Tax at source, growth off track: Why reform cannot wait

Income tax is a levy on income, yet taxpayers in Bangladesh are required to pay Advance Income Tax (AIT) and Tax Deducted at Source (TDS) under the Income Tax Act. 

Both AIT and TDS are imposed on total revenue rather than on profits. In the case of business-to-business (B2B) supply, purchasing enterprises are required to deduct tax at source from specified payments against supply and deposit it to the National Board of Revenue (NBR). 

AIT and TDS, at any point of transaction, create an additional burden by raising the need for higher working capital, particularly for cottage, micro, small and medium enterprises (CMSMEs). 

Moreover, the lack of efficient refund and adjustment mechanisms for AIT and TDS compounds the financial strain on taxpayers, who face significant challenges in recovering overpaid taxes. As a result, product costs rise and the burden is ultimately passed on to consumers. 

These issues substantiate the need for comprehensive tax reforms to ensure a fairer, more balanced tax regime that promotes business growth, compliance, and taxpayer confidence.

Despite the importance of direct taxes, which currently account for around 30% of total tax revenue, Bangladesh's tax regime continues to rely more heavily on indirect taxes (67.1%). The country's Tax-to-GDP ratio remains just 7.49%, largely due to a narrow tax net.

Both income tax and corporate tax suffer from very low compliance: only about 3-3.5 million people submit income tax returns out of around 10 million Tax Identification Number (TIN) holders, while only 24,381 companies out of 288,000 submitted returns. 

Notably, nearly one-third of all income tax revenue is generated by the Large Taxpayers Unit (LTU), comprising major mobile phone operators, tobacco companies, private banks, and high-earning individuals.

Over 80% of tax revenue is collected through TDS, and its scope has been expanding steadily. However, tax deducted at source is often treated as final tax. Consequently, many taxpayers consider their obligation fulfilled once TDS is deducted and show little willingness to submit tax returns or avail themselves of adjustment opportunities.

Section 163 of the Income Tax Act (ITA) 2023 introduces a minimum tax provision, identifying forty-one TDS sections as minimum tax. Sub-section 5 further specifies five industries that must pay a set percentage of turnover as minimum tax, regardless of profit or loss. 

In practice, TDS and AIT, collected at entry ports or at delivery points, act like indirect taxes. They are passed on to end-users and, being largely non-refundable and non-adjustable, they discourage investment and diverge from global tax standards.

In the 2025-26 fiscal budget, the government raised the AIT rate for commercial importers from 5% to 7.5%, while reducing the rate for industrial importers of raw materials from 3% to 2%. The decision to increase the AIT rate for importers, excluding industries, in order to offset VAT evasion could have inflationary consequences.

Taxpayers frequently face difficulties when seeking refunds for excess AIT and TDS. According to NBR data, TDS accounted for about 87.4% of total income tax in FY23. The number of TDS sub-heads increased to 111, compared with 107 before 2020. This steady expansion of TDS coverage has placed an ever-greater burden on businesses.

A study conducted by the Centre for Policy Dialogue (CPD) in FY2022-23, covering 103 profitable companies, revealed that several sectors in Bangladesh face extremely high effective tax rates — in some cases up to 73% — raising serious concerns about equity and competitiveness.

The share of TDS in income tax revenue rose to 87.4% in FY 2024–25 from 84.6% the previous year. Meanwhile, the proportion of refunds declined from 0.35% to 0.24% of total TDS collected. 

The highest refund rate was recorded in FY2019, when refunds accounted for 3.02% of TDS collected. Increasingly, TDS is treated as a final discharge of tax obligations due to changes in the law.

Around three million entities in Bangladesh — including local suppliers, contractors, commission agents, and domestic and international agencies — are subject to TDS. 

Estimated tax collection from TDS entities (across 57 categories) was Tk171,327.16 crore in FY2023, according to NBR annual reports, while actual TDS collection amounted to Tk72,604.92 crore (NBR data).

Bangladesh's revenue mobilisation remains very low by international and peer standards, constraining essential public investment and exposing the country to fiscal vulnerability. 

Excess advance payments have several adverse effects: (1) locking up working capital, (2) delayed or absent refunds, (3) reduced liquidity for operations, (4) financing pressures on low-margin sectors, and (5) the continuation of AIT at the import stage, which, if deemed an Other Duties and Charges (ODC), cannot be applied after Bangladesh's graduation from Least Developed Country (LDC) status.

In the B2B context, CMSMEs supply small components, accessories, raw materials and packaging to both local and multinational industries. These enterprises are efficient and cost-effective, and they play a crucial role in making larger industries competitive. 

However, CMSMEs have become less competitive and are struggling to survive, largely due to high advance taxes such as TDS and AIT. As the first stepping stone for budding entrepreneurs to grow into larger business conglomerates, CMSMEs are vital to the economy.

Yet these small units face multiple layers of taxation. They purchase raw materials from traders or importers, and these are subject to advance taxes at the import and supply stages. 

After the imposition of 5% AIT and 7% TDS, multinational and domestic companies purchasing from CMSMEs are legally bound to deduct further AIT and VAT on the total invoice value. 

This process undermines CMSMEs' competitiveness. CMSMEs contribute significantly to Bangladesh's exports — reportedly 80% as direct exporters, support industries, or deemed exporters in the ready-made garment sector.

By contrast, large companies that produce secondary products in-house are exempt from the 7% TDS and 5% VAT. This tax policy not only disadvantages CMSMEs but also incentivises large conglomerates to divert capital into setting up their own small units, detracting from their core businesses. 

Such practices threaten the survival of backward linkage enterprises in the SME sector, directly contradicting the government's CMSME development policy.

This situation is highly unusual in the global context. Bangladesh must enhance its competitiveness and productivity to achieve economic diversification, stronger growth, and job creation. 

However, the current structure of AIT and TDS undermines these goals. Excessively high advance taxes reduce reinvestment, erode competitiveness, and stifle employment opportunities.

M S Siddiqui is the CEO of Bangla Chemical. He is a former Non-Government Adviser at the Bangladesh Competition Commission and legal economist. 

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.