Karandaaz Launches Report on The State of Business Taxation in Pakistan – Challenges for SMEs
Pakistan (Muhammad Yasir) Karandaaz Pakistan arranged a webinar on 15th March, 2023 to launch its latest study on The State of Business Taxation in Pakistan – Challenges for SMEs. The report provides detailed analysis on the hurdles Pakistani SMEs face when attempting to become tax-compliant, the rules that govern taxation in the country and recommends ways responsible authorities can streamline taxation policy while establishing efficient processes for collection to establish a more optimal tax regime.
SMEs are regularly touted as the backbone of the country’s economy, contributing more than 70% of employment and approximately 25% of the country’s exports. At the same time, however, Pakistani SMEs tend to remain largely outside the formal economy. Estimates for Pakistan’s undocumented or shadow economy range from 35% to 56% of the country’s official gross domestic product (GDP). Another even stronger indicator is provided by data from the Federal Board of Revenue (FBR), Pakistan’s supra tax collection and enforcement authority. Though a recent census of business establishments has not been conducted, proxy data suggests that there could be close to 5.2 million SMEs in Pakistan. Yet, according to the FBR’s 2018 filing data, only about 64,000 associations of persons (AOPs) filed returns. This indicates that only a handful of SMEs are registered with the national tax collection agency.
The SMEs interviewed for this study cited the burden of tax compliance as a bigger hurdle than the actual tax paid or the high tax rates associated with it. Without the adequate resources and skillset for timely compliance with tax obligations, SMEs end up having to pay penalties. In many developing economies, compliance costs are a major deterrent to tax filing and deciding to become ‘formal.’ Evidence collected during the study suggests that, first and foremost, the tax authorities must move beyond revenue-centricity towards the goal of building a cohesive, collaborative, and simplified tax regime that eliminates all the ‘noise’ in the system. To do so, the report contains numerous recommendations, including harmonization of policy across jurisdictions; strengthen handholding and facilitation of SMEs via heavy investment in systems that can be integrated across the government machinery so that data can ‘talk’; adopt automation and smart regulation that is accessible to SMEs; and institute painless tax administration that reduces tax compliance burdens.
CEO Karandaaz, Waqas ul Hasan addressed Pakistan’s shadow economy and said, “One of the key challenges facing the taxation system in Pakistan is its inherent complexity, which leads to high compliance costs and burden for taxpayers. An effective tax system should aim to minimize distortions, facilitate ease of collection, avoid discrimination, and garner acceptability. However, experts suggest that Pakistan’s current tax policy does not adhere to these fundamental principles. According to the 2020 Doing Business Report, Pakistan ranks 161st out of 190 economies for the “paying tax” indicator, which underscores the difficulty and complexity of complying with tax regulations in the country.”
In her opening remarks, Dr. Shamshad Akhtar, Chairperson Karandaaz, said that “As the KRN study underscores tax regime and its implementation pose a real challenge for the SMEs. Underreporting of SMEs is quite pervasive both because the entities do not have records and capacity to report, nor do they wish to because of fear of FBR tax harassment. It would be safe to say what we don’t count we don’t really know: Moreover, SMEs constraints and dynamics render it difficult to design effective policies and support system… SME policy framework in Pakistan is fragmented and entities with conflicting mandates and overriding powers impose their priorities. Taxation structure has for years been regressive given its heavy dependence on high indirect taxes and on tradable sectors. At the same time tax exemption of agriculture, real estate and properties and low progressivity in direct taxes erodes revenue base.”
In his keynote address Federal Minister Mr. Ahsan Iqbal said: “Unlike other nations in the region, Pakistan has yet to adopt an export-led growth strategy, making it crucial to bolster the private sector’s export capabilities to improve the country’s economic situation. Small and medium-sized enterprises (SMEs), the backbone of Pakistan’s economy, contribute significantly to value chains, generate job opportunities, and spur innovation and competition. Therefore, policymakers must prioritize developing and supporting the SME sector through effective policymaking. For instance, tax reform efforts must prioritize directing capital inflows towards productive businesses with export potential instead of unproductive sectors functioning as tax havens in the country. This approach can reduce inefficiencies and widen the tax base, leading to increased revenue collection, facilitating socio-economic development in Pakistan.”
In his closing remarks Dr Najeeb Memon, Chief Commissioner Inland Revenue Karachi, FBR stated that “We must make choices on how to structure the taxation system. However, these choices cannot solely be based on the revenue authorities’ objectives. We must also consider the compliance costs on the tax-paying entities. Non-compliance is not only a result of the tax regime’s complexity, but also the unfair and inefficient system design that actually incentivizes non-compliance. Businesses and individuals are given room to falsely categorize their income, resulting in tax evasion in weakly regulated sectors like real estate and exempt sectors like agriculture. These inequities must be removed from the system. Additionally, larger minimum tax thresholds and lower marginal tax rates for certain sectors have further constricted the tax base, incentivizing tax evasion at the margins. This approach unfairly burdens compliant sectors while failing to enforce tax laws in others. Rather than squeezing the compliant sectors, we need to reform the design of the taxation system in a manner that addresses the core reasons for non-compliance.”
The webinar also included two panel discussions. The first panel comprised of SME representatives and relevant stakeholders to talk about the type of challenges faced in compliance with frequently changing taxation policies. Panelists included Ms. Maryam Sarim, CEO and Founder of Instaenergy; Syed Nabeel Hashmi, Chairman SNH Group of Companies; Mr. Asfandyar Farrukh, MD Urban Brands and Founder Chainstore Association of Pakistan; and Mr. Ehsan Malik, CEO Pakistan Business Council (PBC).
The second panel included representatives of several tax authorities as well as experts on taxation, including Mr. Zain-ul-Abidin Sahi, Chairman Punjab Revenue Authority (PRA); Mr. Tariq Naseem, Head of Islamic Finance Department and Registrar Modaraba, SECP; Mr. Muhammad Raza, Partner A. F. Ferguson & Co.; Dr. Hamid Sarwar, REMIT Project, FCDO; Mr. Akbar A. Tejani, CEO and Co-Founder Befiler (Pvt.) Ltd. and Ms. Darakhshan Vohra, Lawyer and CEO of Soan Valley Tech.
Karandaaz is a Section 42 Company, supported by the UK’s Foreign, Commonwealth & Development Office (FCDO) and the Bill & Melinda Gates Foundation (BMGF). The Company focuses on improving access to finance for unserved and underserved individuals and micro, small and medium enterprises (MSMEs), by providing financing and by leveraging technology platforms.
The survey findings are available on the Karandaaz website at: https://karandaaz.com.pk/karandaaz_publication/