Milk matters

Levied on citizens and corporate entities, taxation is generally used as an effective instrument for the government’s economic and social policy. The principal objective of taxation is to generate funds to finance the duties of the public sector and to accumulate revenues for the functioning of several government processes. However, despite significant contribution to the national GDP, Pakistan’s dairy sector bears the brunt of flawed taxation policies. Thus, it requires immediate tax reforms to help sustain itself and grow the business in the present recession-hit business environment.

The dairy sector in Pakistan majorly falls beyond the tax regulation as it’s a predominantly informal sector. Which means, there are no controlled measures in place to monitor and evaluate the industry’s operations. Moreover, being an informal sector, a number of issues come up, such as lack of proper infrastructure, untrained manpower, quality assurance, fragile production base, and other financial constraints.

Other than the issues mentioned above, the entire value chain from grass to glass suffers from numerous challenges which compromises the quality of milk being produced. These challenges revolve around cleanliness and sanitation of livestock animals and their sheds, unhygienic milking practices, using unhygienic and non-recommended utensils for milk storage, transportation issues between production and consumption points, use of non-recommended preservatives, and non-availability of cooling/chilling facilities. Furthermore, there are no quality checks in place which is the reason these issues are not being addressed, reflecting the most neglected aspect of the whole system, leading to numerous health hazards, costing consumers their lives.

The irony of imposing tax on the dairy sector becomes more pronounced when it is used only for the formal, fully-documented packaged milk industry that always comes to grips with irrational taxation policies. On the flip side, the informal ‘loose milk’ market that already enjoys a gargantuan market share of about 95 percent, manages to go scot-free as far as the taxation regime is concerned, enjoying its premium, an everlasting ‘untaxed’ status.

The dichotomy is often the case in a largely unregulated economy like ours that mostly favours undocumented businesses that keep growing and thriving at the expense of regular, taxpaying business entities. This is so true for the formal dairy production and processing sector that deserves a better tax regime to help it become more competitive, efficient and productive as well as more responsive to public needs by offering nutrient-rich but more affordable milk, yogurt, butter, cheese, and other dairy products.

As a corollary, the abolition of the zero-rated sales tax policy has increased the operational cost of the packaged milk industry, resulting in an uncompetitive market for packaged dairy products. In addition to that, the elimination of the zero-rating tax regime has also resulted in widening the price gap between processed/packaged and loose milk, further affecting the sector’s growth.

The trend dissuades the loose milk segment from entering the regulated sector that pays a high price for its fully-documented, wholly legal, and state-approved tax-paying status. For the packaged milk industry, the withdrawal of the zero-rated regime gives rise to low profitability and also results in a sharp decline in sales volumes and turnover.

The trend is detrimental to the overall business climate as it severely deters further investment in the packaged milk sector and deprives the country of sizeable foreign investment which could be otherwise spent to empower dairy farmers to improve the quality of milk. Uncompetitive business environment for the formal dairy sector has also thwarted investment plans to establish a cold chain infrastructure in the country to boost milk production and storage capacity at par with international standards.

Since the abolition of zero-rating tax regime, the unprocessed milk segment despite being of an inferior quality has been able to retain about 95 percent of the market share and the government is still unable to meet its health objectives. Moreover, the economic objectives are also not being met due to the abolition of zero rating because the numbers are not resulting into desired GDP growth. There seems to be no employment generation, tax revenue enhancement or increased inflows of foreign direct investment (FDI).

The demand for processed milk is highly elastic due to the availability of low-priced loose milk. With rapidly decreasing profit margins, the non-adjustable input sales tax causes a major blow to the processed milk industry, which is already going through lower sales volume. The sale of processed milk market has declined to 30 percent and profit by more than 80 percent in the last three years. The withdrawal of the zero-rating sales tax regime is damaging for the dairy industry, which is currently operating at only 50 percent of its total capacity and needs a tax relief of about Rs3.5 billion per annum to make it competitive as opposed to loose milk sector.

To make matters worse, the removal of the zero-rating sales tax policy in budget 2016-2017 has also resulted in increased cost pressures for the packaged dairy processors, eventually and continuously taking these products away from the reach of the common man. Consequently, it significantly reduces the rate of safe milk consumption, which is vital for maintaining good health and is essential in creating a healthy nation. Pakistan can learn a lot from other countries to promote its dairy industry through effective tax reforms.

The zero-rated sales tax regime is a win-win situation for both the government and the dairy industry. Other than improving sales and profitability for the industry, it creates incentives for new foreign investments, the much-needed support measures for the modernisation of the dairy sector. The government will also earn more revenue from sales tax and income tax.

The implementation of zero-rated sales tax regime will not only improve the sale and profitability of the processed dairy industry, but also aid the government as well as create opportunities to encourage foreign investors to step in once they see the policies favouring such businesses. Such incentives are essential for foreign investments as they result in a much-need support for the dairy sector.

As the current economic conditions are at an all-time low due to the global coronavirus pandemic, the business environment has become even more challenging for the dairy industry. Already dealing with many deep-seated issues, the packaged dairy industry finds itself caught in a vicious circle of slump and losses.

A number of businesses will have to take the brunt of the abolition of zero-rating regime as they might be forced to close operations, if needed actions are not taken by the policymakers. This is a make or break moment for the dairy sector with all eyes on the government to rise to the occasion and address the chief concerns that are holding back the growth of the dairy industry. A balanced tax regime is the need of the hour and the government must announce much-needed tax relief in the forthcoming budget.

The government must review and reformulate its fiscal policy towards the dairy industry. More precisely, the government should remove the sales tax on animal feed and there must be zero-rating on local semen production with no sales tax levied on local and imported semen. By and large, the reintroduction of the zero-rated sales tax scheme for dairy products would go a long way in reviving the dairy sector despite the factors that may contribute to its downfall.