What happens if a software house fails to deduct or deposit withholding tax on salaries and contractor payments?

A software house that pays salaries, freelancers, landlords or foreign vendors acts as a tax collector for the government. When it misses a deduction, or deducts and then keeps the money, the Income Tax Ordinance, 2001 shifts the tax onto the company itself and adds a time-based charge. For an IT exporter there is a second cost: the 0.25% final tax regime depends on withholding statements being filed.

What does the law say about failing to deduct or deposit?

Section 161(1) covers two failures. Clause (a) is a person who fails to deduct tax from a payment as required under Division III of Part V of Chapter X (the withholding provisions, which include salary and payments for services). Clause (b) is a person who deducted the tax but fails to pay it to the Commissioner. In both cases “the person shall be personally liable to pay the amount of tax to the Commissioner”, who may pass an order and recover it.

Three safeguards and follow-ons sit in the same section:

• Hearing first. Section 161(1A) says no recovery is made unless the person has been given an opportunity of being heard.
• Recipient already paid. Section 161(1B) says that if the tax has meanwhile been paid by the person who should have suffered the deduction, no recovery is made from the software house, but it pays default surcharge at 12% per annum from the date it failed to deduct to the date the tax was paid.
• Right to recover. Section 161(2) entitles the software house to recover the tax from the employee or contractor from whom it should have been deducted.

What does default surcharge cost?

Section 205(3) applies to a person who fails to deduct tax as required under Division III of Part V of Chapter X, or fails to pay tax it deducted on or before the due date. The surcharge is 12% per annum on the amount unpaid, running from the date the amount was required to be deducted to the date it was paid to the Commissioner. Section 205(2) refunds surcharge to the extent the underlying tax is later held not payable.

Which penalties can apply?

Section 182 sets penalties in a Table, and says they apply in addition to any other punishment under the Ordinance or any other law. Two entries matter here:

Entry	Failure	Penalty as printed in the Table
1A	Not filing a withholding statement under section 165 (or the related statement sections listed in the entry) by the due date	Rs. 50,000 if the tax withheld had already been paid by its due date and the statement is filed within ninety days of its due date; in all other cases Rs. 2,500 for each day of default, minimum Rs. 10,000
5	Failing to deposit tax due in the time or manner laid down	5% of the tax in default, plus 25% more for a second default and 50% more for a third and later defaults

Entry 5 lists the section on the due date for payment of tax on taxable income in its reference column, not the withholding provisions. The Table does not say in terms whether it reaches withheld tax, so this page does not treat it as settled.

Section 165 requires a quarterly withholding statement, due by 20 April, 20 July, 20 October and 20 January for the quarters ending March, June, September and December. Its proviso requires the statement even where no tax was deducted in the period.

How does it hit the IT export regime?

Section 154A(2) makes the bank’s deduction on IT export proceeds a final tax only on conditions. Clause (b) is that “withholding tax statements for the relevant tax year have been filed if required under the Ordinance”. Section 154A(3) says final taxation does not apply to a person who does not fulfil the conditions. A software house that skips its section 165 statements puts that treatment at risk for the year.

Can the expense still be claimed?

Section 21(c) disallows a deduction, in computing income from business, for expenditure from which tax had to be deducted unless the tax was deducted and paid. Its second proviso treats tax recovered under section 161 as tax paid. This matters for income taxed under the normal rules, such as fees from Pakistani clients. Expenses against export income under final tax are not deductible in any case.

Worked example (illustrative figures)

Kohsar Labs (Pvt) Ltd in Lahore pays a local UI contractor during tax year 2027. On 1 October 2026 it should have deducted Rs. 150,000 but deducted nothing. It notices the error and pays the Rs. 150,000 to the Commissioner on 1 April 2027.

1. Tax the company is personally liable for under section 161(1)(a): Rs. 150,000.
2. Period of default: 1 October 2026 to 1 April 2027, about six months.
3. Default surcharge under section 205(3): Rs. 150,000 x 12% x 6/12 = Rs. 9,000.
4. Total paid by the company: Rs. 150,000 + Rs. 9,000 = Rs. 159,000.
5. Under section 161(2) it is entitled to recover the Rs. 150,000 from the contractor.

The months are rounded here to keep the arithmetic clear. Section 205(3) states the rate per annum and does not set a day-count method.

If the September quarter statement had also been filed late, entry 1A of the section 182 Table would apply on top.

Common mistakes

• Assuming the recipient carries the risk. Section 161(1) places the liability on the payer. Recovery from the recipient is a right, not a defence.
• Skipping nil statements. The proviso to section 165(1) requires the statement even for a quarter with no deductions.
• Treating the export deduction as automatically final. Section 154A(2)(b) ties final taxation to filed withholding statements.
• Claiming the unpaid-withholding expense. Section 21(c) blocks it until the tax is deducted and paid.

What to check in the official text

Read section 161(1) to (3), section 205(2) and (3), section 165(1) and (2), section 154A(2) and (3) and section 21(c). Check entries 1A and 5 of the section 182 Table in the official PDF, because the Table is laid out in columns that the parsed text does not keep. The entry 1A figure of Rs. 50,000 replaced Rs. 5,000 by the Finance Act, 2025, according to the footnote.