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

A software house that pays staff, freelancers or vendors acts as a collector of tax for the government. When it misses a deduction, or deducts and then does not deposit the money, the Income Tax Ordinance, 2001 moves the tax onto the company, adds a time-based charge, blocks the related expense and sets penalties for late statements. The rules below apply to tax year 2027 under the Ordinance amended to 30 June 2026.

Who pays when the deduction is missed?

The software house does. Section 161(1) covers two failures. Clause (a) is failing to deduct tax from a payment as required under Division III of Part V of Chapter X, the Division that covers deductions from salary and from payments for services. Clause (b) is deducting the tax and then failing 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.

The same section adds three points:

• Hearing first. Section 161(1A) bars recovery unless the person has had an opportunity of being heard.
• Recipient already paid. Section 161(1B) says that if the employee or contractor has meanwhile paid the tax, nothing is recovered from the software house, but it pays default surcharge at twelve per cent per annum from the date it failed to deduct to the date the tax was paid.
• Right of recovery. Section 161(2) entitles the software house to recover the tax from the person from whom it should have been deducted.

How is default surcharge worked out?

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 deducted tax on or before the due date. The surcharge is 12 per cent 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 amount is later held not payable.

Can the expense still be claimed?

Section 21(c) says no deduction is allowed, in computing income from business, for expenditure from which the person is required to deduct tax, unless the person has deducted and paid the tax as required. The second proviso says recovery of tax under section 161 counts as tax paid. This bites on income taxed under the normal rules, such as fees from Pakistani clients.

Which penalties can apply?

Section 182 sets penalties in a Table and says they apply “in addition to and not in derogation of” any other punishment. Two entries are relevant:

Entry	Failure	Penalty as printed
1A	Not furnishing a statement under section 165 (and related sections) by the due date	Rs. 50,000 if the tax withheld was paid by its due date and the statement is filed within ninety days of its due date; otherwise Rs. 2,500 for each day of default, minimum Rs. 10,000
5	Failing to deposit tax due, or part of it, in the time or manner laid down	5% of the tax in default, with an additional 25% for a second default and 50% for third and later defaults

The reference column for entry 5 does not list the withholding provisions. The Table does not state in terms whether entry 5 reaches withheld tax, so this page does not treat that as settled.

Section 165(2) sets the statement due dates: 20 April, 20 July, 20 October and 20 January for quarters ending March, June, September and December. The proviso to section 165(1) requires a statement even when nothing was deducted.

How does it affect the IT export regime?

Section 154A(2) makes the bank’s deduction on IT export proceeds a final tax only if listed conditions are met. 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. Missing section 165 statements therefore puts final tax treatment of export income at risk for that year.

Worked example (illustrative figures)

Ravi Code (Pvt) Ltd in Lahore pays a contract QA engineer during tax year 2027. On 1 September 2026 it should have deducted Rs. 90,000 but deducted nothing. It pays the Rs. 90,000 to the Commissioner on 1 March 2027.

1. Tax the company is personally liable for under section 161(1)(a): Rs. 90,000.
2. Period of default: 1 September 2026 to 1 March 2027, six months.
3. Default surcharge under section 205(3): Rs. 90,000 x 12% x 6/12 = Rs. 5,400.
4. Total paid by the company: Rs. 90,000 + Rs. 5,400 = Rs. 95,400.
5. Under section 161(2), it may recover the Rs. 90,000 from the engineer.

Months are used to keep the arithmetic simple. Section 205(3) states an annual rate and does not set a day-count method.

If the September quarter statement was also filed late, and the tax had not been paid by its due date, entry 1A charges Rs. 2,500 a day with a Rs. 10,000 minimum.

Common mistakes

• Assuming the payee carries the risk. Section 161(1) puts the liability on the payer. Recovery from the payee is a right, not a defence.
• Skipping nil statements. The proviso to section 165(1) requires them.
• Treating export tax as automatically final. Section 154A(2)(b) ties final treatment to filed statements.
• Claiming the expense anyway. 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 21(c) with its provisos, section 165(1) and (2), and section 154A(2) and (3). Check entries 1A and 5 of the section 182 Table in the official PDF, because the Table’s columns do not survive text extraction cleanly. A footnote records that the Rs. 50,000 figure in entry 1A replaced Rs. 5,000 through the Finance Act, 2025.