THE DETRIMENTAL IMPACT OF RECENT TAX POLICIES ON PAKISTAN’S INDUSTRIAL SECTOR AND EXPORT COMPETITIVENESS

The recent budget approved by the Parliament appears to be the last nail in the coffin for the already struggling industries of Pakistan. The Government’s aim seems to be to squeeze taxes from those who are already compliant, without making any substantial effort to collect taxes from untaxed or undocumented sectors.

In times when Pakistan is facing a significant balance of payment crisis and is burdened with substantial foreign and domestic loans, the Government’s focus should have been on incentivizing industries to invest in sectors that either export goods or provide local alternatives to imported goods. However, the Government has adopted a different approach, further burdening exporters and other manufacturers.

The following are some major issues and bottlenecks created by the Government, which will hurt exporters and other manufacturers and will prove extremely detrimental to any future investment in Pakistan’s manufacturing sector:

1. Currently, exports are subject to a Final Tax of 1% of export proceeds. As per the Finance Act, 2024-25, exporters will now be subject to an income tax rate of 29% and a super tax of up to 10%, totaling 39%.
2. At present, the Federal Workers Welfare Fund (WWF) is not applicable to exports. However, since exports will now be subject to the Normal Tax Regime, an additional 2% WWF will also be applicable.
3. Despite a 1% minimum tax for exporters, proceeds from exports are now subject to tax collection at 2% (1% minimum and 1% advance). This is incomprehensible, as commercial importers are subject to minimum taxes of 1%, 3.5%, and 6% (based on the category of items) and are not subject to any further income tax withholding.
4. Other manufacturers are subject to a 1.25% minimum turnover tax but are also subject to income tax collection at rates of 1%, 2%, and 5.5% (based on the category of items) at the time of import. Additionally, when they use electricity to manufacture or process these items, they are subject to a 5% tax collection on electricity bills. When they supply manufactured goods to the market, they are again subject to a 5% income tax withholding by the buyer. With all these tax deductions, it becomes nearly impossible for anyone to consider investing in the manufacturing sector in Pakistan.
5. To avail income tax exemption from tax withholding at the time of supply of goods, manufacturers are required to pay upfront advance tax to the tax department. However, instead of complete exemption, the law has now been amended to issue only a tax reduction certificate. Therefore, even after paying income tax in advance, manufacturers will have to request each buyer to provide tax deduction certificates, further increasing operational costs and complications. On the other hand, after paying income tax withholding at the import stage, commercial importers are exempt from any further income tax withholding on supply without needing to obtain an exemption certificate from the Commissioner of Inland Revenue.

In the 1960s, a massive tax cut was John F. Kennedy’s premier election catchline. When a news reporter asked him how he would handle the situation if he fell short of revenue targets, he replied that he would further reduce the tax rate. His logic was clear: “Leave enough money with the entrepreneur to reinvest in the business, and he will come back with higher taxes.” This strategy worked and paid off. There needs to be a balance between the citizen’s right to earn lawfully and the state’s right to tax. The imposition of tax is, by its nature, an interference with the fundamental right of a citizen to earn lawfully. Nonetheless, this interference is necessary, and since it remains an interference, the state’s right to impose taxes must be exercised with restraint and utmost care. However, in Pakistan, taxes are levied without proper planning or long-term vision. The industrialists and salaried class of Pakistan had many hopes from the Finance Minister, but based on the irrational amendments made through the Finance Act, it appears that there is no hope for the revival of industrialization in Pakistan. The Government has been urging foreigners to invest in Pakistan, but with these discouraging tax amendments, even foreign investors will consider relocating existing investments to other countries. If relocation is difficult, they will certainly consider making new investments outside Pakistan. This is evident from a recent notice issued by a listed company on the PSX, informing about the plans of its Board of Directors to establish a manufacturing company in Dubai to undertake manufacturing and other activities related to biscuits and other confectionery items.