Written by Hamza Shahnawaz in Taxation New three-tier methodology accounts for embedded sales tax in supply chains to provide a more accurate estimate of tax expenditure. ISLAMABAD: The Federal Board of Revenue (FBR) has introduced a revised methodology for estimating sales tax expenditure on exempt local supplies, adopting differentiated adjustment factors that reflect the level of embedded taxation within different supply chains. The new approach, detailed in the Tax Expenditure Report 2026, aims to provide a more accurate estimate of revenue forgone from sales tax exemptions by recognising that a portion of sales tax is already collected at earlier stages of production and distribution. Embedded Tax Recognised in Supply Chains According to the FBR, suppliers of exempt goods are not required to charge output sales tax on their sales. However, they are generally unable to claim input tax credits for sales tax paid on taxable goods and services used during production, processing, transportation, storage and distribution. As a result, part of the sales tax remains embedded in the cost of the exempt goods and is ultimately passed on to consumers through the final selling price. To avoid overstating the fiscal cost of exemptions, the FBR has introduced adjustment factors that account for taxes already collected at upstream stages of the supply chain before estimating the net tax expenditure. The report states that the standard sales tax rate of 18 per cent will first be applied to the gross value of exempt local supplies. The relevant adjustment factor will then be used to estimate the actual tax expenditure attributable to the exempt transaction. The FBR clarified that imported exempt goods are excluded from this adjustment mechanism because the tax expenditure arises directly at the import stage, where sales tax would otherwise have been collected. Three-Tier Adjustment Framework The revised methodology divides exempt local supplies into three categories based on the characteristics of their supply chains. Tier 1: Essential Food and Agricultural Inputs The first category carries an adjustment factor of 30 per cent and covers staple food commodities and key…