Is there any taxation problem for the IT export sector? This problem is with how Federal Board of Revenue (FBR), the taxation authority of Pakistan, deals with tax payers. FBR is well-known for pestering taxpayers with pointless and frequently inaccurate tax letters and for refusing even written justifications in-depth at the original tax assessment officer level before overturning it at the Commissioner appeals level. Additionally, if the case is on the edge or the sums involved are higher, even the Commissioner of Appeals won’t concur, forcing the taxpayer to take the matter all the way to the Tribunal level, where they typically prevail.
I believe FBR’s internal performance criteria are based on the quantity of tax liability letters that tax assessment officers issue, even if those notices are later rescinded, rather than the actual money collected. This may be the reason why so many pointless alerts are sent out.
This creates a very negative and painful experience for the taxpayer taking their energies and focus away from growing their business and into dealing with and fighting FBR unnecessarily. As long as it proceeds to the Tribunal level, this might potentially take many months or even years. Unfortunately, FBR keeps downplaying it instead of fixing it.
For the time being, local Pakistani companies and even expats might accept this as a “fact of life” and continue to do business with Pakistan. However, as the IT sector develops and foreign-owned companies look to Pakistan as a back-office location, the ease of doing business is a crucial consideration. This problem may easily become a deal-breaker for Pakistan and provide other nations like India and Bangladesh an advantage.
Are tax breaks required for the IT export industry?
The main question to raise is whether tax exemptions are actually required for the IT export sector in light of the aforementioned considerations. And yes and no are the appropriate answers.
We must first accept that since 1998, granting broad tax exemptions hasn’t been successful. Therefore, continuing it won’t have any different outcomes. Of course, since they are making comfortable profits tax-free, IT export firm owners won’t ever complain.
Second, if our officials’ minds are still clouded by uncertainty, they should take a cue from our neighbour India, whose enormous success is indisputable. Pakistan’s IT exports were probably less than $100 million while India’s were only $5 billion in 2000. They are currently worth about $150 billion, while Pakistan barely has $2.5 billion. If these tax breaks had been the rescue, India, which does not provide tax exemptions, would have seen its IT exports drop while Pakistan’s IT exports would have increased to almost $20 billion today. But it didn’t go like that.
India doesn’t exempt either businesses or independent contractors or remote workers from paying taxes. With a 100% tax exemption for the first five years and a 50% tax exemption for the following five years, they only provide very specific tax exemptions for new capital-intensive IT related infrastructure projects inside Special Economic Zones2 (SEZ). After that, they do not offer any tax exemptions at all.
Pakistan, on the other hand, provides an unconditional, perpetual 100% tax exemption to everyone (businesses, freelancers, remote workers). In reality, the Federal Board of Revenue (FBR) was unaware of the detrimental impacts on the IT export sector that came from providing tax exemptions to independent contractors and remote workers. Even though they are not freelancers, employees of IT export companies are already pressuring their employers to pay them directly from abroad as independent contractors in order to avoid payroll taxes. And many companies are doing this to maintain their competitiveness. Aside from unintentionally encouraging yet another culture of rule-breaking, FBR is also losing payroll taxes as a result of all of this.
Therefore, Pakistan should ideally stop providing these blanket tax exemptions for IT exports and instead only provide extremely specific tax exemptions to SEZs like India. Additionally, Pakistan shall only provide 100% tax exemptions or a 1-3% withholding tax as “final tax” to private limited companies that are subject to double taxation in light of FBR’s issues and the fact that fixing them will be exceedingly difficult (meaning at corporate level). Owners’ dividends and salaries, however, will be taxed.
Furthermore, these tax exemptions, or “final taxes,” ought to be clear and not be subject to Commissioner FBR’s discretion at year-end, when even the smallest infraction or failure to comply might cause them to fail. The goal is to eliminate any tax uncertainty so that firms may confidently plan rather than being afraid of paying 30% of profits at year’s end in the event of the slightest infraction.
By preventing FBR from interacting with certain businesses, this will make conducting business easier. Additionally, this will offer corporate profits that are tax-free for business expansion, which will be a big incentive compared to other nations.
Similar to this, no tax breaks should be provided to any single-taxation companies like AOPs, LLPs, or sole proprietorships. There should be no tax exemptions for independent contractors or remote employees. A private limited company can be simply formed by any IT export business that desires tax exemptions, which will also enhance documentation.
In conclusion, tax exemptions must only be offered to SEZs or, at best, to corporate profits and not to individuals who would utilise the money tax-free for personal expenses rather than expanding the IT export industry.
If taxed, will IT exports suffer?
So, would all the worries being peddled by the IT export business come true if tax concessions are stopped? I disagree, and I’ll explain why.
Will new IT export companies quit entering Pakistan? No, is the response. The rationale is that expat Pakistanis choose Pakistan not because it offers tax breaks, but rather because it is where they feel most at home and have the best chance of success. Furthermore, despite the complaints of their counterparts in other countries, they will not export IT from Pakistan because they are accustomed to paying taxes on their earnings abroad. Additionally, other countries like India do not offer tax exemptions either.
Will current IT export companies relocate abroad, much like the textile industry did? Again, the response is no. Unlike textile, the cost of doing business in IT exports is extremely low, and there are sufficient margins for business owners to be content. In addition, IT export taxes affect profits, whereas operational costs were the problem in the textile sector.
Will Pakistan’s IT export industry bring less money home and keep it abroad? No once more, but with a proviso. Business owners must bring the money they need to Pakistan in order to maintain and expand their operations as well as cover their own costs. Furthermore, even if they park a portion of their earnings abroad, the total sum would still be small. Additionally, parking money abroad has its own difficulties (in addition to being against the law), so many people may decide not to get into it. Additionally, they will be compelled to bring all profits to Pakistan so that they can enjoy them once other loopholes are eventually closed.
If taxed, will independent contractors and remote workers leave Pakistan? The answer is categorically no. First off, their freedom to leave is typically quite constrained. And even with 100% tax exemptions, those who can move out will do so for both personal and professional reasons. Additionally, they are making a good living, which lessens the incentive to leave.
Pakistan must learn from countries like India on all the best practices for growing IT exports. Otherwise, we will keep repeating the same mistakes as before and keep living in a fool’s paradise.
The lesson learned from nations like India is that Pakistan receives more IT export business because expat Pakistanis support Pakistan. Since it is their home and provides them with the best opportunity for success, they act in this manner. They won’t stop creating money if they’re earning it abroad simply because they have to pay taxes on it. Additionally, these Pakistani expats are accustomed to paying taxes abroad.
Due to the bad practise of not paying taxes in this country, only those who are based in Pakistan experience the most difficulty in paying taxes. Fortunately, despite their whining and complaining, these local business owners will continue to operate in Pakistan since it still provides them with the best opportunity for success and guarantees that they will continue to generate substantial profits.
However, foreign visitors won’t come to Pakistan without ease of conducting business, and the IT export sector won’t expand above a certain scale.
(Concluded. The newspaper published the first section of this piece in its edition from yesterday.)