Introduction

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.

Figure 1: Indirect Taxes

Category	Share
Sales Tax	65.5%
Other Indirect Taxes	34.5%

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.

Fragmentations and Distortions in the GST Framework of Pakistan

Structural Inefficiencies of a Multi-Stage Taxation

In a VAT mode GST regime, manufacturers, importers, distributors, wholesalers and retailers are required to collect output tax, claim input tax credits and submit monthly returns. In principle, it is a self-enforcing audit trail. However, in the case of Pakistan, the system collapses at the retail level, where a significant majority of the retailers remain undocumented and non-filers. This mechanism offers an equal chance of leakages for every extra tax collection point in the supply chain. For example, the distributor’s discount and the unregistered retailers significantly result in revenue losses. Moreover, transfer pricing allows the shifting of value and taxable profit between related entities along the supply chain. Additionally, the actual price is further concealed by the unofficial credit agreements, off-invoice payments, and undocumented discounts. The result is persistent divergence in the government’s de jure tax base and de facto tax base.

Retail Tier and the Scale of Informality

The prevalence of unregistered and non-filing retailers is alarming. According to an estimate, only 300,000 retailers are tax filers from a total of 3.7 million retailers in Pakistan. This implies that the rate of tax compliance is even lower than 10%, and approximately 92% retailers remain undocumented.² However, industry estimates suggest that approximately 80% retailers are undocumented.³

92% retailers remain undocumented

These numbers remain stubbornly low, revealing the consistent policy failures across different governments. The IMF country review report states that the “Tajir Dost Scheme,” aimed at including retailers and traders in the tax net through simplified registration, has failed to deliver a significant outcome.⁴ However, the initiative registered 70,000-75,000 shopkeepers/retailers, indicating a marginal improvement in the sector’s overall size.⁵ This underscores the limited effectiveness of voluntary compliance schemes in structurally informal markets.

Limitations of FBR’s Downstream Enforcement Framework

Additional & Advance Tax Regime

The Finance Acts from 2020 to 2025 have addressed the retail non-compliance by imposing additional taxes on unregistered and non-filing retailers instead of redesigning the collection mechanism. Current registered retailers and 2.5% advance income tax on non-filer retailers, bringing the total additional levy to 6.5% along with the 18% standard GST. Along with the additional tax levies, penalties were also introduced for non-compliant retailers, and FBR has been authorised to seal non-compliant premises. These measures reflect a forced approach based on the notion that sufficiently punitive rates will force retailers to get registered and file taxes. However, the empirical evidence doesn’t support this premise as more than 80% of the retailers remain undocumented even after aggressive taxation policy, increasing penalties and registration and enforcement campaigns.

A recent example is the Tajir Dost scheme that received a weak initial response. Although the initiative was able to get around 70,000 retailers registered, the actual tax collected through the scheme was far below the targeted revenue collection, with just Rs 3 million at the end of September 2024, against the target of Rs 10 billion.⁶ Increasing the tax burden on the non-compliant retailers have neither resulted in revenue mobilisation nor significant documentation. This underscores a need for an alternative tax collection mechanism that can ensure revenue mobilisation even in the presence of persistent retail-level informality.

Institutional & Capacity Constraints

Beyond policy formulation, the enforcement is limited by the structural institutional constraints. Despite relatively high statutory tax rates, Pakistan’s tax-to-GDP ratio remains below the regional competitors, reflecting deep-rooted issues in administrative capacity and compliance. The essential distinction is that higher fiscal receipts from levies and ad hoc windfalls do not serve as substantial reform. The compliance challenge is both complex and structural, with a large number of undocumented retailers, a significant number of registered businesses remaining “nil filers”, suggesting issues of under-reporting. In such an environment, additional taxes to enhance enforcement disproportionately affect industry/manufacturers, who are already tax compliant, while the non-compliant retail sector remains only marginally affected. This generates a structural imbalance in which withholding-based enforcement enhances upstream compliance while failing to significantly expand the downstream tax collection.

Policy-Induced Cost Burden on the Industrial Sector

Cost Absorption of Retail Level Tax Enforcement

The most detrimental consequence of the existing tax policy is its commercial impact on formally registered manufacturers of the FMCG sector. The manufacturers are forced to absorb this 4% additional tax within their own margin structure, as passing it on to the retailers comes with the risk of losing shelf space and market share, in a competitive market with already low margins and high-volume distribution. In practice, industry stakeholders note that they are compelled to absorb partial or full additional cost burden to maintain a connection with retailers, ensure product availability and safeguard their market presence. In practice, a tool intended to enforce retail documentation has turned into a recurring operational cost for manufacturers. This essentially alters the desired incentive structure in such a way that it penalises formal compliant manufacturers rather than non-compliant informal retailers.

Incentive structure penalises formal compliant manufacturers.

Discount Reallocation and Transfer Pricing Practices

Another distortion emerges from the extensive use of undocumented discounts and informal trading terms across the FMCG distribution chain. In the absence of printed retail prices, wholesalers and retailers have the liberty to negotiate the transaction prices that significantly differ from the invoice values. This provides a potential for systematic under-declaration of taxable value. The Sales Tax Act has provisions for arm’s length pricing between associated persons. However, the enabling rules have not been publicly announced by FBR, making them essentially ineffective in practice, resulting in an unstable and opaque tax base. Manufacturers who use multi-tier distribution, including factory, Cost & Freight agency, distributor, sub-distributor, and then retailer, face increasing confusion over the true price at which their product is sold and the associated tax obligation at every turn. This intricacy encourages informality and deters investment in formal supply chain architecture.

Equity Implications of the Policy Framework

The burden is not distributed equally. Large, publicly traded FMCG companies incur a disproportionate part of the system’s expenses, as their products are the most visible, branded, and likely to face regulatory scrutiny. In contrast, informal manufacturers who produce unbranded or vaguely branded goods in the same categories operate mostly outside of the GST net. As a result, the formal sector has a structural competitive disadvantage: higher effective costs, a heavier administrative burden, and no equivalent enforcement pressure on informal competitors. This dynamic, if not addressed, will continue to undermine the economic rationale for participating in the formal economy.

Consumer Costs Stemming from Non-Transparent Pricing

The Implicit Tax Burden on Household Budgets

The effects of Pakistan’s informal economy extend beyond fiscal accounting. For the average household, the absence of a printed retail price exposes them to arbitrary overcharging regularly, a silent regressive tax levied not by the state but by an invisible retailer. In Pakistan, a vast majority of 3.7 million retailers are under no enforceable obligation to sell at the price specified by the manufacturers. Without a marked MRP on the product pack, customers, price control agencies, and food safety regulators have no legal basis to dispute overcharging. The implications are significant for the lower-income households, as food accounts for 36.78% total household expenditure across all income categories. Milk accounts for 21.75% of total food spending, followed by wheat at 11.78%, sugar at 3.75%, and cooking oil at 0.28%. In the lowest income quintile, wheat and wheat flour account for 20.06% of the food expenditure, milk for 20.33%, and vegetable ghee for an additional 9.51%.⁷ This indicates that price opacity in these categories disproportionately affects the most vulnerable households.

Overpricing Under a Weak Regulatory Framework

The absence of printed retail pricing has led to market failures. Under the GST framework, manufacturers are required to provide price lists to the trading partners. However, there is no mechanism in place to compel retailers to display or comply with the prices. There are hardly any retail or keryana stores that display the prices, ensuring transparency. Provincial price control authorities have sent notices to businesses regarding inconsistent pricing practices. However, enforcement is still, at best, patchy because the legal framework does not impose a consumer-facing price obligation on the product itself.

The issue is not only one of enforcement capability; it is fundamental in nature. The undocumented retail industry is typically considered a tax administration issue. However, the consumers are immediately affected by the uncertain prices, unjustified markups, and lack of a simple mechanism to verify if they’re being overcharged. Customers in smaller towns and rural marketplaces, where the majority of Pakistan’s population lives, have no alternative when a product lacks a printed price. They pay as instructed.

The current inflationary environment exacerbates this pricing vulnerability. Over six years, household expenditures increased from Rs 37,159 to Rs 79,150, expanding more quickly than incomes.⁸ In this situation, households that already spend two-thirds of their income on food and energy alone suffer a real and measurable welfare cost from a system that leaves retail pricing up to discretion rather than transparency.

Figure 2: Household Expenditures (PKR)

Year	Household Expenditure
2020	37,159
2026	79,150

The Third Schedule: A Superior Structural Approach

The Third Schedule of the Sales Tax Act takes an essentially distinct approach to GST collection. Under this system, sales tax is levied on the basis of the printed retail price on the product package, and the entire tax liability is discharged at the initial point of supply, typically the manufacturer. Retailers and wholesalers have been eliminated as collecting sites. The mandatory printing of retail prices reduces the possibility of downstream price manipulation and establishes a publicly visible, regulatory-enforceable revenue base. In economic terms, the price of the product becomes a piece of publicly observable information that minimises the asymmetry between buyers and sellers.

This is not a hypothetical benefit. For items such as cooking oil, which is offered in 1-litre, 3-litre, and 5-litre pouches and tins at millions of retail locations, the disparity in shelf prices in formal and informal markets is a well-documented issue identified by provincial food authorities. Extending the Third Schedule to these areas would standardise pricing, provide consumers with a clear benchmark, and give provincial food and price control departments an enforceable reference point. The reform thereby meets both consumer protection and tax administration aims concurrently, while protecting industry from additional costs.

Stakeholders Engagement and Feedback

As a part of the research process, a consultative session was held on 7th May 2026 to gather structured feedback from relevant stakeholders on the issues discussed in the paper. The session brought together 23 participants drawn from policymakers, tax practitioners, industry leaders from the FMCG sector, chambers of commerce, consumer associations, and economists. The objective was to put this paper’s proposal for critical peer review and strengthen the policy suggestions through stakeholders’ insights. The following questions were mainly discussed in the session:

1. Has the strategy of additional taxation on unregistered retailers delivered meaningful documentation outcomes, or has it primarily raised costs on the formal sector?
2. Can upstream GST collection under the Third Schedule improve revenue integrity and compliance without increasing the overall tax burden on consumers or industry?
3. Which essential grocery categories should be prioritised for Third Schedule inclusion, and what institutional process should govern their addition?
4. How should the government balance the consumer protection benefits of mandatory retail price printing with the administrative transition costs for manufacturers and FBR?

Main Points of Stakeholders’ Perspective

1. All stakeholders unanimously agreed that the current additional tax system has not led to a substantial improvement in the expansion of the formal retail base. Industrial representatives, in particular, noted that these additional levies have essentially become a recurring operational cost borne by manufacturers. The empirical data also support this assessment, as more than 80% of retailers remain unregistered despite the additional taxation and enforcement drives.
2. Industrial representatives endorsed the expansion of the Third Schedule as tax collection is done completely at the production level against the printed retail price; this approach protects industries from the burden of additional tax and guards the government revenue stream against the downstream informality.
3. There was a broad consensus among stakeholders that the consumer commodities currently outside the Third Schedule represent a significant economic gap. However, stakeholders also noted that the structural limitation of the Third Schedule is a standalone reform.
4. Economists and tax practitioners highlighted that the third schedule doesn’t address the fundamental failure: the lack of self-enforcing incentives within Pakistan’s GST design. Pakistan’s tax system continues to function on the idea that compliance can be achieved by state monitoring and aggressive enforcement, a model that has remained ineffective after three decades of evidence.
5. It was argued that formalisation accelerates in the presence of economic incentives. India, Latin America and Rwanda serve as examples that long-term tax base growth depends on consumer incentives, smart technology and structural reforms.
6. The session concluded with a two-tier consensus: Third Schedule expansion serves as an immediate, technically viable solution to protect formal manufacturers. However, it cannot be presented as a long-term reform. Additionally, the structural flaws that limit the self-enforcing mechanisms need to be addressed for increasing formalisation and minimise revenue leakages.

Proposal for Expansion of Third Schedule & Recommendations

This section incorporates the paper’s analytical analysis and conference recommendations to propose a framework that needs to be adopted by policymakers.

Prioritise Expansion of the Third Schedule

Under the Third Schedule of the Sales Tax Act 1990, different consumer commodities, including water, biscuits, chocolates, drinks, ice cream, coffee, shampoos, soaps, and boxed tea, are covered for which the GST is paid on the printed retail price and discharged at the production stage. This approach essentially eliminates the retail tier from the GST collection chain, securing government revenue from informality. Its operational logic is transparent, upstream, and MRP-anchored, which is structurally superior to the regular VAT mode in the Pakistani market setting, where retail-level informality is structural and persistent. By linking tax responsibility to the printed retail price at the production level, the government ensures its income stream regardless of whether the downstream store is registered, filing, or complying. This is especially noteworthy given that around 80-92% of retailers remain outside the formal tax net, a structural reality that no amount of more tax, penalty enhancement, or registration campaign has changed over the last decade.

Proposed Categories for the Third Schedule Expansion

The following packed commodities are the top priorities for inclusion in the Third Schedule of the Federal Budget 2026-2027.

Tier 1 – Highest Priority

1. Packaged Milk and Dairy Products: Milk accounts for 21.75% of total household food expenditure across all income quintiles. The lack of stated retail pricing in this category exposes the most vulnerable households to arbitrary overcharging, undermining provincial food authority enforcement efforts. The packaged dairy market (liquid milk, powders and infant formulas) is dominated by large, officially recognised firms, making upstream collecting administratively viable without transitional complexity.
2. Cooking Oil: Cooking oil accounts for a sizable portion of food expenditure in low-income households; vegetable ghee alone accounts for 9.51% of food spending in the lowest quintile. The price difference between formal and informal retail channels for oil offered in 1-litre, 3-litre, and 5-litre SKUs is a recorded concern of provincial food regulators. The introduction of the Third Schedule would standardise consumer-facing pricing and provide price-control regulators with an enforceable benchmark.

Tier 2 – Strong Case

3. Packed Flour and Wheat Products: Wheat and wheat flour account for 11.78% of total household food spending, with 20.06% in the lowest income quintile. Although the market is largely dominated by unbranded, loose packaging flour bags. However, inclusion of branded, packaged flour sold by registered millers in the Third Schedule would shield the formal flour industry from the competitive disadvantage imposed by informal, unbranded competitors operating fully outside the GST net.
4. Condiments and Ketchup: These commodities are largely dominated by formal business and come with proper packaging and branding. Their inclusion in the Third Schedule would increase consumer transparency and enhance revenue collection.
5. Frozen Foods: Frozen foods, although they have small market penetration, have a large number of formal businesses and also have a small relevance, making it a safe option for Third Schedule integration.

Institutional Governance of the Third Schedule Expansion

A significant weakness in the current taxation framework is the lack of a transparent, rule-based mechanism for adding commodity categories to the Third Schedule. Historically, additions were made ad hoc through Finance Acts, with no stated criterion framework, impact assessment, or stakeholder participation method. This study recommends the following institutional process for governing the Third Schedule inclusions.

1. Eligibility Criteria: A consumer commodity can be included in the Third Schedule if it is primarily produced by registered manufacturers, has over 100,000 retail points of sale, has documented price disparity between registered and unregistered channels, and is a significant budget item for the lower two income quintiles, according to household expenditure surveys.
2. Revenue Impact Assessment: The Tax Policy Office should provide a revenue impact assessment for proposed additions, comparing predicted upstream tax collection to existing VAT-mode income from the same category and adjusting for leakage reduction. Stakeholders consultation should be done to support the assessment.
3. Phase Implementation with Monitoring: Each new category added to the Third Schedule shall undergo a 12-month post-implementation review to evaluate revenue performance, consumer pricing trends, and industry compliance.

Risks and Mitigation

The following risks are associated with the expansion of the third schedule that are worth noting.

VAT Evasion and Supply Chain Disruption: The Third Schedule disrupts the supply chain by skipping the distributor and retailer layers, breaking the self-reinforcing audit process outlined in VAT theory. In Pakistan, where that system is already mostly inoperable at the retail level, this is a manageable trade-off. However, the FBR must guarantee that distributor-level input tax claims are appropriately adjusted to avoid multiple credit claims on products previously taxed upstream.

Potential Delay to Structural VAT Reforms: The institutional lock-in is the biggest systemic risk. If the Third Schedule expansion lowers the government’s revenue cost of retail-level informality, there may be less political urgency for deeper VAT reform. This risk must be reduced by treating the Third Schedule expansion as an explicitly transitional measure.

Upstream Revenue Concentration Risk: Revenue collection at the manufacturing level provides a single point of audit dependence. To prevent volume underreporting, the FBR must ensure that significant manufacturers in newly covered categories face greater audit scrutiny and real-time production data reporting.

Addressing the fundamental flaws in Pakistan’s VAT system necessitates a change away from punitive, enforcement-driven compliance and toward a technology-enabled and incentive-based formalisation paradigm. According to international experience, long-term VAT reform hinges on simplifying business registration, integrating federal and provincial GST systems, developing digital payment integration, and providing consumer incentives for invoice documentation. Pakistan already has much of the necessary infrastructure, including NADRA, mobile connectivity, and existing POS systems. The policy problem is thus institutional rather than technological: combining various systems into a unified framework that decreases informality, increases invoice-chain integrity, and makes formal involvement economically beneficial to merchants, customers, and producers alike.

Conclusion

Pakistan’s GST framework has a structural flaw: a multi-stage tax system working in a primarily informal retail industry. Enforcement-led initiatives have failed to increase compliance, with fewer than 10% of the 3.7 million merchants registered, and schemes like Tajir Dost producing insignificant outcomes. Meanwhile, the “further tax” regime has primarily raised costs for the compliant industry, leaving informal retailers unscathed. The Third Schedule provides a more effective transitional approach, pushing GST collection to the production stage via printed retail prices. This protects compliant enterprises, increases price transparency, and decreases distortions that promote informality. However, long-term reform necessitates consumer incentives, streamlined registration, and technology-driven compliance. Pakistan’s low tax-to-GDP ratio reflects base inadequacies rather than insufficient tax rates.

Policy Recommendations

The following are some immediate actions for the Federal Budget 2026-2027:

Expansion of the Third Schedule: The Finance Bill 2026-27 should amend the Sales Tax Act of 1990 (Third Schedule) to cover packaged milk and dairy products, edible oils and cooking fats, branded packaged flour, frozen foods, and condiments under the third schedule. The appropriate GST rate should stay at 18%, which is consistent with the standard rate and ensures revenue neutrality.

Elimination of Further taxation: The 4% further tax under Section 3(A1) of the Sales Tax Act of 1990 should be phased out in the Federal Budget of 2026–27. Thirty years of evidence and academic consensus confirm that this instrument is structurally deficient: it does not broaden the retail tax base and instead imposes a recurring cost penalty on nominally compliant producers. Its abolition should be combined with the simultaneous extension of the Third Schedule to ensure that the exchequer incurs no net revenue loss.

Implement a transparent institutional process for future third-schedule additions: The Tax Policy Office should establish a clear criterion framework for the inclusion of commodity categories to the Third Schedule, based on the eligibility conditions provided in this brief. This framework should include mandated revenue impact evaluations, a 12-month post-implementation review period, and public consultations. This procedure will develop institutional legitimacy for the mechanism while preventing ad hoc, lobbying-driven extensions.

Integrate Third Schedule MRP Data to Provincial Price Control Systems: FBR should enter into a data-sharing framework with provincial food authorities and Competition Commission of Pakistan to share verified MRP data for all Third Schedule items. This will provide province-specific regulators with an enforceable legal reference for consumer price protection, as well as allow for systematic monitoring of retail price conformance through formal and informal channels.

Establish a consumer invoice incentive scheme: The Ministry of Finance and FBR should develop and test a consumer-facing invoice incentive programme, such as a GST lottery or payback scheme, that is linked to scanned purchase invoices submitted via a mobile application. The method should be implemented in two or three urban centers in the first year, with a national rollout planned for 2028. International experience from Portugal, China, and Latin American economies suggests that such programs can raise retail-level invoice issuance by 3-5 percentage points in two years of adoption. The fiscal cost of cashback payments should be factored into the predicted net revenue gain from increased invoice compliance.

Formalisation of a federal-provincial GST coordination council: The government should form a permanent Federal-Provincial GST Coordination Council that includes the FBR, provincial revenue authorities, the Ministry of Finance, and the Finance Departments of all four provinces. The Council need to be tasked with: (a) resolving input-output adjustment disputes at the goods-services border; (b) developing harmonised audit standards; (c) publishing a medium-term roadmap for GST structural reform; and (d) comparing Pakistan’s GST architecture to India’s integrated GST model as the long-term structural target. Council meetings should be held quarterly with published minutes.

Notes

1. FBR, “Year Book 2024-2025”. Available at: download1.fbr.gov.pk
2. Rana, Shahbaz, “Only 50 retailers register with FBR”, Express Tribune, 17th April, 2024. Available at: tribune.com.pk
3. Haq, Shahram, “FMCG industry pushes for GST reform”, Express Tribune, 30th April 2026. Available at: tribune.com.pk
4. “IMF Country Report No. 25/109”, May 2025. Available at: imf.org
5. Sarfaz, Sohail., “Shopkeepers/traders: FBR mulling another registration scheme”, Business Recorder, 24 March 2025. Available at: brecorder.com
6. “IMF Country Report No. 25/332”, December 2025. Available at: elibrary.imf.org
7. “Household Integrated Economic Survey (HIES) 2024-25”, PBS.
8. Ibid.