Pakistan’s export of IT has received a lot of recent media attention. The reason is that after a long period of relatively flat or nominal growth, IT exports began to expand by 12–15% in 2017, and then significantly increased by 46% in 2021 and 23% in 2022.
Since 1998, when there were only a few businesses offering IT export services from Pakistan, I have been operating an IT export firm between Islamabad and Silicon Valley, California, therefore I can attest to this firsthand.
The Covid-19 pandemic in early 2020, which most likely gave it the significant boost we saw in 2021, and second, the higher than usual economic growth in the US7 (US accounts for more than 60% of IT exports), along with other first-world countries, were the most likely causes of Pakistan’s recent IT export growth.
Companies were compelled by COVID-19 to permit employees to work remotely from their homes. As a result, a culture of remote work was established, which is necessary for outsourcing tasks successfully to a country like Pakistan.
Pakistan benefited significantly from being one of the few nations in the world to have a high-quality and reasonably priced English-speaking professional workforce.
Tax exemptions, according to the IT export sector, must exist.
However, the IT export industry has been arguing that the 100% tax exemptions on IT exports are the real driver of the sector’s growth, and if they were to be removed (as the government recently attempted under pressure from the IMF), the sector’s growth would not only come to a halt but actually reverse.
According to them, without these tax breaks, new IT export companies will stop operating in Pakistan and go to more alluring locations in our area, such as India, Bangladesh, and the Philippines. Additionally, they claim that the current IT export companies will park their money abroad rather than bringing as much into Pakistan as they currently do.
In the worst case, many of these currently operating IT export companies (and freelancers) would leave Pakistan, much like some Pakistani textile factories that had to relocate to Bangladesh because Pakistan’s prohibitively high energy costs made them less competitive prevented them from operating there.
For a nation like Pakistan that is severely short on foreign currency, this is obviously a very terrifying scenario. Since the late 1990s, government officials who may not completely comprehend the nature of this industry get alarmed and continue to grant 100% tax exemptions to IT exporters. In reality, the IT export industry was outraged just a short time ago when the government, under pressure from the IMF, slapped a modest 0.25% to 1% withholding tax as the “final tax” on IT exports.
Fortunately, the alarming picture projected by the IT export sector couldn’t be further from the truth. On the contrary, the expansion of Pakistan’s IT exports is unrelated to these broad tax exemptions (this growth or lack of it is dependent on totally different factors). I’ll tell you why.
Structure of the IT export market
Let me first go over the structure of Pakistan’s IT export business so you can better appreciate why the fears of the IT sector are unfounded. The corporate side, which serves as the IT export sector’s true skeleton, as well as independent contractors and remote workers make up the sector.
Businesses on the corporate side hire staff, train them, and use them to provide services to customers, business partners strategically, or parent firms abroad. Most of these exporters of IT services engage in software development or other related commercial ventures. A few of them additionally offer call centre services. Then there are other companies that offer a wide range of IT-enabled business services. Data centre setups, IT manufacturing and warehousing operations, and other higher scale industries are not very widespread at the moment.
Many IT export companies offer their services directly to clients in other countries or create their own software products and market them to customers around the world. They virtually always use a front foreign corporate entity in a developed nation in this situation. This organisation is in charge of locating customers, cultivating relationships with them, obtaining their business, and managing the sales and marketing aspects of the operation.
In this arrangement, the offshore business entity is typically a minority owner and is viewed as a service provider, while the front foreign business entity typically controls the majority ownership of the whole business. As a result, only the profits of the offshore business entities are remitted to Pakistan, while the majority of profits go to the foreign business entity owners and are kept elsewhere.
Additionally, Pakistanis living abroad who are friends or relatives of the Pakistani company owners own the front business firm wholly or in part.
A major, well-established parent firm overseas receives back-office services from a few IT export companies. They are able to do this because the parent company’s senior management and executives, who are also some expat Pakistanis, had a say in the decision to establish the offshore office in Pakistan.
Last but not least, a lot of Pakistan-based IT export companies are successful abroad thanks to relationships and other marketing strategies used by their owners and executives. Even in this scenario, the more prosperous organisations set up a phoney front company abroad so their consumers would feel safe doing business with an organisation incorporated in that nation. In this instance, the majority of profits are transferred to Pakistan, with only a small amount remaining overseas to support local business requirements. Any gains held abroad are subject to taxation there at year’s end.
The corporate sector is the backbone of Pakistan’s IT export business since it creates the organisational knowledge and ecology necessary to expand this sector, create intellectual property (IP), and eventually market it internationally. Long limited to the export of IT services, India has recently advanced to the next stage and is increasingly creating its own goods and intellectual property (IP) and marketing it internationally. There are very few product-based IT export companies in Pakistan (my business is luckily among them).
On the other hand, freelancers and remote employees are typically qualified and experienced people who began their careers working for a corporate IT export company and have now gained enough experience to obtain work directly from international clients or employers.
Freelance marketplaces like Upwork, Fiverr, and others are where freelancers typically locate their clients and short-term tasks. Following the Covid-19 outbreak, a new phenomena known as remote employees has gained a lot of popularity. Through placement services like Turing.com and others, remote workers are able to secure longer-term contract jobs with international firms.
The contribution of independent contractors and remote employees to the IT export sector is far less than that of businesses (although they earn considerably more than previous local jobs). However, some of them go on to open their own businesses, build their own teams, and make contributions. To further their careers, some people eventually travel and work abroad in places like the Middle East, Europe, the US, Canada, and Australia.
Why does Pakistan attract IT services companies?
The fundamental query is: Are there any tax exemptions that cause IT export firm to move to Pakistan? The answer is simply no. Therefore, why does the IT services industry visit Pakistan? Below, I’ll explain why.
Pakistan’s availability of a high calibre, reasonably priced, proficient English-speaking workforce is one of the factors driving IT export business there. Pakistan also offers top-notch IT infrastructure, with offices in at least major cities like Islamabad, Lahore, and Karachi, as well as high-speed bandwidth.
Despite recent inflation, the overall cost of doing IT export business in Pakistan is fairly competitive. Unlike the textile sector, the IT exports sector has very comfortable profit margins to absorb any such cost fluctuations and Pak Rupee devaluation also helps in this regard. This is why despite being forced to almost double employee salaries in the last 2 years, the IT Sector is still comfortably profitable.
But, all these reasons by themselves are not enough because India, Bangladesh, and Philippines also offer the same value.
Therefore, the main drivers of the IT services industry in Pakistan are Pakistanis living abroad. These Pakistanis who live abroad do this because they feel at home in Pakistan and have family and emotional ties to the country. This is especially true for IT export companies with solely Pakistani owners, who frequently returned to Pakistan after studying or working abroad for the same reasons.
All of these Pakistani expats choose Pakistan as their home country out of pure self-interest because they believe they will have complete control over their businesses and therefore the best chance of success there. It would make no sense for them to travel to an unfamiliar location like India, Bangladesh, or the Philippines. The same is true of India, Bangladesh, and the Philippines, where the growth of their IT export industries has been greatly aided by their expat populations.
All of this implies that there are very few opportunities for Pakistani IT export companies to relocate. They won’t go anywhere else as long as they can profit from Pakistan in the same way that they can in other comparable nations.
Is there a tax issue affecting the export of IT?
Is there a tax issue with the IT export sector that needs to be fixed and that, if not resolved, could harm its future growth? And a resounding “yes” is the response. I have a suspicion that the IT export industry is using this legitimate complaint to ask for tax exemptions.