “Less Income Tax” and then Net Profit after Tax. The quarterly paid advance income tax is posted to this account and after the closing i made a journal entry to post that income tax to equity. Is this the right way?

Your description does not make sense. The service provider has nothing from which to deduct tax. As the seller, the utility provider might apply withholding tax on its sales invoice to you. But you would then deduct the tax (withhold it) from your payment to the provider. And you would then remit the tax to the authority on behalf of the provider.

What you describe is the reverse. The provider is apparently setting aside a portion of your payment and remitting that to the authority. That is not withholding tax or tax withheld at the source. That is a consumption tax, but payable to your account with the tax authority rather than to the government for general purposes.

Is this tax shown as a line on your bill that adds to the amount owed? Or is it subtracted only after you pay the provider? It sounds like this should be accounted for as a 100% custom tax code as described in this Guide: https://www.manager.io/guides/8901. But exact procedures will depend on further information.

Again, this does not meet Manager’s definition of withholding tax. This is a separate charge to your account and should be entered as a separate payment, posted to a suitable asset account for later use discharging your tax obligation.

This is the more customary situation I described first. But it does not mean that taxes are paid by the business. They will be paid by the owner. Business accounts should not include income tax liabilities or payments.

This was your response to my description of the second scenario. This and the first cannot both be true. It must be one or the other. Sort this out with a qualified local accountant if you have doubts.

This matches what I said above. The amount set aside by the bank is a separate charge. It should be recorded as a distinct payment. You cannot combine this as a second line on your payment to an outside payee, because the payee is the bank.

If you are personally responsible for all income taxes, as you first said in your revised post, income tax payments should not be entered in your business records at all.

I will further look in to the situation and consult with an accountant as well. It is great to always have you here for help. Thanks a lot dear.

how was the issue resolved with taxes?

As a sole proprietor you have to post all income taxes to owner’s equity. But do consult local laws.