Pakistan’s Finance Act 2025 and Taxation Reforms

The provided text offers an extensive discussion on the Finance Act, 2025, primarily focusing on its impact on taxation, e-commerce, and business regulations. Speakers address new provisions such as withholding tax for online marketplaces, the use of AI for input tax credit verification, and changes to assessment procedures and audit selections. Significant attention is given to penalties for non-compliance, the suspension and blacklisting of businesses, and restrictions on cash transactions. The dialogue also explores amendments to income tax definitions, super tax rates, pension income, and asset purchases, emphasizing the government’s push for digitalization and broader tax base collection.

Digitalization and Evolution of Taxation Mechanisms

The sources discuss several key aspects of the taxation mechanism, highlighting changes, new systems, and enforcement measures introduced, particularly with a focus on digitalization and broadening the tax base.

Here’s a breakdown of the taxation mechanisms:

• Withholding Taxation on Online Marketplaces (Section 11):
• A 2% withholding tax is applied to sales made in online marketplaces.
• This 2% is not an additional tax but rather reduces the output liability of the seller.
• The online marketplace or courier service acts as the holding agent, deducting the tax and automatically reducing the seller’s output tax on their portal.
• This mechanism is part of the broader effort to tax e-commerce.
• The tax collected by online marketplaces will be inserted into a monthly statement, which will automatically appear on the seller’s portal, allowing for easy credit of the holding tax.
• For online platforms, a special rate of 1% applies if payment is made via bank channel, and 2% if it’s cash on delivery.
• This is generally declared as a final tax declaration under Section 7A. However, there is ambiguity regarding how this final tax on transaction value impacts overall taxable income and how it’s reflected in returns, potentially requiring clarification from the C Board.
• Automated Risk Management System for Input Tax Credit (AI-based):
• A new system has been developed to check input tax credit using AI.
• This system, like an “MRI machine,” will verify if the claimed input tax aligns with the business’s line of business or the product being sold. For example, if a mineral water supplier claims to have used iron or wood not typically used in that business, the system will flag it.
• If the system stops an input tax credit, a registered person can submit an application to the commissioner within 30 days to justify their claim. If the commissioner remains silent, the restriction is removed; otherwise, the person may need to go to court.
• Tax consultants are advised to understand their clients’ business models and product recipes to effectively deal with these restrictions.
• Best Judgment Assessment:
• This power is given to the commissioner to assess tax when there is non-compliance, such as unpaid taxes (e.g., under 236G) or unfiled returns. It has been a provision in earlier cases as well.
• Commissioner’s Powers regarding Business Operations:
• Commissioners have been granted three types of powers:

1. Suspension of bank accounts operations for three days, renewable for another three days, and then permanent closure if commitment is not fulfilled.
2. Suspension/Blacklisting of business operations: This power, previously lost, has been restored. Direct suspension can occur without notice, despite court orders requiring an opportunity for explanation. The commissioner must decide whether to blacklist or restore within 10 days. Blacklisting affects the right to appeal under Section 21.
3. Ban on property transfer.

• These powers allow control over businesses that might not have bank accounts or are running factories without them.
• E-Billing and Digital Device Integration:
• The system now requires the use of digital devices with QR codes for e-billing.
• Consignments of goods transported by vehicles must be registered in the system, and particulars must be inserted into invoices, which will be integrated for FBR to monitor goods movement.
• Tax on Digital Transactions in E-Commerce (Section 11J):
• This new section imposes tax on payments received for supplies digitally delivered within Pakistan using online platforms, including marketplaces and websites.
• The tax rate is 1% for bank channel payments and 2% for cash on delivery.
• This tax is declared as a final tax.
• Courier companies or online marketplaces are now designated as “prescribed persons” under Section 153, meaning they will deduct tax from payments to suppliers and deposit it, making it final tax.
• If a person’s taxable income becomes greater than their immutable income, they are required to provide audited accounts.
• This measure aims at broadening the tax base by bringing the e-commerce sector into the tax ambit.
• Tax on Digital Presence (for Non-residents):
• A separate law has been introduced for tax on digital presence, primarily targeting foreign vendors who provide goods or services in Pakistan online.
• A 5% tax rate is charged on such transactions.
• This mechanism differentiates between resident and non-resident online suppliers.
• Restrictions on Input Tax and Expenses (Section 21 & 73):
• Section 21 (R): If a sale exceeds two lakh rupees and payment is not received through a banking channel or digital means (for a single invoice or multiple transactions in one invoice), 50% of the expenditure attributable to that sale will be disallowed. This applies broadly, even to small shops and manufacturers, and aims to discourage cash transactions.
• Section 21 (purchase disallowance): 10% of expenses attributable to purchases are disallowed if the purchase is made from a person who is not a holder of a national tax number (NTN). This is a new board of revenue collection mechanism.
• Section 73 (Sales Tax): The source mentions Section 73 (in sales tax) dealing with a limit of 5000 units with one supplier annually. Also, if a buyer does not deposit money into a digital bank account, the input for the supplier may be finished. There is a debate on the interpretation of Section 73(4) regarding unregistered persons selling up to Rs. 10 crore.
• There is no clash between Section 21 (Income Tax) and Section 73 (Sales Tax) as they use different criteria (single invoice vs. single account/party).
• New Assessment Order Verification (Section 120):
• Assessment orders will be completed by verifying declarations against maximum possible data. The operation of this section is contingent on official notification by the board, which has not yet occurred.
• The system is intended to check returns against available data, but limitations exist due to the lack of integration of government department data (e.g., from mobile companies, judges’ CPR).
• Recovery Proceedings (Sections 138 & 140):
• These recovery proceedings will not be initiated until a decision has been made by at least three forums (e.g., commissioner appeal, tribunal, high court). This is seen as a positive development, preventing immediate recovery until higher forums have decided.
• Data Sharing (Banking and Financial Institutions):
• Banking companies and financial institutions are now required to share details of every taxpayer with FBR. This means tax information is transparent and easily accessible, reducing the ability to hide transactions.
• Officer Posting for Monitoring (Section 175(6)C):
• FBR officers can be posted to monitor production, supply of goods, rendering of services, and stock of goods. Their scope is limited to these four areas and they cannot question anything else.
• Audit Selection Criteria (Section 105A):
• A person’s case will not be selected for audit if their income tax returns have been audited in the last four years. This is a significant relief for compliant taxpayers.
• E-Commerce Registration Requirement:
• Courier companies and online marketplaces are now required to ensure that any person they deal with (e.g., for picking up goods) is registered for income tax. Failure to do so incurs heavy penalties.
• Restrictions on Ineligible Persons (Section 114C):
• A new section restricts “ineligible” persons from buying property or cars above a certain value, opening bank accounts above a certain limit (e.g., 50 million rupees), or withdrawing cash above a certain amount.
• To be “eligible,” a person must have consistently filed returns and statements, and they must explain the sources of investment before investing. These restrictions do not apply to non-residents.
• Depreciation Allowance Disallowance (Section 22):
• If tax is not deducted at the time of purchasing a new asset, the depreciation allowance for that asset will not be granted.
• Changes in Appeal System:
• The old appeal arrangement has been reinstated.
• Taxpayers now have two rights of appeal: either directly to the tribunal or first to the Commissioner Appeals.
• It is generally advised to access the Commissioner Appeal Forum first as it offers more flexibility, time to explain the case, and a friendly environment compared to the tribunal, which has less margin for discretion and limited time for arguments.
• Previously, the right of appeal under the Black Act was withdrawn but has been restored.
• Other Noteworthy Changes/Discussions:
• Broadening of Tax Base: A major focus is shifting to e-commerce to bring a large chunk of previously untaxed businesses into the tax net.
• Shift to Transaction-Based System: The overall policy is moving towards a daily basis income and transaction-based system.
• Tax on Recreational Clubs: Membership income of recreational clubs (over 10 lakh membership) is now treated as normal business income, not non-profit.
• Pension Income (Section 12): Pension income exceeding 1 crore rupees will be taxed at 5%, while up to 1 crore will have a zero rate. A concession is given to those over 70 years of age, where their pension (if less than salary income) is taxed at salary income rates.
• Investment Tax Credit (Section 63): Tax credit is offered for investment in low-cost housing schemes.
• Asset Purchase Restrictions (Section 75): For cash payments for assets (property, vehicles) above a certain amount (e.g., 2 lakh for sales tax, implicitly higher for income tax related to asset purchase), banking channels are mandated.
• Limitation Periods: Changes were made to show cause notice limitation periods, with an extension from 180 days to one year in some cases. However, extensions for tax payers are also requested.
• “In-house” Transactions: The concept of “in-house” transactions, where internal documents of transfer are generated without external movement of goods, is acknowledged.
• Digital Invoicing: A future seminar is planned on digital invoicing.

Overall, the taxation mechanism is moving towards a highly digitalized, automated, and interconnected system aimed at increasing transparency, broadening the tax base, and enhancing compliance, often by imposing strict restrictions and penalties for non-compliance with digital payment and reporting requirements. However, concerns remain regarding the practicality of these rules given the ground reality of the economy.

Digital Evolution of Tax Compliance and Input Tax Credit

The taxation mechanism in the sources provides a detailed overview of the system for input tax credit, emphasizing new digital advancements and stricter compliance measures.

Here’s a comprehensive discussion:

1. Automated Risk Management System (AI-based Check) A significant development in the taxation mechanism is the introduction of an automated risk management system for input tax credit, powered by Artificial Intelligence (AI). This system is designed to verify the legitimacy of claimed input tax credits. It functions like an “MRI machine,” scrutinizing whether the input tax claimed aligns with the business’s specific line of activity or the product being sold. For instance, if a mineral water supplier claims to have used iron or wood, materials not typically associated with their business, the system will flag and stop that input tax credit.

• Resolution Process: If the AI system stops an input tax credit, the registered person has the option to submit an application to the commissioner within 30 days to provide justification for their claim. If the commissioner does not respond within this period, the restriction on the input tax credit is automatically removed. However, if the commissioner upholds the restriction, the person may need to escalate the matter to a court of law.
• Consultant’s Role: Tax consultants are advised to thoroughly understand their clients’ business models and product recipes to effectively address and resolve issues arising from these AI-driven restrictions.

2. Restrictions and Disallowances on Input Tax Credit and Related Expenditures

The sources highlight several provisions designed to restrict input tax credit and disallow certain expenditures, primarily aimed at broadening the tax base and discouraging cash transactions:

• Disallowance for Purchases from Non-NTN Holders (Section 21): A new provision dictates that if a person makes purchases from an individual who does not hold a National Tax Number (NTN), 10% of the expenses attributable to these purchases will be disallowed. This is a new revenue collection mechanism. The speaker notes a potential ambiguity, as Section 181 may treat a CNIC as an NTN for individuals, which could broaden the scope of this disallowance.
• Disallowance for Cash Sales Exceeding Threshold (Section 21R): If a sale exceeds two lakh rupees and the payment is not received through a banking channel or digital means, 50% of the expenditure attributable to that sale will be disallowed. This applies to a single invoice, even if it contains multiple transactions. This measure is intended to discourage large cash transactions across all types of businesses, from small shops to manufacturers. There was initial concern about a clash with Section 73 (Sales Tax), but it was later clarified that Section 21 (Income Tax) and Section 73 (Sales Tax) do not clash as they operate on different criteria (single invoice vs. single account/party).
• Impact of Multiple Disallowances: The cumulative effect of these disallowances (10% on certain purchases and 50% on certain sales) could lead to a significant portion of expenses (potentially 60-70%) being disallowed, raising concerns about the feasibility of doing business.
• Depreciation Allowance Disallowance (Section 22): If tax is not deducted at the time of purchasing a new asset, the depreciation allowance for that asset will not be granted. This links tax deduction at source to the availability of depreciation, an important component of tax credit for assets.
• Digital Payment Mandate for Assets (Section 75): For the purchase of assets like property or vehicles, if the payment exceeds a certain amount, banking channels are mandated. This reinforces the push for digital and traceable transactions.
• Sales Tax Input Disallowance (Section 73): In the context of Sales Tax, if a buyer does not deposit money into a digital bank account, the input tax credit for the supplier may be disallowed. This emphasizes the importance of digital payment channels for maintaining input tax eligibility.

3. General Principles and Considerations The shift in the taxation policy is towards a highly digitalized, automated, and interconnected system. The intent is to make tax information transparent and easily accessible, reducing the ability to hide transactions. This comprehensive approach aims to ensure compliance and broaden the tax base, especially by bringing the e-commerce sector into the tax net. However, the practical implications and ground realities of such stringent rules are also a point of discussion. The overall policy is moving towards a daily basis income and transaction-based system. Compliance with law, whether financial or tax-related, is becoming increasingly critical, as digital systems will make it difficult to hide transactions or avoid tracking.

Digital Tax Revolution: Policy, Mechanisms, and Challenges

The sources indicate a significant shift in taxation policy towards a highly digitalized, automated, and interconnected system, with a strong focus on the digital economy. This move aims to enhance transparency, ensure compliance, and broaden the tax base, especially by bringing the e-commerce sector into the tax net.

Here’s a discussion of the digital economy as presented in the sources:

• Policy Shift and Intent:
• The government’s policy has fundamentally changed, moving towards a “daily basis income transaction base system”.
• The entire focus of the recent budget is on digital services, e-commerce, and online platforms.
• The intent is to make tax information transparent and easily accessible, making it difficult to hide transactions. This necessitates a change in mindset for both taxpayers and tax consultants, moving “from intimacy to reality”.
• Key Measures and Mechanisms in the Digital Economy:
• Automated Risk Management System for Input Tax Credit: An AI-based system acts like an “MRI machine” to verify the legitimacy of input tax credit claims, checking if they align with the business’s activity or product. If a claim is flagged, the registered person can apply to the commissioner for justification within 30 days.
• Withholding Taxation on E-commerce: A 2% withholding tax is applied to sales made through online marketplaces or courier services. This amount is automatically reduced from the output tax liability. The online marketplace or courier service acts as the withholding agent. Courier companies are now mandated not to work with individuals unregistered for income tax, with heavy penalties for non-compliance.
• Disallowance for Cash Sales (Section 21R): If a sale transaction on a single invoice exceeds two lakh rupees (200,000 PKR) and payment is not received through a banking channel or digital means, 50% of the expenditure attributable to that sale will be disallowed. This applies across all business types and is meant to discourage large cash transactions.
• Digital Payment Mandate for Asset Purchases (Section 75): For the purchase of assets like property or vehicles exceeding a certain amount, banking channels are mandated.
• Sales Tax Input Disallowance (Section 73): In Sales Tax, if a buyer does not deposit money into a digital bank account, the input tax credit for the supplier may be disallowed, further emphasizing digital payments for tax eligibility.
• Consignment Registration via Digital Devices: A new system requires registering consignments of goods transported by vehicles using e-billing and digital devices with QR codes, integrating with the FBR system for monitoring.
• Registration for Courier Companies/Online Marketplaces: Any courier company or online marketplace must register itself and ensure its users are tax-registered before booking consignments.
• Tax on Digital Transactions (Section J-1): A new section applies a tax on payments for digital transactions in e-commerce platforms. For goods delivered within Pakistan using local online platforms (including marketplaces and websites), the rate is 1% if paid through a banking channel and 2% for cash on delivery. This tax is declared as a final tax, meaning no allowances or deductions are given against it, which raises questions about profit allocation for businesses with mixed sales (online and counter).
• Definition of E-commerce and Online Marketplace: The ordinance specifically defines “e-commerce” and “online marketplace” to clearly bring them into the tax net.
• Tax on Digital Presence: A separate law has been introduced for “Tax on Digital Presence,” primarily targeting foreign vendors providing goods or services in Pakistan, with a 5% tax rate on transactions like advertisements in Pakistan.
• Centralized Data and Transparency: The system aims for absolute transparency, with data from various sources (bank accounts, CPR, mobile companies, etc.) becoming readily available at a “single click,” making it difficult to hide transactions or income. FBR officers are also empowered to monitor production, supply of goods, services rendered, and stock.
• Implications and Challenges:
• Broadening of Tax Base: A primary objective is to capture the large e-commerce sector that was previously outside the tax ambit, aiming to expand the client base.
• Compliance and Anti-Fraud: The stringent digital measures are designed to enforce compliance and reduce tax fraud by tracing transactions and making evasion more difficult.
• Feasibility Concerns: The cumulative effect of various disallowances (e.g., 10% on purchases from non-NTN holders, 50% on large cash sales) could lead to a significant portion of expenses being disallowed, raising concerns about the practicality of doing business, especially for smaller entities.
• Adaptation for Businesses: The move requires businesses, including small shopkeepers, to adopt digital transaction methods and maintain meticulous records, which may be challenging given the “ground realities”.
• Equity Issues: Concerns are raised about taxing individuals who may not fall into traditional tax brackets, such as the vast number of mobile users who might not be filers, and the disparity between the documented and undocumented economy.
• Consultant’s Role: Tax consultants are urged to understand their clients’ business models and product recipes deeply to navigate these AI-driven restrictions and new compliance requirements.

In essence, the digital economy is no longer just a sector but has become the backbone of the new taxation regime, with a comprehensive digital framework intended to capture, monitor, and tax transactions on a daily and real-time basis, moving away from traditional, less traceable methods.

Business Model Imperative: AI Tax Compliance

The concept of the business model is critically important in the context of the new taxation mechanism, particularly due to the introduction of advanced digital and AI-powered verification systems.

Here’s why understanding the business model is emphasized:

• Justifying Input Tax Credit Claims: With the implementation of an automated risk management system for input tax credit, powered by Artificial Intelligence (AI), the legitimacy of claimed input tax credits is rigorously checked. This AI system functions like an “MRI machine,” scrutinizing whether the input tax claimed aligns with the business’s specific line of activity or the product being sold.
• Example: If a mineral water supplier claims input tax credit for materials like iron or wood, which are not typically associated with their business or product, the AI system will flag and stop that credit.
• Consultant’s Role: To address such challenges effectively, tax consultants are explicitly advised to deeply understand their clients’ business models and product recipes. This includes knowing the raw materials used and the manufacturing process. Without this detailed knowledge, consultants may struggle to justify flagged input tax claims.
• Navigating Restrictions and Ensuring Compliance: The sources highlight a shift towards a highly digitalized, automated, and interconnected tax system designed for transparency and increased compliance. Understanding one’s business model is crucial for businesses to:
• Face Restrictions: The new systems will intercept input tax claims if they don’t align with the declared business model. A thorough understanding allows businesses to provide the necessary justification to the commissioner if a claim is restricted.
• Equip for System Requirements: The overall advice for tax professionals and taxpayers is to “change from intimacy to reality” and equip themselves to meet the requirements of the new system by understanding the business model and product manufacturing.

In essence, the new tax regime demands a comprehensive and detailed understanding of one’s business operations, moving beyond superficial knowledge. This granular understanding of the business model is presented as a fundamental requirement for successful navigation of and compliance with the evolving digital tax landscape.

Digital Taxation: New Era of Compliance

The sources indicate a significant and concerted push towards enhanced tax compliance within the digital economy, driven by a new taxation mechanism and a fundamental shift in policy. The core intent is to broaden the tax base, increase transparency, and ensure that transactions, particularly those in the rapidly growing e-commerce sector, are brought into the tax net and properly accounted for.

Here’s a detailed discussion of tax compliance as presented in the sources:

• Policy Shift towards Digitalization and Transparency for Compliance:
• The government’s policy has moved towards a “daily basis income transaction base system”. This means a shift from traditional assessment methods to real-time, transaction-based monitoring.
• The entire focus of the recent budget is on digital services, e-commerce, and online platforms.
• The aim is to make tax information transparent and easily accessible, making it difficult to hide transactions. This necessitates a change in mindset for both taxpayers and tax consultants, moving “from intimacy to reality”.
• Key Mechanisms and Tools for Enforcing Compliance:
• Automated Risk Management System for Input Tax Credit (AI-based): An Artificial Intelligence (AI) powered system acts like an “MRI machine” to verify the legitimacy of input tax credit claims. This system checks if the claimed input tax aligns with the business’s activity or product. If a claim is flagged, the registered person can apply to the commissioner for justification within 30 days. This puts the onus on businesses to prove the direct relevance of their input purchases to their declared business model and product recipes.
• Withholding Taxation on E-commerce: A 2% withholding tax is applied to sales made through online marketplaces or courier services. The online marketplace or courier service acts as the withholding agent, deducting this amount, which then reduces the seller’s output tax liability. This mechanism ensures that a portion of the tax is collected at the source of digital transactions.
• Disallowance for Cash Sales (Section 21R): If a sale transaction on a single invoice exceeds two lakh rupees (200,000 PKR) and payment is not received through a banking channel or digital means, 50% of the expenditure attributable to that sale will be disallowed. This measure is designed to discourage large cash transactions across all business types and push for digital payments.
• Digital Payment Mandate for Asset Purchases (Section 75): For the purchase of assets like property or vehicles exceeding a certain amount, banking channels are mandated.
• Sales Tax Input Disallowance (Section 73): In Sales Tax, if a buyer does not deposit money into a digital bank account, the input tax credit for the supplier may be disallowed, further emphasizing digital payments for tax eligibility.
• Consignment Registration via Digital Devices: A new system requires registering consignments of goods transported by vehicles using e-billing and digital devices with QR codes, integrating with the FBR system for monitoring. This allows FBR to monitor the movement of goods.
• Registration for Courier Companies/Online Marketplaces: Any courier company or online marketplace must register itself and ensure its users are tax-registered before booking consignments. Failure to comply carries heavy penalties.
• Tax on Digital Transactions (Section J-1): A new section applies a tax on payments for digital transactions in e-commerce platforms. For goods delivered within Pakistan using local online platforms, the rate is 1% if paid through a banking channel and 2% for cash on delivery. This tax is declared as a final tax, making deductions or allowances against it unavailable.
• Tax on Digital Presence (Foreign Vendors): A separate law introduces a 5% tax rate on foreign vendors providing goods or services in Pakistan, specifically targeting transactions like advertisements. This captures cross-border digital transactions.
• Centralized Data and Transparency: The system aims for absolute transparency, with data from various sources (bank accounts, CPR, mobile companies, telecom services, IP addresses) becoming readily available at a “single click,” making it difficult to hide transactions or income. FBR officers are also empowered to monitor production, supply of goods, services rendered, and stock.
• Suspension and Blacklisting Powers: The Commissioner has been granted powers to suspend business operations for three days if commitments are not fulfilled, which can lead to permanent closure if default persists. This includes suspension or blacklisting for tax fraud and non-compliance.
• Implications and Challenges for Compliance:
• Broadening of Tax Base: A primary objective is to capture the large e-commerce sector that was previously outside the tax ambit, aiming to expand the client base and ensure all relevant transactions are taxed.
• Stringent Enforcement and Anti-Fraud: The digital measures are designed to enforce compliance and reduce tax fraud by tracing transactions and making evasion more difficult. Tax fraud proceedings are now initiated directly through inquiry, similar to NAB procedures.
• Feasibility Concerns and “Ground Realities”: The cumulative effect of various disallowances (e.g., 10% on purchases from non-NTN holders, 50% on large cash sales) could lead to a significant portion of expenses being disallowed, raising concerns about the practicality of doing business, especially for smaller entities and in an economy where cash transactions are prevalent. The sources explicitly question the feasibility of applying such stringent rules without considering “ground realities” in Pakistan, where many small businesses still operate in cash.
• Adaptation for Businesses: The move requires businesses, even small shopkeepers, to adopt digital transaction methods and maintain meticulous records. Tax consultants are urged to deeply understand their clients’ business models and product recipes to navigate these AI-driven restrictions and new compliance requirements.
• Equity Issues: Concerns are raised about taxing individuals who may not fall into traditional tax brackets, such as the vast number of mobile users who might not be filers, highlighting a disparity between the documented and undocumented economy.
• Importance of Proper Documentation and Defense: The new regime emphasizes that “transactions being genuine” and proper “documentary evidence” are the main requirements for compliance. Taxpayers face “huge loss” if records are not properly maintained or cases are not defended.
• Audited Accounts Requirement: If taxable income exceeds immovable income, audited accounts are now mandatory, further pushing for formal accounting and compliance.

In essence, tax compliance under the new regime is no longer optional; it is mandated through a comprehensive digital framework that aims to capture, monitor, and tax transactions on a daily and real-time basis, moving away from traditional, less traceable methods. The success of this framework hinges on both the government’s ability to implement it effectively and the taxpayers’ willingness and capacity to adapt to stringent digital and record-keeping requirements.

By Amjad Izhar
Contact: amjad.izhar@gmail.com
https://amjadizhar.blog

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