Fixing retail evasion upfront

Formal businesses in Pakistan lack a level playing field, especially in the FMCG sector.

The GST rate of 18 percent is already very high, and the incentive to evade it is strong enough for new informal players to emerge or for existing ones to gain scale.

On top of this, for items that fall under standard sales tax, there is an extra 4 percent levy on unregistered retailers and an additional 2 percent income tax on items subject to standard sales tax.

Since small retailers remain reluctant to enter the tax net, the formal manufacturer, or the consumer effectively either bears this additional 6.5 percent tax.

With over 90 percent of retailers in the country operating undocumented, this additional tax becomes a serious problem. They do not want to get registered. Nothing has worked on them in the past thirty years. The recent Tajir Dost scheme also failed miserably. In addition, even many registered players in the retail and wholesale value chain pay little to no tax.

All these penal taxes do is place the burden on formal players while giving an unfair advantage to informal operators. An almost 25 percent price delta is enough for undocumented manufacturers or importers to increase their market share.

Formal players cannot move away from small, unregistered wholesalers and retailers, as that would risk losing market share and shelf presence in most places. At the same time, they cannot fully pass on the higher cost to consumers, as competitors can undercut them in a price-sensitive market.

That is the challenge for GST collection in value-added form when enforcement measures are weak. Historically, penal taxes have not worked in Pakistan. The filer and non-filer distinction over the past decade failed to expand the tax net. The same is true for taxes on unregistered retailers.

One way to deal with this is to bring more consumable items into the Third Schedule of the Sales Tax Act. Currently, several items, including water, biscuits, coffee, ice cream, chocolates, juices, beverages, packaged tea and spices, soaps and shampoos, are part of the Third Schedule. Their retail prices are printed on the packaging, and sales tax on behalf of the value chain is collected upfront from the manufacturer. This reduces evasion and allows the government to collect GST from a market worth over Rs2.5 trillion.

On the other hand, items such as cooking oil, ketchup, milk and dairy products, infant formula and others remain under the standard sales tax regime, where tax is collected at various stages of the supply chain — manufacturers, distributors, retailers, and consumers. These layers add complexity, increase the cost of doing business, and when someone chooses to remain invisible in the value chain, others have to bear the brunt.

The issue is that retail prices are not required to be printed on the packaging for these items. This leaves consumers at the mercy of retailers, who can charge prices of their own choosing. In the value chain, undocumented discounts and under-declared taxable values not only make the system opaque but also create room for leakages, especially in small towns and villages.

The solution is simple: add the above-mentioned items to the Third Schedule to bring transparency to the value chain. This would protect consumers from overcharging, give formal players space to compete without being undercut by tax-evading operators, and help the government collect the full tax due.

It is a win-win situation, but the government must also think of more direct ways to bring retailers into the tax net.

Expanding the Third Schedule to include categories such as cooking oil, ketchup, milk and dairy products, infant formula, frozen foods, flour and noodles would benefit the government by increasing visibility across the retail value chain, improving GST collection, reducing leakages, and creating a fairer competitive environment for formal businesses.