Export-led growth and effective tax management: Leveraging Digital Product Passport

As the EU tightens its regulations, many countries view compliance as a mere obligation, but the implications of this can have benefits far beyond maintaining trade relations.

By aligning with sustainability standards, Pakistan can unlock access to global value chains, drive export-led growth, and tackle long-standing inefficiencies in the industrial value chain, including under-reporting, sales tax evasion, and the misuse of EFS.

With the EU accounting for 30 percent of Pakistan’s total exports, any regulatory shift from the EU will inevitably impact Pakistan’s trade. Rather than viewing this as a challenge, the policymakers need to turn this into an opportunity. While Pakistan has made progress under the GSP+ since 2014, continued access to the EU market will now depend upon compliance with their emerging regulations.

One such framework is the Digital Product Passport (DPP) under the Eco-design for Sustainable Products Regulation (ESPR), which was introduced in mid-2023 and will be enforced from 2027 onwards in sectors such as textiles, metals, and batteries.

As the name suggests, the DPP represents a digital transformation in the industry’s value chain, enhancing transparency by digitally documenting product origins and production processes. It ensures due diligence in human rights and environmental standards across the value chain, preventing any product from qualifying for export without meeting transparency requirements. These requirements will be verified through a QR code displaying key production details, hence making the DPP a mandatory requirement for exporting to the EU.

But there’s more to it. Beyond ensuring due diligence, digitization through the DPP offers a real-time solution to perennial issues like under-invoicing, under-reporting, and EFS misuse. Pakistan must recognize this as a strategic advantage. Greater transparency will not only enhance access to global markets but also reinforce tax compliance.

Why digitizing the value chain through DPP is imperative?

Since 2013, Pakistan’s exports to the EU have grown significantly, with total exports increasing by 76 percent and textile exports by 87 percent. However, as buyers now prioritize transparency and traceability, the DPP is no longer just a compliance requirement - it is a binding regulatory necessity for maintaining and expanding Pakistan’s presence in the EU market.

Given this shift, it is crucial to recognize the link between the DPP and its potential role in addressing Pakistan’s structural challenges.

The FBR has long sought to curb tax evasion through initiatives like the Track and Trace System (TTS), but its limited scope has failed to eliminate illicit practices in many sectors. True value chain traceability requires a broader approach - one that ensures due diligence while tackling tax fraud.

Pakistan’s textile sector remains highly fragmented, with SMEs constituting a significant portion of the value chain, primarily operating at the ginning and spinning stages. Many SMEs either supply large exporters or cater to the domestic market, but the lack of integration across the textile value chain leaves multiple supply channels vulnerable to tax evasion.

Following the removal of the sales tax exemption on local supplies for exports under the EFS through FY2025 budget, exporters have increasingly turned to duty-free and sales tax-free imported yarn, which was comparatively cheaper. This shift away from sourcing domestic inputs - such as yarn from SMEs - combined with the EU’s strict traceability requirements, has made identifying the origins of imported yarn critical.

Any product containing yarn that directly or indirectly originates from Xinjiang (Uighur region) faces an EU ban, jeopardising not only exports but also brand credibility and future trade policies.

Despite these concerns, gaps in monitoring imported yarn usage persist. Many manufacturers misuse the EFS by diverting duty-free inputs to local production instead of exports, distorting the local yarn and cotton market. In parallel with the illegal use of this policy, 40% of SME spinning units have shut down due to the influx of imported inputs, further impacting local farmers who are left without buyers for their cotton.

At the farming stage, a significant number of unregistered cotton farmers in Pakistan operate within an informal market, relying heavily on uncertified seeds. This has led to poor cotton yields, increasing Pakistan’s dependence on high-value cotton imports from the US and Brazil. By making farmer registration mandatory for compliance, the DPP will enhance traceability and improve cotton productivity.

Another major challenge requiring DPP’s digital intervention is the widespread tax evasion in cotton trading, commonly referred to as “Golmaal.” Approximately 2 million cotton bales are under-reported annually to evade sales tax. Estimates suggest that in FY 2024 alone, PKR 32.8 billion in sales tax was lost due to Golmaal cotton bales and banola, perpetuating tax evasion across the value chain.

Given these deep-rooted challenges, implementing the DPP is no longer optional; it is in fact an urgent necessity. A robust digital traceability system will ensure compliance, curb tax evasion, eliminate Golmaal practices, and expose corruption under the EFS.

Strategic use of DPP and role of FBR:

The implementation of this system requires urgent action from the FBR, starting with the creation of a centralized database shared with relevant ministries, such as the Ministry of Commerce.

All players in the textile value chain must register and integrate into the system to qualify for exports to the EU. The final product will carry a QR-coded DPP, containing compliance details from farm to finished garment.

To track Golmaal cotton bales, RFID (Radio Frequency Identification) technology can assign unique group IDs for real-time monitoring from the field to ginning, storage, and shipping, all linked to the centralized database.

Similarly, QR codes on yarn, fabric, and finished products will trace raw material origins - whether imported or domestic - while also verifying compliance with sustainability standards, including water and energy usage and forced labor practices. Transaction records documenting manufacturers, suppliers, and buyers will ensure full value chain visibility.

With real-time digital records, the FBR can monitor value addition at each stage, significantly reducing tax evasion. Value addition currently stands at 5 percent in ginning, 10 percent in spinning, 15 percent in weaving/knitting, 20 percent in finishing, and 50 percent in garment manufacturing.

The DPP will make this data transparent for policymakers. Linking it to POS-based tax collection will automate tax calculations, eliminating underreporting, fake invoicing, and ghost transactions, while also reducing manual intervention in tax collection.

Preventing the misuse of EFS through automation:

As discussed, the EFS has caused two major distortions in the textile value chain: the misuse of duty-free imports in local manufacturing and the challenge of tracing imported yarn origins. These issues undermine the system’s purpose and require urgent intervention.

As of 2024, EFS supports over 1,700 exporters, who must submit an annual reconciliation statement within 30 days of the fiscal year’s end, with audits every five years. The previous five-year

retention period for duty-free imports—now reduced to nine months - enabled large-scale misuse, with imports meant for exports diverted to local manufacturing to evade taxes.

To address this, tracing the origin of imported yarn - including its cotton source, production process, and compliance with labor and environmental standards - has become critical for exports to the EU. The DPP will enhance oversight by digitally linking each imported input to its final exported product, preventing misuse.

By integrating DNA testing and digital verification, imported yarn and fabric can be tested at entry points and assigned a QR code verifying their origin. These records will be matched with final products to ensure compliance with EU regulations and prevent EFS misuse.

This system will ensure exporters use duty-free inputs within the nine-month retention period, eliminating misdeclaration and diversion. Failure to reconcile input usage with output will result in penalties or EFS revocation by the FBR.

Additionally, sales tax collection will be automated, ensuring that tax refunds under zero-rated regimes like EFS are granted only to genuine exporters.

Urgent call for making traceability mandatory in Pakistan:

To make this digital transformation happen, the government needs to urgently step up.

Past experiences demonstrate that without a legally binding system, the desired outcomes will remain elusive. Therefore, the NCC must be designated as the sole regulatory body for exporters’ compliance.

A centralised database integrated with the NCC will enable it to oversee compliance with sustainability standards across the value chain and issue DPPs (in the form of QR codes) to textile exporters, allowing European buyers to access due diligence details directly from the final product.

Exporters who fail to provide the required information will not receive a DPP and, consequently, will be unable to export.

This will ensure exporters cooperate in data sharing and adhere to tax regulations. Non-compliance should result in penalties, including the revocation of EFS benefits.

Urgent attention is needed to designate the NCC as the regulatory authority and make the DPP a mandatory requirement. This will not only give Pakistan a first-mover advantage in South Asia but also enhance tax management, ensuring the country stays ahead in both sustainability and fiscal discipline.

Copyright Business Recorder, 2025