KARACHI: Small and medium-sized enterprises (SMEs) believe the burden of tax compliance is a bigger hurdle than the actual tax paid or the high tax rates associated with it, according to a yet-to-be-released study conducted by Karandaaz Pakistan, a non-profit that focuses on improving access to finance for the underserved population.

Speaking at a webinar on the state of business taxation in Pakistan, Karandaaz CEO Waqas ul Hasan said a key challenge facing the taxation system is its inherent complexity, which leads to high compliance costs and burdens taxpayers.

According to the 2020 Doing Business Report, Pakistan ranks 161st in 190 economies for the paying-tax indicator, which underscores the difficulty and complexity of complying with tax regulations.

SMEs contribute more than 70 per cent to total employment and have a share of 25pc in exports. However, they tend to stay outside the formal economy. Estimates for the undocumented or shadow economy in Pakistan range from 35pc to 56pc of GDP.

Even though no census of business establishments has been conducted recently, proxy data suggests there can be close to 5.2 million SMEs in Pakistan. Still, only 64,000 or so associations of persons (AOPs) filed returns in 2018, according to the filing data of the Federal Board of Revenue (FBR). The dismal number indicates that only a handful of SMEs are registered with the national tax collection agency.

Evidence collected as part of the Karandaaz study suggests that the tax authorities “must move beyond revenue-centricity” and towards the goal of building a cohesive and simplified tax regime that eliminates all the noise from the system. The study makes recommendations like harmonising the policy across jurisdictions along with the handholding of SMEs via heavy investments in systems that can be integrated across the government machinery to enable data to “talk”.

Karandaaz Chairperson Dr Shamshad Akhtar said underreporting by SMEs is pervasive because these entities lack records and capacity to report in addition to the fact that they wish to stay out of FBR’s bounds owing to the harassment factor. “It would be safe to say what we don’t count, we don’t really know,” she said, adding that such constraints render it difficult to design effective policies.

The SME policy framework is fragmented and entities with “conflicting mandates” and “overriding powers” impose their priorities, she said.

FBR Chief Commissioner Inland Revenue Dr Najeeb Memon said the taxation system must consider the compliance cost 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 incentivises non-compliance. Businesses and individuals are given room to falsely categorise their income, resulting in tax evasion in weakly regulated sectors like real estate and exempt sectors like agriculture,” he said, adding that these inequities must be removed from the system.

Larger minimum-tax thresholds and lower marginal tax rates for certain sectors have further constricted the tax base, incentivising tax evasion, he added.

Published in Dawn, March 16th, 2023