ISLAMABAD: The country’s tax gap has ballooned to a staggering Rs7 trillion in the previous fiscal year (FY24), a sharp rise from Rs1.289tr in FY22, underscoring the urgent need to boost tax compliance to meet IMF targets, Dawn has learned from knowledgeable sources.

This significant increase, almost equal to the Federal Board of Revenue’s (FBR) total collection in 2023-24, highlights a worrying trend and calls for an immediate strategy to enhance tax compliance and meet IMF benchmarks. The tax gap refers to the difference between what taxpayers owe and what they actually pay.

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The FBR’s first tax gap report was compiled in 2022, with the second report following three years later, in September 2024. These reports provide crucial data to assess taxpayer compliance with federal tax obligations.

Official sources told Dawn on Saturday that the worrying data has laid the groundwork for a comprehensive reform plan, set to be implemented over the next three to four years. The reforms will include the introduction of digital invoicing, desk audits of tax returns, performance-based bonuses, and a documentation prize scheme to encourage compliance.

Fresh data lays groundwork for reforms to be implemented over next three to four years

“We will present the reform package to the prime minister next week for approval,” an official source said.

The sales tax gap widened from Rs519 billion in 2022 to Rs3.2tr in FY24, primarily due to tax evasion in key sectors, low collection rates, fake invoices, capacity constraints among tax officials and corruption.

To address this, the most significant reform — mandatory digital invoicing for all manufacturers — will be implemented within the next four to five months. Similarly, tax officials will receive training to better understand value chains and sector experts will be appointed to strengthen oversight.

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The FBR also intends to implement a “citizen monitor” scheme, rewarding purchasers who produce non-digital receipts from shopkeepers. Currently, point-of-sale (POS) systems are installed in 33,000 outlets, and the number will be expanded to 60,000 as part of the reforms, with a strong focus on improving compliance in existing outlets. The revival of the POS purchaser award system, which was discontinued a few years ago, is also under consideration.

Due to low compliance, the income tax gap also widened significantly to Rs2tr in FY24, up from Rs730bn. Individuals and Associations of Persons (AoPs) alone accounted for Rs1.3tr of this gap, with collections from these groups totalling Rs500bn in FY24.

Under the planned reforms, the FBR will engage between 2,000 to 4,000 Chartered Accountants (CAs) or ACCA auditors for a year to conduct desk audits of over half of all tax returns. At the same time, newly developed software will evaluate tax returns for irregularities and cross-check them against other databases.

Currently, there is no formal structure to review tax returns, and tax authorities lack the capacity to perform these reviews. The FBR has only 500 auditors, many of whom do not have professional expertise.

The tax gap in customs duties has also risen, from Rs40bn to Rs300bn in FY24. Similarly, the cost of smuggling to revenue losses was estimated at Rs700bn. The FBR will seek parliamentary approval for further changes once the prime minister has approved the reforms.

The reforms will focus on creating performance-based incentives for tax officers, enhancing their managerial skills and developing sector-specific expertise. Major sectors targeted for improved tax collection include textiles, tobacco, sugar and cement.

The FBR also plans to enhance its IT infrastructure and recruit competent staff for the Pakistan Revenue Automation Limited over the coming months.

Published in Dawn, September 15th, 2024