1 percent turnover tax: revenue reform or a new burden on SMEs?

Bangladesh’s low tax-to-GDP ratio highlights the need for greater revenue to fund infrastructure, social welfare and development. However, revenue measures must not undermine investment, employment or voluntary compliance.

The mandatory turnover tax on non-corporate businesses and professionals has therefore become a major concern among taxpayers. Under Section 163(6) of the Income Tax Act, 2023, as amended by the Finance Act, 2026, taxpayers must pay the prescribed turnover tax when their normal income-tax liability is lower.

Tap here to add The Daily Star as a trusted source

The tax applies to gross receipts, even when losses are incurred. The general rate is 1 percent, with sector-specific variations and a 0.2 percent rate for newly established industrial undertakings during their first three years.

The issue is not whether businesses should pay tax. The real question is whether gross sales or gross receipts (essentially, turnover) are an appropriate basis for determining tax liability, particularly for small and low-margin enterprises. Income tax is normally levied on net profit, the amount that remains after legitimate business expenses have been deducted.

A turnover tax, by contrast, is imposed on total sales, effectively treating sales volume as though it were income. However, a business may generate a high turnover while earning only a small profit. In such cases, taxing turnover rather than profit can impose a disproportionate burden, especially on businesses with thin profit margins.

Consider a small rice trader who starts with capital of only Tk 500,000 and repeatedly reinvests the same money throughout the year. Suppose the trader buys rice at Tk 75 per kilogram and sells it at Tk 80. With annual sales of Tk 12 million, the trader sells 150,000 kilograms and earns a gross profit of Tk 750,000. From this amount, the trader needs to pay Tk 150,000 for transportation, Tk 60,000 in rent, Tk 96,000 in salaries, Tk 12,000 for electricity and Tk 24,000 in other operating expenses. Total operating expenses come to Tk 342,000, leaving a net profit of Tk 408,000.

At a turnover-tax rate of 1 percent, the trader must pay Tk 120,000 in tax. But if tax were calculated on actual income, and Tk 408,000 were the trader’s only taxable income, the liability after the tax-free threshold would be around Tk 5,000 as minimum tax. The turnover tax would therefore be approximately 24 times higher. More strikingly, the Tk 120,000 tax would absorb almost 30 percent of the trader’s net profit. If the business made a loss in the following year, turnover tax could still be payable because the system does not consider profitability.

The turnover tax raises concerns under the ability-to-pay principle, which requires taxation to reflect a taxpayer’s real economic capacity. Gross sales are not the same as income. A trader may record crores of taka in sales yet retain only a small margin after paying suppliers, interest, transport, rent, wages, utilities and other expenses. This burden is especially severe for SMEs operating with limited capital and bank financing.

Rising borrowing costs, raw-material prices, transport expenses, electricity charges, digital banking fees and merchant discount rates have further reduced profitability, making turnover-based taxation increasingly disproportionate.

When small businesses are required to pay tax equal to 1 percent of gross sales, their working capital can decline rapidly. Working capital is the lifeblood of a small business; when it shrinks, the business may struggle to replenish inventory, pay employees, settle suppliers’ bills and service bank loans. This can lead to delayed payments, reduced employment, increased borrowing or even business closure. The consequences extend beyond the taxpayer, affecting employees, suppliers, lenders and consumers.

Turnover tax may be administratively simple where accounting records are weak, but simplicity should not undermine fairness. A disproportionate system can discourage formalisation, promote cash transactions and push businesses into the informal economy, ultimately reducing revenue. In countries such as the United Kingdom, Canada, Australia, Singapore and Japan, business income is generally taxed on net profit.

Simplified regimes in developing economies often consider business size, sector, profit margins and compliance capacity. Their purpose is to ease compliance, not penalise enterprises. Bangladesh should therefore adopt the following balanced measures that protect revenue while supporting sustainable SME growth:

First, the turnover tax rate for qualifying small and medium-sized businesses and professionals could be reduced from 1 percent to 0.2 percent.

Second, a tiered structure could be introduced, with tax rates varying according to annual turnover, business size and sectoral profit margins. A small grocery shop should not bear the same effective tax burden as a large, high-margin enterprise.

Third, businesses that consistently use formal banking channels and maintain basic digital records could receive targeted tax incentives.

Fourth, genuinely loss-making businesses below a defined threshold should be eligible for temporary relief. Appropriate documentation requirements and safeguards could be introduced to prevent abuse.

Fifth, the government should develop a phased roadmap for moving from turnover-based taxation towards profit-based taxation. This transition could be supported by expanding access to simple digital bookkeeping tools and affordable tax advisory services.

Finally, major tax policy changes should be preceded by structured consultations with business associations, professional bodies, tax experts and research institutions. Tax policy is more effective when those affected understand it, consider it reasonable and have the practical ability to comply.

Small and medium-sized enterprises are vital to employment, entrepreneurship and social stability in Bangladesh. Their tax contribution should be assessed not only in terms of immediate revenue but also by its impact on investment, jobs, business survival, access to finance and the future tax base.

Economic growth and revenue growth are mutually reinforcing. Reconsidering the 1 percent turnover tax therefore supports better, not lower, taxation. A tiered rate, relief for genuine losses and gradual movement toward profit-based assessment could protect revenue while allowing small businesses to grow, formalise and contribute more sustainably.

The writer is a financial sector analyst and can be reached at faysal.aqc@gmail.com