Illustration A
A tyre manufacturer produces tyres worth Rs 5 billion where the margin of profit is say 25 percent. This will result in a profit of Rs 1.25 billion on which tax at the rate of 35 percent is payable. This equals Rs 462.5 million.
This liability of Rs 437 million can be brought to Rs 50 million (1 percent if Rs 5 billion) if in some manner the profit is shifted from ‘manufacturing’ to ‘retail side’.
The simple way is to give ‘discount’ (there are other means also) to the retailers to the extent that profit at manufacturing stage is almost nil. What the manufacturers would require will be to identify 25 retailers and sell them goods worth Rs 200 each.
In this manner, the profit of Rs 1.25 billion will be taxed at the rate of 1 percent of turnover in the hands of retailers instead of 35 percent in the hands of the manufacturer.
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The only bottleneck in implementation of this avoidance scheme is the manner of transfer of funds from retailers to the manufacturers. There are numerous ways to pass this profit on to the manufacturer. The simplest may be providing interest-free loans and advances to manufacturers to that extent by the retailer or selling an expensive plot at a low price, etc.
Furthermore, if the product sold is not subject to sales tax under the Third Schedule (sales tax at retail price by the manufacturer) then there will be loss of sales tax at the rate of 18 percent on the margin shifted to the retailer. This margin is itself enough to make a case of arbitrage.
In all situations if that shifting is to be done then there will have to be a higher profit rate on the sale by the retailer. If the imputable tax system as described in the aforesaid paragraph applies in the manner that profit above 2.85 percent is taxed at the full rate then the tax savings will be to the extent of profit up to 2.85 percent only and any additional profit margin will be taxed at the full rate. The author considers that this has not been taken into account in the rules.
This illustration denotes that by introducing this system the government is incentivizing the manufacturing and importers not to pay tax at 35 percent as there is a manner to pay (legally) the tax at the rate of 1 percent by having transfer pricing. Is there a check by way of imputable income?
The question remains unanswered. Without prejudice to the same, if there would be a concept of imputed tax then retailers will be very hesitant to accept that scheme as they remain subject to all proceedings for profit above 2.85 percent of turnover. This means that such imputed income concept is not there in the rules.
This illustration does not present a tax law. It is a business reality. Shifting profit from one hand to another is quite easy in economies like that of Pakistan. If this system is implemented then it would definitely mean that manufacturers and importers will be incentivized to shift their profits to retail and arrange their affairs accordingly. For example, who can stop the wholesale importers of spare parts to import and sell at the cost to cost basis and avoid tax on the profit margin by having connivance with the auto parts dealers on Montgomery Road or Plaza in Lahore and Karachi?
Illustration B
A sweetmeat shop has twenty outlets and if the turnover of all these outlets is added then it exceeds Rs 200 million. It would be very easy for that person to avoid any liability for tax by having a ‘Franchise Agreement’ with the existing current manager in charge at the branch. In that case the person taxable will be that manager who will be taxed at the rate of 1 percent on turnover with sales less than Rs 200 million. There will be no difference in products sold as those goods will be supplied or available with that brand name under the franchise agreement. There are ways to bring back the funds from the manager to the actual owner.
This illustration demonstrates that even if the goods are sold as branded products even then there is a possibility of profit shifting to avoid the high incidence of tax which is presently leviable under the law.
These two illustrations and many other examples would demonstrate that the scheme as announced is not a simplified scheme for the retailers. It is a manner of providing an amnesty to the manufacturer and importers if they intend to pay tax on their activities at less than 37 percent (29+8). This comment is however subject to the ultimate resolution about imputed tax which in the author’s view has been conceived not to be applicable.
Natural equilibrium
Although the scheme has been announced to cater for bringing the retailers into the tax net, the study reveals that the policy makers have not taken into account that there cannot be such a huge difference in the incidence of tax for persons involved in the whole supply chain for the same product.
All income in the chain has to bear the same incidence of taxation. This has been disturbed in this case. This means that no economy can operate where the tax on manufacturers is 35 percent on income with sales tax at the rate of 18 percent and the retail trade is subject to tax (direct and indirect) at the rate of 1 percent of turnover. If it is so, the natural economic equilibrium will start operating and the profits in one way or other will be shifted from manufacturing to retail sector which will ultimately reduce the overall tax collection in the country on that product. This is inevitable.
In this sense, the scheme, notwithstanding its technical detail, is not desirable under general principles of adequate fiscal and economic policy. If the government wants to give concessions to the retailers then it can be stated that such retailers would be subject to an indirect tax on turnover of 1 percent which will also be treated as ‘income tax’ and no more tax would be payable on that sum. This is what it is.
Nevertheless, if the government is confused on imputed income and stopping the chances of shifting of profit from manufacturing and imports to retailers then it means that the proposal has not been examined in a real life perspective manner. If so, retailers who want to opt for the scheme would remain confused.
This scheme is effectively an anti-growth recipe. It effectively says that firms should be fragmented if the sale exceeds Rs 200 million of the business. It discourages, by implication, any form of corporatisation in the retail sector.
Anti-growth for local industry
This scheme is yet another step which has been taken in the past 40 years in Pakistan to discourage local manufacturing against imports. In Pakistan, local manufacturing is subject to a tax plus other levies of over 40 percent on their net income.
Now the manufacturing sector is being asked to compete with imported Chinese products where after the application of the scheme overall tax incidence, without imputed tax, if any, would not be more than 4 to 5 percent of the turnover. (This 4 to 5 percent is the sum determined by adding the tax at import stage plus 1 percent tax on turnover by the retailer). This means that the local manufacturing industry will become highly uncompetitive against imports on account of this non-tariff local taxation. The real solution to Pakistan’s economy lies in giving concessions to the manufacturing sector instead of directly or indirectly promoting imports against local manufacturing.
Obvious discrimination
Any person who is a ‘retailer’ not eligible for this scheme will face discrimination on three apparent counts. Firstly, there is no sales tax on the margin of the retailer in this case. This is a big amount being 18 percent of the sale price. This high rate is enough to transfer profit from manufacturer to retailer unless the products are Third Schedule items. Furthermore, if the profits are shifted in the manner as indicated above then real advantage for businesses will lie in saving sales tax as that is an amount payable to an ‘outsider’ being the government.
In that case the government will have no option except to charge sales tax on manufacturers at retail price which is effectively an excise duty and denial of VAT. That would be a burial of VAT in Pakistan forever. This shifting of profit and exemption from sales tax can substantially reduce the sales tax collection unless all such goods products are placed under the Third Schedule, which is a weird law.
In this connection it is important to note that for that purpose the problem will not be limited to finished goods.
The raw materials being agricultural products, imports and goods manufactured in Pakistan are all routed through markets being retailers having turnover less than Rs 200 million.
Secondly, there is no requirement to withhold tax on purchases made by that retailer. The manufacturers will be encouraged to sell to such retailers as these retailers will not withhold their cash which effectively remains non-refundable to the manufacturer in almost all cases.
The high rate of withholding creates a clear incentive for the manufacturer not to sell to retailers who are required to withhold. It is therefore almost certain that if this proposal is implemented then withholding on supplies by the manufacturer will reduce substantially.
The third difference is the rate of tax on two kinds of retailers having shops adjacent to each other in the market.
One is 1 percent of turnover (without imputed tax) against 35 percent of net income. This means that in almost all the cases the retailers falling under this system will pay substantially less tax in comparison to those retailers where the turnover exceeds Rs 200 million. It is reiterated that keeping in view the real market conditions of Pakistan it is almost certain that over 90 percent of the retailers will qualify under this scheme. It therefore discourages any person to invest in the manufacturing and large scale sector. This would lead to clear fragmentation of existing medium and large sized retail businesses.
Transformation of wholesale sector
This scheme is a clear recipe to eliminate ‘wholesale trade’ in ‘form’ from the supply chain/market. It would not be possible both for the manufacturer and the retailer to involve wholesalers in the present form. If they are kept in the loop then such persons will be subject to sales tax and income tax at the rate of 35 percent on income with tax deduction provisions and other procedural issues. This is not a commercially feasible idea.
Nevertheless, these wholesalers will continue to exist in substance after changing the shape of ‘agent’ instead of wholesalers.
Products will be procured for the retailers by the same wholesaler; however, in form he will be the dealer or agent of the manufacturer. This practice is already prevalent in the case of yarn market in Faisalabad and sugar trade in general. This means that this sector will continue to exist; however, their role in legal form will change to sale agents
Involvement of trade associations
Another issue relates to the involvement of the trade association in the tax proceedings.
Firstly, there is no legal basis to involve a third party in the proceeding of a particular taxpayer. Furthermore, there is no basis to determine the representative trade body under any law of the country. There may be the Cloth Market Association, Akbari Mandi Association, Lahore Traders Association, LCCI or FPCCI.
Thirdly, it is almost certain that there will be two or more than two groups in all such associations. The one group, not in power, cannot be left under the control of another group. These kinds of provisions cannot practically operate under any taxation system.
Overall analysis
This scheme in the author’s view is a loss-loss for the government. It is so as:
a. The government will not get tax on income and sales tax on value addition by the retailer (unless the product is subject to sales tax under the Third Schedule) from the retail sector;
b. The government will lose almost all of the deduction being made on supplies by the manufacturers under Section 153 of the Ordinance. The buyers are not required to withhold tax;
c. There will be no documentation of assets and income as retailers are not required to keep books of accounts etc;
d. Organized and big businesses in the sector will be highly discriminated;
e. Ultimately, the profit will be shifted from manufacturing to retailers as a result of natural economic equilibrium;
f. Tax deduction from the manufacturers on supplies will reduce substantially;
g. There will be a difference between imputable income and actual income. The manner of handling the same is not there in the scheme. There is no easy answer to this complicated problem;
h. Trade association could act like mafias disturbing the economic climate; and
g. The only positive aspect of this scheme is that miscreant manufacturers would now sleep well as they may not be required to handle undisclosed production. They may sell such products to retailers officially with a tax incidence of 1 percent of turnover. Their only problem would be to arrange the return of profit earned by the retailer to them. There are ways and means to do that.
Nevertheless, in this manner the economy would be documented in the sense that all the persons who buy from the manufacturers will be identified. However, both manufacturers and retailers have gotten away from real income taxation by arranging their affairs in an ‘appropriate’ manner in the Pakistani sense. Sales Tax, if required to be received, would have to be done in a weird manner of the Third Schedule to the Sales Tax Act, 1990.
In summary, it is stated that the proposal laid down is required to be re-examined carefully. It does not resolve the issue being faced by the country on the fiscal side.
The net effect is less tax for the government. This is bound to create an impression in the minds of already hesitant retailers that overtime after realising the pitfalls the government will alter and change the scheme against the interest of the retailer. This has been a past experience with such proposals.
In this situation it is expected that a large number of retailers may not opt for the scheme even if it is assured that there is no question about unexplained assets being income earned over and above the imputed income. There is a need to have a holistic view of all the issues before finalizing the matter.
(Concluded)
Copyright Business Recorder, 2026
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