Tax dilemma

LAHORE: Pakistan adheres to International Financial Reporting Standards (IFRS), which do not permit businesses to classify pass-through taxes — such as sales tax and withholding tax — as part of their expenses or tax burden in financial statements.

However, many Pakistani firms continue to include these taxes in their reported tax contributions, creating a misleading impression of their actual tax liabilities.

Sales tax in Pakistan is collected at multiple stages under the value added tax (VAT) system, with businesses charging it to consumers and depositing it with the Federal Board of Revenue (FBR). In well-regulated VAT systems — such as those in the European Union (EU), Canada and Australia — businesses deduct input taxes from their sales tax liability. While Pakistan allows similar deductions, businesses frequently struggle to secure refunds due to administrative delays and disputes, making them reluctant to claim adjustments.

A significant portion of the economy — including retail, services and real estate — operates outside the VAT system, leading to cascading taxation, where tax is charged on already taxed amounts, increasing costs. In contrast, developed economies enforce structured VAT compliance to prevent such inefficiencies. Furthermore, tax fraud through fake invoices -- used to claim fraudulent input tax adjustments -- remains a persistent challenge in Pakistan, whereas developed economies rely on digital monitoring to curb such practices.

In mature tax jurisdictions, businesses act strictly as intermediaries for sales tax collection and do not count it as their own tax payment. However, in Pakistan, India and Bangladesh, many firms present sales tax as part of their total tax contribution, allowing them to appear as major taxpayers despite merely collecting the tax from consumers.

This practice is particularly pronounced in Pakistan due to low compliance with direct income tax. Many businesses highlight their indirect tax contributions to demonstrate compliance. Government and tax authorities reinforce this perception by publishing lists of “top taxpayers” that include sales tax collectors, distorting the true picture of corporate tax obligations.

A fundamental difference between Pakistan and developed economies lies in corporate taxation structures. In well-regulated economies, large corporations typically pay more in income tax than they collect in sales tax, as their corporate profits are high. However, in sectors with low-profit margins — such as retail, wholesale and hospitality — the sales tax collected often exceeds the income tax paid. In Pakistan, this discrepancy is even more pronounced due to widespread profit underreporting, which minimises income tax liabilities while inflating the perceived tax contribution through sales tax collection.

Similar trends exist in India and Bangladesh, where businesses sometimes highlight GST/VAT as part of their tax burden. However, India’s Goods and Services Tax (GST) framework includes a structured input tax credit mechanism and automated reconciliation between buyers and sellers, reducing the risk of businesses overstating their tax contributions.

Even several state-owned enterprises in Pakistan engage in this practice. They frequently report sales tax as part of their total tax contribution, despite merely acting as collection agents. Similarly, banks in Pakistan include withholding taxes deducted from customers — on cash withdrawals, transactions, and profits — in their reported tax contributions. This further distorts the perception of corporate tax compliance. Due to the lack of clear disclosure requirements, it remains difficult to determine which banks accurately report their tax contributions without including these pass-through amounts. Legally, there is no explicit prohibition against businesses presenting sales tax or withholding tax as part of their total tax contributions. However, the spirit of tax laws and financial reporting standards discourages this practice. Addressing this issue requires greater transparency in tax reporting. The government should enforce stricter disclosure requirements to differentiate between direct and indirect tax contributions. Strengthening digital monitoring, streamlining refund processing and improving VAT compliance mechanisms would help prevent businesses from manipulating tax data to create a misleading impression of their contributions. Without such reforms, the perception of corporate tax compliance in Pakistan will remain distorted, obscuring the true tax burden on businesses and the economy.