SME Development / 05/06/2026 / TPAP Research Team
Small and medium enterprises occupy a paradoxical position in Pakistan's economic conversation. On the one hand, they are celebrated as the backbone of the economy — accounting for the vast majority of registered businesses, employing tens of millions, and driving activity in virtually every sector and region. On the other hand, the policy environment they operate in — particularly with regard to taxation — systematically disadvantages them relative to larger firms, informal competitors, and imported goods.
This is not a niche concern for business associations. It is a structural constraint on Pakistan's economic growth, employment generation, and formalisation agenda.
The Compliance Cost Problem
The most immediate challenge for Pakistan's SMEs is the sheer cost of compliance. A medium-sized business operating across provincial boundaries may be subject to federal income tax, federal sales tax on goods, provincial sales tax on services with four separate authorities, professional tax, property tax, and various local levies. Each system has its own registration requirements, filing calendar, audit processes, and penalties. For a business with 20 employees and a single accountant, fully navigating all of these requirements without constant external professional support is close to impossible.
The Withholding Disadvantage
When a larger business or government department makes a payment to an SME, it deducts withholding tax at source. In theory, this deduction should be offset or refunded at year-end against actual liability. In practice, the combination of high withholding rates and a dysfunctional refund system means SMEs frequently find themselves in persistent advance tax positions — having paid more through withholding than their actual liability warrants — with refunds delayed for years and working capital trapped in the tax system. For businesses operating on thin margins with limited access to formal financing, this is genuinely damaging.
The Formalisation Paradox
One of the most counterproductive consequences of Pakistan's SME tax burden is its effect on the incentive to formalise. The government rightly identifies expansion of the formal sector as a central economic policy goal. But formalisation has a cost: the compliance burden. A business that formalises immediately becomes subject to all the obligations described above, while its informal competitor bears none of them and may operate with a meaningful cost advantage.
The government cannot simultaneously ask SMEs to formalise and maintain a tax compliance environment that makes formalisation economically punishing. These are contradictory demands, and they produce a predictable outcome: a large informal economy that successive governments have failed to meaningfully shrink.
The Turnover Tax Problem
The turnover-based minimum tax under Section 113 of the Income Tax Ordinance is especially problematic for SMEs. It requires businesses to pay a minimum tax based on gross turnover — even when operating at a loss or at very thin margins. For capital-intensive or low-margin businesses, this can be genuinely confiscatory, taxing revenue rather than income and extracting value from businesses that are not generating positive returns.
What SME Tax Reform Should Prioritise
A genuine fixed-tax or simplified scheme for businesses below a meaningful revenue threshold — replacing the full complexity of income tax and sales tax with a single, periodic payment — would dramatically reduce compliance costs and formalisation barriers. Rationalisation of withholding rates, combined with a legally enforceable refund timeline, would release trapped working capital. And a concerted effort to align federal and provincial tax administration would reduce the multi-system compliance burden that currently falls most heavily on businesses operating across provincial lines.
None of these changes are technically complicated. They are politically complicated — because simplification reduces the discretion available to administrators. Changing this requires organised, sustained, evidence-based advocacy. It requires taxpayers to be organised. That is what TPAP is working to build.
TPAP Membership CTA: Pakistan's SMEs need an advocate in the tax policy room. TPAP is that advocate — and we are stronger with every member who joins. If you run a business in Pakistan, your experience is evidence, your voice is data, and your membership is power. Join TPAP today at tpap.org.pk.