IT export sector – II

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 notorious for harassing taxpayers through frivolous and often incorrect tax notices and not accepting even detailed written explanations at initial tax assessment officer level only to then reverse it at Commissioner appeals level. And, if the case is a border-line one or the amounts are larger, then even the Commissioner Appeals won’t agree and the taxpayer has to fight it all the way to Tribunal level and usually win it.

I suspect FBR’s internal performance metrics are based not on actual revenue collection but on how many tax liability notices are issued by tax assessment officers even if they get reversed later. This could be why so many frivolous notices are issued.

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 this can easily span many months to even years if it goes to the Tribunal level. Unfortunately, FBR keeps downplaying it instead of fixing it.

Now, local Pakistani businesses and even expats might accept this as a “fact of life” and still do business with Pakistan. But, as IT sector grows and foreign-owned business entities consider Pakistan as their back-office destination, ease of doing business is a huge factor and this issue can easily become a show-stopper for Pakistan and give other countries like India and Bangladesh an edge.

Are tax exemptions needed for the IT export sector?

So, in light of the above-mentioned points, the main question to ask is whether tax exemptions are really needed for the IT export sector or not. And, the answer is both No and Yes.

First, we must agree that giving blanket tax exemptions since 1998 hasn’t worked. So, continuing it will not bring different results. Of course, IT export business owners will never complain because they’re earning comfortable tax-free profits.

IT export sector – I

Secondly, if there are still doubts in our policymakers’ minds, then they must learn from our neighbor India because you cannot argue with their success which is quite huge. In 2000, India’s IT exports were only $5 billion and Pakistan was probably less than $100 million. Today they are over $150 billion and Pakistan is only $2.5 billion. Had these tax exemptions been the savior, Pakistan’s IT exports would have grown to over $20 billion today and India, which does not offer tax exemptions, would have seen its IT exports decline. But that didn’t happen.

India offers no tax exemptions to either businesses or freelancers/remote workers. They only offer very targeted tax exemptions for new capital-intensive IT related infrastructure projects inside Special Economic Zones2 (SEZ) with 100% tax exemption for the first 5 years and 50% tax exemptions for the next five years and nothing after that.

Pakistan on the other hand offers a blanket 100% tax exemption to everybody indefinitely (businesses, freelancers, remote workers). In fact, by offering tax exemptions to freelancers / remote workers, Federal Board of Revenue (FBR) didn’t realize its negative side effects on IT export sector. Now, IT export businesses are being pressured by their employees to pay them directly from abroad as freelancers to avoid payroll taxes even though they’re not freelancers. And, many businesses are doing this to stay competitive. And FBR is losing payroll taxes from all of this and not to mention unintentionally promoting another culture of rules violation.

So, Pakistan should ideally stop these free for all tax exemptions on IT exports and only offer very targeted tax exemptions to SEZs like India. Additionally, considering FBR’s problems affecting ease of doing business and being realistic that it is very difficult to fix, Pakistan must offer either 100% tax exemptions or 1-3% withholding tax as “final tax” but only to private limited companies with double-taxation (meaning at corporate level). But dividends or salaries drawn by owners will be taxed.

Additionally, these tax exemptions or “final tax” should be unambiguous and not subject to Commissioner FBR’s discretionary powers at year-end where the smallest violation or non-compliance could unravel it. The purpose here is remove all tax uncertainty so businesses can confidently plan instead fearing 30% tax on profit at year end in case of even smallest violation.

This will provide ease of doing business by keeping FBR away from these businesses. And, this will also provide tax-free corporate profits for business expansion which will be a huge incentive in comparison to other countries.

Similarly, no tax exemptions should be offered to any single-taxation businesses like AOPs, Limited Liability Partnerships (LLP), or sole proprietorships. Freelancers and remote workers should also not get any tax exemptions. Any IT export business that wants tax exemptions can easily incorporate into a private limited company which will improve documentation as well.

In summary, tax exemptions must be targeted either to SEZs or at most to corporate profits only and not given to individuals who will use this tax-free money for personal use instead of growing the IT export sector.

Will IT exports decline if taxed?

So, if tax exemptions are discontinued, will all the fears being spread by IT export sector come true? I do not think so and let me explain why.

Will new IT export businesses stop coming to Pakistan? The answer is No. The reason is that expat Pakistanis decide on Pakistan not because of tax exemptions but because this is where they’re comfortable and actually have the greatest probability of success. And, even if their offshore counterparts complain, they will not take IT export business out of Pakistan because they’re used to paying taxes on their profits abroad. Plus, other places like India are also not offering tax exemptions anyways.

Will existing IT export businesses relocate overseas like the textile industry? The answer is again No. Unlike textile, IT exports cost of doing business is very competitive and there are enough margins for business owners to be happy. Besides, IT export taxes come into the play on profits whereas textile sector issue was operational costs.

Will IT export business bring less money to Pakistan and park it abroad? The answer is No again but with a caveat. Business owners have to bring money to Pakistan which is needed to run and grow their business and also to meet their own expenses. And, even if they park a portion of their profits abroad, this amount is insignificant compared to the total money. And, parking money overseas has its own complications (not to mention being illegal) that many may choose not to get into. Also, over time, when other loopholes are plugged, then they will be forced to bring all profits to Pakistan so they can enjoy them.

Will freelancers/remote workers move out of Pakistan if taxed? The answer is a strong No. First, their ability to move out is usually quite restricted. And, those who can move out will move out even with 100% tax exemptions for personal and professional reasons. Besides, they’re making very good money so there is less incentive to move out.

Conclusion

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 from countries like India is that IT export business comes to Pakistan because expat Pakistanis favor Pakistan. They do this because it is their home and gives them the greatest chance of success. As long as they’re making profit overseas, they’re not going to go anywhere just because they have to pay taxes on it. Besides, these expat Pakistanis are already used to paying taxes overseas.

It is only those based in Pakistan who have the greatest pain in paying taxes due to the unfortunate culture of not paying taxes here. Fortunately, although these local business owners may crib and complain, they will stay in Pakistan because it still offers them the best place to succeed and they would still be making very good profits.

But, ease of doing business is a huge factor without which foreigners will not come to Pakistan and IT export sector will not grow beyond a certain size.

(Concluded. The first part of this article was carried by the newspaper in its yesterday’s issue)