The great tax exodus

Published February 19, 2024

TAX evasion significantly impedes human development in Pakistan, hindering the provision of essential public services, addressing socio-economic disparities, and ensuring a sustainable future. Despite efforts to strengthen the tax system, evasion persists, depriving the government of revenue and hindering investment in critical sectors of education, healthcare, infrastructure, and social welfare.

This exacerbates inequality, restricts access to services, perpetuates poverty, and obstructs progress towards the Sustainable Development Goals.

To grasp the scale of evasion, it’s vital to assess the magnitude of the informal economy. Estimates indicate that the shadow economy accounts for roughly 40 per cent of the nation’s GDP — a cornerstone for evaluating the ramifications of tax evasion on the broader economic landscape.

Pakistan, a major tea importer, sees significant tax evasion in the tea industry due to smuggling and illegal trade. The automotive sector, including auto lubricants and tyres, experiences substantial growth fueled by imports, making it vulnerable to tax evasion through smuggling. The pharmaceutical industry also faces tax evasion challenges due to smuggled and counterfeit medicines. Additionally, tax evasion is rampant in the real estate sector, characterised by under-invoicing and file transactions.

The informal economy, undervaluing properties on paper and rampant smuggling in various sectors have led to sub-par revenue collection by the FBR

Under-invoicing, particularly rampant in the real estate sector, involves deliberately undervaluing properties during transactions to evade taxes. Properties’ declared values in sale/purchase deeds often undervalue the actual market worth.

This practice has significant implications for tax revenues and economic stability, resulting in government revenue losses and market distortions. In 2021, in just 300 property transactions in Karachi, an excess of Rs13 billion was paid compared to the property valuation rates set by the Federal Board of Revenue (FBR). This substantial amount suggests the existence of considerable unreported or untaxed funds within the market, shedding light on the prevalence of black money in the real estate sector.

Legislative gaps exacerbate the issue, with the absence of a legal framework in the Islamabad Capital Territory until 2020 contributing to billions in tax evasion and fostering corruption in land revenue administration.

Despite efforts by FBR to address under-invoicing through valuation tables, pressure from property stakeholders has limited their effectiveness, highlighting ongoing challenges in combating tax evasion. The revenue administration in Islamabad Capital Territory and Karachi faces challenges due to outdated land classification methods.

To combat this, land valuation should consider real estate value, location within Islamabad’s zones, and adherence to land-use regulations.

In Karachi, discrepancies in property transactions indicate significant unreported funds, highlighting rampant tax evasion in the real estate market. Cash transactions exacerbate the issue, enabling the parking of black money and tax evasion.

Despite efforts by the federal government, structural issues persist, including under-invoicing and insufficient documentation. There is a dire need to focus on legislative reforms, improved valuation methods, and enhanced documentation practices to curb evasion effectively and promote transparency in Pakistan’s real estate sector.

The demand for tyres in Pakistan is projected to increase significantly, with the Ministry of Communications estimating 65 million vehicles on the road by 2030, up by 3.4 million vehicles annually.

Presently, the country has around 35m vehicles after adjusting for the pandemic shutdown. However, 65pc of the tyre market is met by illegal or smuggled tyres, while only 20pc are locally manufactured and 15pc are legally imported.

Tax evasion and counterfeiting in the tyre industry have led to substantial losses to the national exchequer, with an estimated tax loss of Rs35bn from undocumented trade in 2022.

Additionally, weak enforcement has enabled traders to evade taxes, with practices such as under-invoicing and concealing tyres to avoid detection. Addressing these issues requires stronger enforcement mechanisms, stricter regulations, and public awareness campaigns to discourage the use of counterfeit and reclaimed products and ensure vehicle performance and safety.

Tax evasion and illicit trade thrive in Pakistan’s tea industry, predominantly fueled by imports, as Pakistan remains one of the largest importers of tea worldwide. Rural areas, with limited tax enforcement, favour loose tea, especially in regions like Khyber Pakhtunkhwa and Balochistan. Exploitation of the Afghanistan-Pakistan Transit Trade Agreement worsens the situation, with smugglers diverting tea intended for export to the domestic market.

Loose tea also poses health risks, with reports of adulteration and confiscations. With stagnant import numbers despite population growth, smuggling fills the gap, necessitating stringent enforcement and awareness campaigns to safeguard public health and the economy.

The writer is the head of content at a communications agency

Published in Dawn, The Business and Finance Weekly, February 19th, 2024

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