Withholding taxes affect startup costs. Withholding taxes are important in determining legal structure of a startup.
There is an ongoing debate: what should be legal structure of a startup? Legal structure can be sole proprietorship, partnership or limited liability company.
Determination of appropriate legal structure is not theoretical issue. You cannot decide this on social media opinions. It is entirely a practical concept, and can vary from startup to startup. Therefore, I strongly recommend expert advice before making a final decision.
In a previous post, I discussed this from income tax liability perspective. This post is particularly for small startups and those in early stages of growth.
Three important factors affect the decision about legal structure of a startup in Pakistan. These are important because of their direct relationship to the cost of doing business in Pakistan. Point is withholding taxes can increase startup costs.
- Withholding Agent under Sales Tax Act
- Withholding Agent under Income Tax Ordinance
- Minimum Income Tax Liability
Withholding Agent under Sales Tax Act
11th Schedule of the Sales Tax Act, 1990 provides information regarding withholding agents and withholding of sales tax. Most of the businesses in Pakistan are un-registered. And, you deduct sales tax when make a purchase from an un-registered supplier.
Individuals and partnership firms are not withholding agents under the sales tax law. Therefore, individuals and partnerships are not required to deduct sales tax when they make payment to an un-registered supplier.
This exemption is not available to companies. If a company makes purchases from an un-registered supplier, it is required to deduct 5% sales tax at the time of payment.
Business environment in Pakistan is different from developed countries. Un-registered suppliers normally do not allow to deduct 5% sales tax. Instead, startups bear this cost of 5%.
Please note that this withholding provision is not applicable in case of Third Schedule items, commercial importers, and supplies by an Active Taxpayer to a registered person.
Withholding Agent under Income Tax Ordinance
Withholding tax provisions that I will mention here are also important. They have direct relationship to the cost of doing business in Pakistan. These provisions are applicable to all companies. However, these provisions apply only to those individuals and partnerships whose annual sales are Rs. 100 million or more.
Problem is again behavior of businessmen in Pakistan. Nobody wants to pay a single penny towards taxes. If you want to make tax compliance, you will have to bear the cost of these taxes. These taxes are mentioned below:
- 15% tax is required to be deducted at the time of making payment of royalty or fees for technical services to a non-resident person [S. 152(1)].
- 4%-4.5% tax is required to be deducted at the time of making payment for supplies when aggregate payment to a single party is Rs.75,000 or more in a year [S. 153(1)(a)].
- 8%-10% tax is applicable at the time of making payment for services when aggregate payment to a single service provider is Rs.30,000 or more in a year [S. 153(1)(b)].
- 7%-7.5% tax applies at the time of making payment to a contractor irrespective of the value of contract [S. 153(1)(c)].
Tax rate is increased by 100% in all above cases when the vendor is not an active taxpayer.
Another provision is regarding deduction of tax at the time of making rent payment u/s 155. All companies are required to deduct tax from rent payment when annual rent is more than Rs. 200.000. However, individuals and partnerships are required to deduct tax only when annual gross rent is equal to or more than Rs. 1.5 million.
For example, if annual rent is Rs.1,499,999, tax would be Rs.135,000. Again, most of the landlords don’t bear this cost. Unfortunately, the lessee would have to bear this cost.
Minimum Income Tax Liability
Here I will discuss two provisions of the Income Tax Ordinance, which require businesses to pay minimum income tax, even in case of loss. Yes, you have read correctly. Minimum tax is payable even when the business sustains loss.
First provision is minimum tax u/s 113. This minimum tax liability is applicable to all companies regardless of the value of sales revenue. However, minimum tax u/s 113 is applicable only to those individuals and partnerships whose annual turnover is Rs. 10 million or above. Minimum tax is payable at 1.5% of turnover.
Second requirement is alternative corporate tax u/s 113C. Alternative corporate tax is payable at 17% of accounting profit before tax. However, this is applicable only to companies, and not individuals and partnerships.
Please note that whichever of the above taxes (u/s 113 or 113C) is higher, is payable.
For companies, withholding taxes increase startup costs and cost of doing business. Therefore, these costs should be kept in mind while deciding legal structure of startups in Pakistan.
If you need any further guidance regarding application of taxes or choice of legal structure of your startup, feel free to contact.