Tax Exemptions for Startups in Pakistan
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Startup scene in Pakistan is developing at a rapid pace. SECP data shows that there were 5,724 companies in the Information Technology sector in Pakistan as of June 30, 2018. Out of these, 1,375 companies were incorporated during financial year 2018 alone (12.1% of total number of companies incorporated during the same period). When startup activity is increasing at such a high rate, it is important to discuss the tax exemptions/credit available to startups in Pakistan.
Definition of Startup
Potential entrepreneurs might find it confusing to precisely define “startups”. A number of definitions are available. Eric Ries in The Lean Startup defines a startup:
A startup is a human institution designed to create a new product or service under conditions of extreme uncertainty.
Tax laws, however, stick to their own definition of startup.
Government of Pakistan inserted definition of startup in Income Tax Ordinance, 2001 (the Ordinance) through Finance Act, 2017. Prior to that, the Ordinance didn’t have any specific provisions to provide tax exemptions for startups. This move was intended to promote and encourage innovation and entrepreneurship in Pakistan, particularly in the field of Information Technology.
To define a startup in the Ordinance, the Federal Government inserted a new clause (62A) in section 2 of the Ordinance.
As per this definition, a startup means business of:-
– a resident individual;
– AOP; or
– a company
that commenced on or after 01.07.2012. Any business that was incorporated before 01.07.2012 is not eligible for these tax exemptions. The definition further provides that, a startup is a business that delivers technology driven products or services to any sector of the economy. Also, to meet the definition of startup, the Ordinance provides following two conditions:
(1) The persons is registered with and duly certified by the Pakistan Software Export Board (PSEB); and
(2) The person has annual turnover of less than Rs. 100 million in each of the last five tax years.
The above definition is restrictive in nature, somehow. It imposes following restrictions to be eligible as a startup.
A business or entity can be startup without meeting above restrictions. But, that prerogative rests solely with the Federal Government. The Federal Government can notify any business of a person or class of persons as a startup for taxation purposes and by imposing any specific conditions as the Government deems appropriate.
So “technology driven product or service” is the key term here. For example, an “android game” is a startup whereas an “e-commerce store” selling shoes online is not a startup. Similarly, an online marketplace such as Daraz.pk is a startup whereas Darimooch.com selling beard grooming products online is not a startup in the eyes of FBR.
Tax Exemptions/Credit
The Ordinance provides 100% tax credit and an exemption for startups.
100% Tax Credit Against Income Tax Liablity of the Startup
Profits and gains of startups were exempt from income tax up till promulgation of Tax Laws (Second Amendment) Ordinance, 2021 on March 22, 2021.
Effective from March 22, 2021, income of a startup is not exempt from income tax; instead, startups have been allowed a 100% tax credit against their income tax liability.
There are SIX conditions attached to eligibility for 100% tax credit. These conditions are enumerated below:
- The startup is required to be certified by the Pakistan Software Export Board (PSEB).
- 100% tax credit is available in the year of certification by PSEB and the next following two years.
- The startup has filed the income tax return.
- Tax required to be deducted or collected has been deducted or collected and paid by the startup. In other words, the startup has discharged its duty as a withholding agent. For further details on withholding of taxes, read this article.
- The startup has filed with FBR the withholding tax statements for the immediately preceding tax year.
- The startup has filed the sales tax returns for the tax periods corresponding to the relevant tax year. Therefore, relevant sales tax registration (PRA, SRB, BRA, KPRA, FBR) is also must.
The startups are eligible for 100% tax credit regarding tax payable under any provisions of ITO, 2001 including minimum tax and final tax. However, the startup can be subjected to audit proceedings u/s 177 and 214C.
Exemption from Deduction of Withholding Tax upon Receipt of Payments as Required by Section 153
Under normal circumstances, a buyer is required to deduct 3% tax at the time of making payment to a vendor on account of providing IT services. By virtue of this exemption, the buyer will no more be required to deduct tax at the time of making payment to IT service provider.
For example, a startup is engaged in software development. A customer of the startup intends to make a payment of Rs. 500,000 to the startup. He would make payment of Rs. 485,000 to the startup and deduct income tax of Rs. 15,000. After this tax exemption, the customers would not deduct any tax and make full payment to the startups for a period of three years, as explained above.
You can check the exemption clause (43F) in Part IV of Second Schedule of the Income Tax Ordinance, 2001.
I hope now you understand which tax exemptions/credits are available to a startup in Pakistan. If you still have any questions, comment below or feel free to contact.
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Q .how to show export of IT Services In Sales Tax Return
You can show it as Other Revenue in the fixed/final tax column.
The Bank Al Habib automatically generated the ePRCs for the transactions that I have received from foreign banks (Wise, Payonner) with the ITRS purpose code 9471. However, PSEB requires the purpose code as 9186. How this can be made possible?
You have to contact with your banker.
What if we don’t have a company bank account and we haven’t registered in PSEB. What will be the taxability of income earned?
For export of services, normal rate of 1% income tax will apply. It will be final tax.
Assalam o aliqum Mr. Rizwan
I am have started a retail business outlet sanitary ware 6 months ago.
Previously I used to do import business and but due to govt policy, I have closed that business. I have added my new business name with FBR on my NTN. Retail business don’t fall under tier1 criteria for sales tax registration, but I am approached by FBR team , who asked me to install POS machine at my new shop. Either their act is legal or I have any remedy to such improper act.
I am from Hyderabad Sindh
Please advise
POS 1 requirement is for Tier 1 retailers. Please note that a retailer can be a Tier 1 retailer. If you mention more details about the business, maybe I can guide you better. [Business nature, retail shop area, shop location, etc.]
What if i start a startup business now then how could i show last five years profit?
Pls confirm
Your question is not clear. Please elaborate.
I have an NTN since 2000 and ran an IT services business for 15 years, due to health issues I have not done any business for past 5 years and currently employed as an IT Manager. I would like to restart my business and confused about a few items.
1) Can I qualify as a Startup if I use my old business name xxxx Systems?
1a) If yes then what is the proceedure.
1b) If no then can I qaulify if I change business to xxxx Technologies but use the same NTN number by adding the new business name to it?
2) Can businesses who qualify as Startup do business locally? Or are the tax benifits only for IT exports?
1) To qualify as a startup, you will need to add a new business in the NTN (NTN of sole proprietor remains the same). Procedure is simple. Just add the new business in NTN, and open a new business bank account.
2) Benefit of 0.25% tax is only for IT exports. Local businesses, if they do qualify as startup, can avail 100% tax credit for up to three years.
I could not understand, what does it mean by 100% tax credit for start up? Plz elaborate it in non technical way….
I will explain it in a simple way. Say, the annual tax liability of a startup works out to Rs.20,000. When the tax liability is finalized, any tax credits (or say rebates) available are deducted from the tax liability. If the startup has a 100% tax credit available, Rs.20,000 will be deducted from Rs.20,000 tax liability. The net tax liability will become zero.
Thank you Rizwan Sab
Dear Rizwan,
I’m running a private limited software house in Pakistan. We have software products which we sell and we also develop software on demand. I’m not clear about two things:
1. What will be the tax if I sell software in local market (in Pakistan)?
2. What will be the tax if I sell it in foreign countries?
Thanking you in advance.
Thank you Jalal for the comments. Before answering your question, I would need to know your Province and whether your question relates to income tax or sales tax. Thanks
I have found this article the clearest and most straightforward and it has cleared many of my doubts. Can you please add some details about the sales tax for the companies which don’t reside in the ISB region?
1) Companies which export their software produtcs/services abroad
2) Companies which sells software products/services with in Pakistan (other than ISB area)
Will be helpful for many people I guess. Thanks in Advance.
When you talk about outside ISB area, you need to specify the province. Because each province has its own sales tax on services law. For example, in Punjab, if export of IT services is your only source of income, then the company is required to register as a withholding agent. However, if the company is providing local IT services as well, normal sales tax registration with Punjab Revenue Authority (PRA) is required.
Hi,
we already have a software company which was incorporated 15 years ago was registered with PSEB at that time but we didnt renew and it was dormant, for tax exemption for three years do we need to create a new company?
Creation of new company is not required. You only need to ensure pending compliance requirements of the company.
Does Income tax apply on 1st year of start up? If yes then, Is tax rate is same as 29% corporate tax rate?
Income tax applies even from first year. Tax rate of individuals and partnerships (AOPs) is based on different income slabs. It is not fixed like corporates.
As you know, the banks have stated deducted WHT at source on the time of Foreign Payment being made to a software house? Is there any exemption allowed to IT sector which relieves it from the deduction of 1% WHT at the time foreign payment is credited in bank account?
Also can you list all the exemptions a Pvt Ltd Software company which is incorporated after 01.07.2012 and is duly registered with PSEB can avail.
Thanks
Yes, the exemption from deduction of 1% income tax deducted by the banks is available to exporters of IT services. You have to provide an exemption certificate to the bank. Application for exemption certificate can be submitted through IRIS portal of FBR.
1) Its income from provision of local IT services shall be eligible for 100% tax credit (for three years max) including minimum tax and final taxes.
2) Its income from export of IT services shall also be eligible for 100% tax credit including minimum tax and final taxes up to Tax Year 2025.
very helpful! i am thinking to open a company in pakistan that will provide the commissioning service to foreigner companies during the startup/commissioning of their project.
To offer this service the employee (of pakistan based company) will travel to that country to be present there and modify the plc softwares and to do other commissioning activies.
Is this type of service can be considered as IT Extended services or startup company to avail the tax relief.
As physically nothing is being saled from pakistan but only the services that have major part as software modifications (development in some cases).
it would be great if you guide regarding this.
Thanks
Thank you Abdullah. Please note the service should be technology driven. If it actually involves software development, and if it can be confirmed from the agreement with the client and invoice raised, then yes, it will qualify as a startup company. Neverthless, it would be export of services, where there will be final tax of 1%. Plus, export of services is exempt from applicablity of sales tax.
Very helpful information regarding tax exemptions and definition of “Startup” by SECP.
Dear Shahid Aslam, thank you for the comments. Focus of the definition is “technology driven product or service”, and I believe “Digitalsofts” can also be a startup. You would only need registration with PSEB for 3-year tax exemption of Pakistan source income. Exports obviously will be exempt from tax if at least 80% proceeds are brought into Pakistan.