1. Introduction / Executive Summary

Pakistan's GST framework has a structural flaw: a multi-stage tax system working in a primarily informal retail industry. The informal retail sector has consistently avoided compliance, resulting in revenue leakages, enhanced enforcement complexities, and creating market distortions that weaken fiscal performance. For undocumented businesses, Pakistan’s tax policy has relied on penalty instruments like further tax, additional tax, and withholding tax. This defies the enforcement-based documentation and focuses on the indirect incentives embedded within the tax system.

The Sales tax is the largest contributor among the indirect tax distribution in Pakistan. Alone in FY 2025, sales tax constituted 65.50% of the total indirect tax collection.1 The General Sales Tax (GST), levied under the Sales Tax Act 1990, transitioned from a provincial levy to a centralised federal tax system following significant institutional shifts in 1948 and 1952. The Sales Tax Act enhanced the coverage across the supply chain by broadening the tax base from a stage-specific levy on imports/manufacturing to a multiple-stage consumption tax designed on the principles of Value-Added Tax (VAT) from manufacturing through wholesalers to retailers. However, the retail tier of this stream has consistently shown structural aversion to compliance, resulting in revenue leakages, enhanced enforcement complexities, and creating market distortions that weaken fiscal performance.

To address the issue of revenue leakages and encourage the unregistered businesses to get registered, under Section 3(A1) of the Sales Tax Act, 1990, the government has imposed a “further tax” for the goods sold to unregistered persons. Under the Finance Act, 2023, its rate was increased from 3% to 4%. This tax is not a new levy; it was initially introduced in 1998 to penalise the sales to unregistered retailers, was abolished in 2004, but reintroduced in 2013. However, its tightening under the Finance Act, 2023, was aimed at enforcing documentation. Additionally, a withholding tax (advance tax) of 2.5% on transactions with unregistered retailers was imposed.

For undocumented businesses, Pakistan’s tax policy has relied on penalty instruments like further tax, additional tax, and withholding tax for transactions with unregistered retailers/wholesalers. This defies the enforcement-based documentation and focuses on the indirect incentives embedded within the tax system. However, these efforts have not resulted in any positive outcomes; instead have increased the enforcement complexity and negatively affected the manufacturers and consumers only.

In addition to the VAT mode, the GST is also collected upfront at the manufacturing stage for the articles included in the Third Schedule of the Sales Tax Act. The retail price is printed on the product pack, ensuring that the tax base is transparent, enforceable, and less exposed to revenue leakages. Currently, the third schedule covers commodity categories including water, biscuits, chocolates, coffee, ice cream, beverages, syrups & squashes, shampoos, soaps, packed tea and spices.

This paper examines the interlinked problems: the structural distortions embedded in the current VAT-mode GST framework at the retail level, institutional constraints of the FBR’s downstream enforcement strategy, and the disproportionate burden this system has imposed on the formal, compliant manufacturers. The paper also evaluates the Third Schedule of the Sales Tax Act as a structurally superior mechanism for GST collection and advocates in favour of its expansion to essential food and consumer goods before the Federal Budget 2026-2027.