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.
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.