Pakistan’s Bold Move to Separate IRS and Customs: A Step Toward Tax Reform

The Government of Pakistan has once again set its sights on bifurcating the Inland Revenue Services (IRS) and Customs departments, a long-standing and critical reform designed to bring structural improvements to the country’s revenue collection mechanism. Prime Minister Shehbaz Sharif recently approved the move to split these two major departments, a plan first announced in 2023 but never fully realized. The renewed effort comes as part of a broader strategy aimed at reforming the maritime sector, enhancing infrastructure, and boosting the efficiency of tax collection in the country.

This reform holds significant implications for the future of Pakistan’s fiscal structure and tax administration, and if implemented effectively, could bring about a more streamlined, specialized, and accountable revenue system.

Historical Context: IRS and Customs Under FBR

In Pakistan, the Federal Board of Revenue (FBR) currently administers both the Inland Revenue Services (IRS) and the Pakistan Customs department. These two entities are responsible for the bulk of the country’s tax revenues — IRS collects direct taxes like income tax and sales tax, while Customs deals with import/export duties and international trade regulations. Historically, the integration of these departments under the FBR has posed challenges, particularly in terms of policy coherence, oversight, and the division of operational responsibilities.

There have been long-standing debates regarding the need to separate these two departments, each of which requires specialized knowledge, operational focus, and distinct management. The lack of separation has often led to inefficiencies, and reform advocates argue that splitting them will allow for more focused management of each function.

Government’s New Reform Plan

The decision to formally split IRS and Customs has been driven by recommendations from a task force that reviewed Pakistan’s maritime sector. The task force put forward 99 measures to reform the sector, including modernizing port infrastructure and introducing better facilitation for international trade. Among these measures, the separation of IRS and Customs emerged as a key proposal.

The proposed reform involves establishing three separate boards to handle the functions currently managed by the FBR. These are:

1. Policy Board: This board will be tasked with policy formulation for income tax, sales tax, and federal excise duty. It will be chaired by the finance minister and will include members from the private sector to ensure that the board stays aligned with industry needs.
2. Oversight and Governance Boards: These will include separate boards for IRS and Customs, each chaired by a retired tax official or an expert in the field, nominated by the finance minister. Private sector involvement is also planned to strengthen accountability and governance.

If these boards are successfully established, the position of FBR chairman will be abolished. In its place, the respective chairpersons of these new boards will lead their departments, focusing on governance and operational excellence within their domains. Furthermore, the members currently overseeing both IRS and Customs under the FBR will be replaced by Director Generals for IRS and Customs, giving each department specialized leadership and a clearer chain of command.

Expected Benefits of the Separation

The bifurcation of IRS and Customs is expected to bring a host of benefits, both in terms of efficiency and accountability:

• Specialization: The separation will allow for more focused and specialized management of each function, leading to better policy formulation, enforcement, and collection. IRS and Customs deal with vastly different issues — direct taxes on income and wealth, versus taxes on goods crossing international borders — and each requires specialized knowledge and focus to function optimally.
• Operational Efficiency: By separating these two departments, the government expects to address long-standing inefficiencies in tax collection. Customs officers and IRS officials often operate with conflicting priorities; giving each department a separate governance structure will allow for better prioritization and management of resources.
• Policy Clarity: One of the goals of this reform is to ensure that tax policy is separated from tax collection. Currently, the FBR is involved in both the formulation of tax policy and its enforcement, which can lead to conflicts of interest. By creating a separate Policy Board dedicated to policy formulation, the government aims to make the process more transparent and accountable.
• Private Sector Involvement: The inclusion of private sector representatives in both the policy and governance boards is expected to bring much-needed industry insight and help align the tax system with the realities of the business environment. This can contribute to a more business-friendly tax structure that encourages compliance while minimizing the administrative burden on companies.

Challenges and Skepticism

While the reform plan appears promising, there are considerable challenges and skepticism surrounding its implementation. A similar initiative was announced in November 2023 but never saw the light of day. The government is now facing questions about its commitment to fully implement this reform.

One critical concern is that despite the prime minister’s approval of these measures, the FBR has not yet appointed a separate member to oversee Customs administration, as recommended by the task force. Instead, the same member continues to oversee both IRS and Customs, raising doubts about the government’s intent to expedite this reform.

Moreover, the timeline set for the completion of the bifurcation — March 31, 2025 — appears ambitious given the complexities involved in restructuring these departments, and any delays could fuel further doubts about the reform’s viability.

IMF’s Role and Broader Tax Reforms

This reform is also part of a larger transformation plan designed to address Pakistan’s massive revenue gap, which stands at Rs7.1 trillion. The government has committed to deploying digital solutions for tax collection, as well as introducing a range of reforms aimed at improving the country’s tax-to-GDP ratio.

Additionally, Pakistan’s agreement with the International Monetary Fund (IMF) calls for the separation of tax policy formulation from tax collection. This aligns with the current proposal to have the new Policy Board handle tax policy, while IRS and Customs will focus solely on implementation and collection.

Conclusion: A Step Towards Modernization?

The government’s renewed push to bifurcate IRS and Customs is undoubtedly a bold step towards modernizing Pakistan’s tax administration. If implemented effectively, the separation could bring significant improvements in operational efficiency, policy clarity, and governance, all of which are sorely needed to bridge the country’s tax revenue gap.

However, successful implementation will require overcoming significant bureaucratic inertia and skepticism about the government’s commitment to fully following through on these reforms. The coming months will be crucial in determining whether this bold reform initiative will finally break through or meet the same fate as previous efforts to restructure the tax system.

As Pakistan continues its efforts to revamp its tax collection framework, the focus on separating IRS and Customs reflects a growing awareness of the need for specialization, transparency, and accountability in public administration. This could be a crucial turning point in the country’s journey towards a more effective and sustainable tax system.