It hasn’t been long since the word “Startup” has made an entry in the government’s legal dictionary, making its way to the Income Tax Ordinance 2001; through Finance Act 2017, however, our fellow citizens have been calling out their business as “Startup” for a very long time.
To promote entrepreneurship and Startups, regulatory bodies such as the Federal Board of Revenue (FBR) and Security and Exchange Commission of Pakistan (SECP), have worked out their ways. FBR, whose primary purpose is to promote compliance with tax and related laws in the country, has also provided a definition of Startups to highlight their separate role and importance in the economy and provide them tax-based incentives.
On the other hand, SECP is continuously reforming its company registration processes to cater to the needs of a growing number of Startups looking forward to apply for registrations as a company.
Recently, our government has passed the Budget and Finance Act 2021, amending many of the tax laws in Income Tax Ordinance 2001.
For clarity of the reader, the Income Tax Ordinance 2001 is the set of underlying laws related to tax collection on income of an individual or a business, updated each year through a Finance Act which the parliament passes. This year, substantial changes have been made through the Finance Act 2021, impacting Startups and the IT sector’s overall outlook.
First, we need to look into the definition of a Startups as defined under the law in section 2 of Income Tax Ordinance at clause (62A) start-up, which states (i) a business of a resident individual, AOP or a company that commenced on or after first day of July 2012 and the person is engaged in or intends to offer technology driven products or services to any sector of the economy provided that the person is registered with and duly certified by the Pakistan Software Export Board (PSEB), and has a turnover of less than one hundred million in each of the last five tax years. Foreign Companies and Branches of Non-Residents are also Companies for tax purposes and are covered in the definition of start-up.
This means our regulatory body only recognizes those businesses registered on or after the 1st day of July 2012 as Startups. These businesses also need to register with the Pakistan Software Export Board, which is another independent governmental body like FBR or SECP.
Previously, if these conditions were met, a startup was was given tax exemptions on total income but not after the Finance Act 2021 as some new requirements have been placed to claim tax benefits such as tax credit or tax exemptions.
Following a general rule any person providing taxable services or a carrying out business activities which are deriving Income needs to get itself registered in any one of the common legal form, i.e. (1) as a sole proprietor (2) as an Association of Persons commonly known as a partnership (3) as a company from SECP. Also, Exemptions were available to all these forms of business registrations.
However, through Finance Act 2021, a new section, “65F – Tax credit for certain persons,” has been added, which provides a tax credit for up to one hundred per cent of the tax payable for the period and shall be available subject to fulfilment of the following new conditions. (a) return of income has been filed; (b) withholding tax statements for the relevant tax year have been filed in respect of those provisions of the Ordinance, where the person is a withholding agent; and (c) sales tax returns for the tax periods corresponding to the relevant tax year have been filed if the person is required to file a Sales Tax Return under any of the Federal or Provincial sales tax laws.
This section covers the tax credits for the Startups certified by PSEB and next two following tax years from its registration and other Businesses engaged in providing IT Services or IT Enabled Services up to the period ending on June 30, 2025, only if eighty per cent of the export proceeds are brought into Pakistan in foreign exchange remitted from outside Pakistan through normal banking channels.
For clarification, new clauses, namely (30AD) & (30AE) in section 2, have been added to define the scope of IT Services and IT Enabled Services. (30AD) Information Technology (IT) services include software development, software maintenance, system integration, web design, web development, web hosting and network design; and (30AE) IT enabled services include inbound or outbound call centres, medical transcription, remote monitoring, graphics design, accounting services, Human Resource (HR) services, telemedicine centres, data entry operations, cloud computing services, data storage services, locally produced television programs and insurance claims processing.
Suppose these services are exported, and earnings from them are brought into Pakistan directly into a bank account. In that case, a business can claim the tax credit as mentioned earlier up to one hundred per cent by meeting all the new conditions.
In the wake of the recent changes, it is evident that to qualify for the tax credit, a Startup Business, Freelancers or Business providing IT services or IT enabled Services also needs to register itself in provincial tax bodies to comply with the local sales tax laws. For Example, a Startup Business registered as a Private Limited Company from SECP having a National Tax Number from the Federal Board of Revenue also needs to register in Sindh Revenue Board and file monthly sales tax returns.
Another significant change is the insertion of section 154A, which allows a bank to deduct 1% withholding tax on the export proceeds for Services from businesses not eligible, i.e. not meeting conditions mentioned above. Moreover, additional tax will also be applicable based on profit in normal manner if conditions are not met. Furthermore, the FBR has said that they may prescribe rules for clarity. Currently, it appears that an exemption certificate would be needed from Commissioner to avoid withholding tax under section 154A.
Pakistan has also set great examples for best practices in accelerating women social entrepreneurship. To promote women empowerment for the first time through finance division, a new concept of “woman enterprise” has been introduced.
It is defined as a startup established on or after July 1, 2021, as a sole proprietorship concern owned by a woman or an AOP (partnership), whose all partners are women or a company whose 100% shareholding is held or owned by women.
To encourage and promote such women-led Startups, the tax on profit derived from these businesses has been reduced by 25%. This means that these women-led enterprises will pay 25% less tax on their income than their male counterparts engaged in the same businesses.
The government has recognized the importance of the IT sector in accelerating the country’s economic success. Every day, a growing number of software companies, call centres, and other information technology enterprises register in Pakistan. The government and the regulatory authorities must do their part in easing the overall policies and procedures. More programs such as Kamyab Jawan Youth Entrepreneurship Scheme should be introduced as a tool to encourage startups and entrepreneurs.