Promoting IT industry for foreign exchange
In the current fiscal year, i.e. 2022-23, Pakistan is experiencing the fastest increase in the prices of consumer goods and services so much so that the headline inflation reached 27.26% in August – the highest in 49 years. As per the fiscal dominance hypothesis, high inflation persists due to huge, persistent budget deficits financed through the creation of money. Therefore, the extent of inflation depends on how the budget deficits are financed.
Various policy options are available to reduce fiscal deficits or to finance those. The fiscal deficits could be reduced by enhancing revenue collection and decreasing expenditure. For example, many countries have introduced windfall tax on extra profits of oil companies in the wake of the Russia-Ukraine war so as to generate additional tax revenues to deal with their increasing budget deficits. Summarily, the fiscal deficits could be financed through borrowing or money creation, given that the other factors remain constant.
To tame inflation, it is suggested that revenue collection be increased from direct taxes, rather than through regressive taxes, so as to balance the budgets. Realizing the importance of direct tax revenue, the government has introduced several provisions such as section 7E (tax on deemed income) and section 4C (super tax on high-earning persons) into the income tax law through Finance Act, 2022, with an aim to generate additional revenue for balancing the budgets. Similarly, capital value tax has been introduced to tax the foreign assets of residents.
Since financing fiscal deficits through money creation leads to inflation; therefore, those should be financed through enhanced revenue collection or through borrowing or foreign remittances.
Increasing tax revenue – preferably through direct taxes – is imperative to overcome fiscal imbalances. Increasing tax revenue needs broadening the base of the real economy which could be achieved by boosting public-private investment. More importantly, private investment can be enhanced through multiple options. One such option is to provide tax incentives as part of tax policy for encouraging private investors to invest, especially in export-oriented sectors. Among others, IT and IT-enabled services form an important sector with huge potential of earning foreign exchange besides the broad-basing of the real economy and generating additional tax revenue, which could be utilized to finance fiscal deficits.
Pakistan’s IT industry has recorded steady growth in the past few years. At present, the size of the software sector alone is approximately $3.5 billion. The software market is export-oriented and total software exports were approximately $1.9 billion in 2020-21. Given the young, energetic and driven population of youth – nearly 65% of the country’s total population – the actual potential of the IT industry is yet to be explored.
In view of the emerging significance of the IT industry, the government has already introduced several tax measures for its development and promotion under the Income Tax Ordinance, 2001 (ITO, 2001) and the Sales Tax Act, 1990 (STA, 1990).
To facilitate IT and IT-enabled service-providers, the government has introduced a final tax regime under which export proceeds of computer software or IT or IT-enabled services are taxable at a reduced income tax rate of 0.25% instead of 1%. Nevertheless, the benefit of reduced tax liability at a lower income tax rate is available to persons registered with, and duly certified by, Pakistan Software Export Board (PSEB) and have filed tax returns, withholding statements and sales tax returns, if required. Moreover, no credit for foreign taxes paid is allowable to such persons.
Similarly, profits and gains of venture capital companies and venture capital funds are exempted from income tax for three years, i.e. from tax year 2023 to tax year 2025, under clause 152, Part-I of the Second Schedule to ITO, 2001.
Besides, a 100% tax credit against tax payable including, alternate corporate tax, minimum tax and final tax would be available to start-ups for a period of three years; starting from the year in which the start-up is certified by the PSEB. However, the benefit of 100% tax credit would be available only if the start-up has filed tax returns, withholding statements and sales tax returns, if required.
Additionally, pursuant to section 113 of ITO, 2001, the reduced minimum tax rate of 0.25%, instead of the standard minimum rate of 1.25%, is applicable on turnover from supplies through e-commerce including from running an online marketplace.
Other tax concessions for IT and IT-enabled services sector include reduced withholding tax rate of 5% instead of 12% on commission and brokerage in case of a person running an online marketplace under clause 28C, Part-II of Second Schedule to ITO, 2001, and exemption on dividend income and long-term capital gains of any Venture Capital Fund from investment in zone enterprise for 10 years commencing from the date of issuance of license by the authority. Importantly, withholding tax provisions concerning dividend income, profit on debt and brokerage and commission are not applicable to Venture Capital Company.
Under the sales tax regime, a reduced rate of sales tax of 5%, instead of a standard rate of 17%, is applicable on the supply of personal computers (PCs) and laptop computers, notebooks whether or not incorporating multimedia kit, if imported in CBU condition, is available under the Eighth Schedule to the STA, 1990. Locally manufactured laptops, computers, notebooks, whether or not incorporating multimedia kits, and personal computers are exempt under the Sixth Schedule to the STA, 1990. Furthermore, exemption from sales tax on the import of various parts for assembling and manufacturing personal computers and laptops is also available to certified manufacturers and assemblers under the Sixth Schedule to the STA, 1990.
To provide the above tax exemptions and concessions to maximum businesses in the IT and IT-enabled services sector, the scope of the definition of IT has been expanded in the income tax law to include software development, software maintenance, system integration, web design, web development, web hosting and network design. Similarly, the scope of the definition of IT-enabled services has been also expanded to include inbound or outbound call centres, medical transcription, remote monitoring, graphics design, accounting services, human resource services, telemedicine centres, data entry operations, cloud computing services, data storage services, locally-produced television programs and insurance claims processing.
It is worth mentioning that with an average annual growth rate of 30%, Pakistan’s IT industry has enough potential to contribute far more to the overall economy given support and facilitation from the government. If supportive policies for investment, coupled with effective regulations, continue, IT and IT-enabled services sector would have a significant contribution to the economic growth and development of the country by broadening the base of real economy, employment generation, foreign exchange earnings and additional tax revenue generation, which would have a reducing impact on fiscal imbalances and inflation.
The author is serving as Additional Commissioner Inland Revenue at Federal Board of Revenue, Pakistan. He can be contacted at email@example.com