Sales tax evasion in Pakistan has become a pervasive threat to the country’s economic stability, government revenue and fair competition in the business sector.
TAXATION
Sales tax evasion in Pakistan has become a pervasive threat to the country’s economic stability, government revenue and fair competition in the business sector.
While sales tax is intended to be a key source of funding for public services and infrastructure, fraudulent business practices have hollowed out the system, allowing billions in revenue to slip through the cracks. These deceptive activities not only deprive the state of much-needed funds but also place law-abiding businesses at a significant disadvantage, forcing many to compete in a race to the bottom to survive.
At the heart of sales tax fraud in Pakistan lies a series of well-orchestrated schemes. One of the most common is the use of fake or flying invoices, where businesses create fictitious purchase records to claim input tax refunds on transactions that never took place. These fabricated invoices inflate expenses, enabling companies to either lower their tax liabilities or demand bogus refunds. In many cases, these invoices are issued by shell companies -- firms set up solely for fraud and quickly shut down once authorities begin investigating.
Alongside this is the rampant underreporting of sales, particularly in sectors that remain largely cash-based, such as retail, hospitality and construction. Without point-of-sale systems or digital records, many businesses can easily conceal their true turnover, evading taxes while appearing legitimate.
Another sophisticated method of evasion is carousel or circular trading fraud. Here, a network of businesses repeatedly trade the same goods in a loop, each claiming input tax refunds while the actual movement of goods is minimal or non-existent. Eventually, one company -- often a ghost firm -- disappears without paying the due tax, leaving the government with substantial unpaid liabilities.
Meanwhile, misclassification of goods is a quieter but equally damaging tactic. Businesses deliberately label taxable items as exempt or assign them to lower tax brackets, such as declaring luxury goods as essentials to benefit from reduced rates. This form of evasion is especially common in imports, where incorrect HS codes are used to avoid duties and taxes.
The digital economy, too, has opened new avenues for manipulation. Online businesses, digital service providers, and e-commerce platforms have begun using virtual structures and inflated input costs to reduce their tax liabilities. Some shift profits to foreign entities to avoid paying domestic sales tax, while others falsely claim input credits on digitally manipulated invoices. The complexity of cross-border transactions and the absence of stringent digital regulations make these schemes harder to detect and punish.
Businesses deliberately label taxable items as exempt or assign them to lower tax brackets, such as declaring luxury goods as essentials to benefit from reduced rates. This form of evasion is especially common in imports
Despite the sophisticated nature of many of these frauds, the reasons behind them are deeply rooted in structural weaknesses. High sales tax rates, especially when coupled with complex compliance procedures and bureaucratic red tape, serve as strong disincentives for honest reporting. Many small and medium enterprises find it more practical to operate informally rather than spend time and resources navigating an inefficient system. Weak enforcement is another significant factor. Tax authorities often lack the capacity, technology, or legal backing to conduct thorough audits. Investigations are slow, prosecutions are rare, and penalties are too lenient to serve as real deterrents.
Corruption and collusion within the tax administration exacerbate the problem further. In some cases, businesses pay bribes to avoid scrutiny or to get fraudulent refunds processed. This culture of impunity undermines any serious attempts at reform and erodes public trust in the system. Consumers, too, play a role — many willingly accept cash transactions to avoid paying tax, thus reinforcing the off-the-books economy.
The responsibility for this widespread fraud does not rest solely on business owners. Tax consultants and accountants often act as enablers, using their expertise to exploit legal grey areas or even forge documentation. Government authorities, due to inefficiency or complicity, allow fraudulent businesses to operate unchecked. And while some consumers are unaware of the implications of tax evasion, others knowingly participate in the shadow economy to save a few rupees, unaware that they are contributing to the weakening of the country’s economic fabric.
Tackling this problem requires a multi-pronged approach. Stronger enforcement and more frequent audits are essential. Surprise inspections and real-time monitoring systems could deter businesses from engaging in fraud. Equally important is the adoption of digital technologies. Mandatory e-invoicing and AI-based tax analytics can help identify suspicious transactions and detect anomalies. A centralised digital record-keeping system would improve transparency and make it more difficult for ghost firms and bogus invoices to survive scrutiny.
Legal reforms must also be a priority. Harsher penalties, including criminal charges and public blacklisting, can create serious consequences for tax fraud. At the same time, whistleblower programmes offering financial incentives and anonymity could help uncover fraud from within companies. Educating the public about how tax fraud affects national development and encouraging them to demand proper invoices can shift consumer behaviour and build a culture of compliance.
On a broader level, international cooperation is crucial. With many companies exploiting cross-border loopholes and tax havens, information sharing between governments and international audits can help trace fraudulent activities that extend beyond national boundaries.
Sales tax fraud in Pakistan poses a significant challenge, undermining governance, exacerbating inequality and hindering economic development. The revenue lost each year could be used to fund schools, hospitals and infrastructure projects that lift millions out of poverty. Curbing this menace requires a strong political will, institutional reform and active public participation.
And only a transparent, accountable and technologically equipped tax system can help Pakistan create a fair business environment, ensure economic justice and security for its fiscal future.
The writer is the president of the Pakistan Tax Bar Association.
