Withholding self-employed and business incomes: An application to Italian firms

Abstract

The paper proposes the application of a generalised withholding tax scheme to business-to-business transactions, in order to combat the evasion of income-related taxes levied on self-employed workers and businesses, as an alternative to the standard regime based on self-reporting. The scheme proposed here is comprehensive in scope, since it applies to all B2B transactions involving the self-employed and businesses, and can be regarded as an extension of the withholding tax regimes which are currently applied to specific sectors and/or business categories and self-employed taxpayers in some countries. We argue, even on the basis of a simple conceptual framework, that the benefit of extending such a withholding mechanism to profit taxes is twofold. On the one hand, consisting of an advance payment on the effective profit tax liability, it contributes to curbing tax evasion due to non-payment in a system characterised by a standard self-reporting mechanism. On the other hand, and more importantly, the withholding system—retaining information about each transaction subjected to it—enhances third-party information reporting if the withholding tax is applied to transactions that are otherwise excluded. This paper offers details on operational aspects of the proposed withholding tax mechanism. In particular, a critical issue in implementing the withholding regime lies in the choice of the tax rate, and more specifically in setting a level that is effective in reducing tax evasion without generating excessive tax refunds. This issue is discussed by applying the withholding mechanism to balance sheet microdata of all non-financial Italian companies.