Azeem Ahmed Khan

Pakistan’s information technology industry achieved remarkable milestones by crossing the $2.6-billion mark in exports in 2022, proving to be the fastest-growing sector in the country. "It has demonstrated the potential to address the current account deficit and shape the financial future of Pakistan," Chairman of Pakistan Software Houses Association (P@SHA) Zohaib Khan said in a policy paper titled "Unleashing the True Potential of the IT &ITeS (IT-enabled Services) Sector" in Pakistan.

The paper serves as a policy guide to make Pakistan an attractive tech destination and to create a robust framework that will drive the growth of Pakistan's IT/ITeS industry. “The IT industry - supporting the livelihoods of 800,000 professionals and freelancers, and over 10,000 companies - holds the unique distinction of being Pakistan's export industry with a 77% trade surplus," Zohaib Khan said in the paper’s foreword. He believes that implementing the measures suggested by P@SHA will not only attract foreign investment but also promote industry growth and enhance the sector's competitiveness on the global stage.

P@SHA has recommended the immediate reinstatement of 100% income tax exemption from export income for IT and ITeS companies for five years. Initially, the IT/ITeS industry was granted a fiscal incentive of 100% tax exemption until 2025. However, in July 2021, a policy shift occurred from tax exemption to a Tax Credit Regime. The process for tax credit application was imprecise and cumbersome. Furthermore, in 2022, the Final Tax Regime was introduced, which revoked the Tax Credit Regime.

The frequent changes in the tax regime, despite the initial commitment to tax exemption until 2025, have created uncertainty among IT companies and a lack of confidence in investors, the paper said. When policies change too frequently, companies may choose to withdraw their operations and relocate to countries with more favourable and consistent business climates, the paper stressed and urged the government to introduce consistent policies that ensure the growth of the tech industry.

P@SHA has also proposed reform for Capital Gains Tax for IT &ITeS. It has demanded exempting the income of venture capital (VC) funding for startups until 2030, with the current rate of 29% being reduced to zero per cent. The exemption on profits and gains of VC funding for entities in Pakistan is set to expire in 2025. However, most of the funding that Pakistani-origin startups receive is done outside the jurisdiction of Pakistan, as these startups are often incorporated in other countries to gain investor confidence for raising VC.

Additionally, investment in Pakistan is seen as high-risk compared to other countries. Therefore, the exemption must be extended to 2030, or at least seven years from implementation, with assurances of continuity, so that investors feel confident in sending their venture capital funds into Pakistan. In order to bring clarity in relation to income earned by VCs, the term profits and gains need to be replaced with "any income" to ensure that all returns on such investments, including business profits and capital gains are exempted from tax, the paper said.

P@SHA has also recommended that dividends paid by start-up companies and export-oriented IT companies be given tax exemption. Currently, the tax on dividends is 15% to 25%, which discourages companies from bringing money to Pakistan. This type of taxation discourages sole/Association of Persons businesses (startups and exporters of IT & IT-enabled Services) from transitioning into corporates.

The second stage of taxation in the form of dividend tax in companies is hence also a hinderance in bringing foreign direct investment (FDI) into such entities. This exemption on dividends would encourage FDI to come directly into Pakistan instead of being parked outside Pakistan and incentivise corporatisation.

P@SHA has also suggested the removal of duties and sales tax on laptops and other IT hardware for Pakistan Software Export Board-registered IT/ITeS companies involved in the production of IT &ITeS-related software, solutions, services, products, consultancy, and hardware.

Duties, sales tax, and any other levies and taxes should be removed from items imported into Pakistan for re-export after a slight modification. Items to be used as sub-components or components of a technology/IT solution/platform for value-added manufacturing for further export must be declared exempt from all duties, GST, other taxes, and levies, the policy paper suggested.

The IT industry faces a significant challenge in the form of high customs duties on imported hardware components, leading to inflated equipment costs. Currently, IT firms are obligated to bear 100% overhead when importing hardware. High customs duties on hardware increase equipment costs, ultimately affecting the profitability of IT firms.

Computer hardware and technology sub-components imported into Pakistan for the purpose of exporting them by adding new software and/or hardware components or by configuring them as part of a larger hardware and/or software system attract import duties. This makes Pakistan unfeasible for such technology solutions export. 

P@SHA has proposed an exemption of sales tax on basic equipment (computers and laptops) for the IT &ITeS industry. The availability of essential and quality equipment increases services productivity, resulting in better digital transformation and thereby increasing exports.

P@SHA has also proposed that the tax exemption of software (services) be restored. It observed that currently, there is a difference of opinion on software as goods or services between the federation and provinces, and therefore exemption by the federation would lead to ease of doing business for the sector. Tax officers tend to view software as goods and charge sales tax accordingly. With the exemption, the provincial authorities can claim the right to charge sales tax as services. FBR can also collect such sales tax under the Information and Communication Technology Ordinance 2001 on services.

P@SHA has suggested reforms for forex retention and utilisation. It has demanded immediate reinstatement of 100% income tax exemption from export income for IT and ITeS companies for five years. Similarly, 100% retention in foreign currency for international income should be allowed.

P@SHA has also proposed 100% retention in foreign currency for international equity allowed by foreign residents for investment in Pakistan (inward remittance).
It has also suggested 100% retention of foreign currency for international and local VC/PE funds, with the condition that the fund should at least be deployed 70% in IT/ITeS companies/startups within three years. While 35% of the foreign currency amount received in a year is to be repatriated without limitation.

P@SHA observed that the policies outlined in Chapter 12 of the Foreign Exchange Manual restrict foreign currency retention of IT sector exporters to a mere 35% of their proceeds, necessitating them to exchange the rest at uncompetitive bank forex rates. Consequently, the exporters are disinclined to bring their export proceeds to Pakistan, and the fluctuating dollar rate creates further uncertainty. 

It is imperative to recognise that the IT/ITeS sector has unique operational requirements that differ from other industries. IT/ITeS companies must regularly make payments for imported services, including servers and advertising, which often lack local alternatives, such as Google or YouTube advertising. Therefore, allowing full retention of inward foreign currency is of utmost importance to IT/ITeS firms. In the bigger picture, enabling 100% retention of inward foreign currency will increase forex inflows, as reducing the cost of doing business will increase foreign investment and encourage firms to park their foreign currency in Pakistan.

According to P@SHA, foreign currency payments are processed by authorised dealers, who often create unnecessary hindrances due to a lack of understanding and over-compliance. The inordinate delays and complexities associated with even the simplest transactions discourage IT/ITeS companies from keeping their foreign currency funds in Pakistan.

To be internationally competitive, IT/ITeS companies need to be agile with instant access to funds transferred to and from Pakistan. The difficulties in the payment process make Pakistan an infeasible destination to set up such operations and create an unfavourable business environment for both local and foreign companies. Therefore, it is essential to streamline this process and make forex transactions direct and hassle-free without the need for time-consuming steps, P@SHA suggested.

Credit: Independent News Pakistan-WealthPk