8% Minimum Tax on Companies to Kill ICT Companies, Startups: PASHA

Recently imposed 8% Minimum Tax on companies will have a detrimental and disastrous effect on not only IT industry but also to technology and entrepreneurial innovation in Pakistan, said PASHA in a statement.

Press statement said that imposition of Minimum Tax will undo much of what has been achieved and put technology and innovation in Pakistan in a backward direction.

Background

Currently, withholding tax (WHT) of 8% is deductible by withholding agents when making payments to service providers, if they are companies. Service providers are entitled to offset the tax suffered against its final Income Tax liability, based on taxable income computed in terms of the provisions of the Ordinance.

Consequently the tax withheld is treated as Advanced Income Tax payments which can be all claimed back at the end of the year as refund.

However, with new Finance act, The tax withheld regardless of the whether the service provider company is profitable or loss-making in the year is its Minimum Tax liability.

The tax withheld, regardless of the whether the service provider company is profitable or loss-making, will be considered as its Minimum Tax liability

Hence for loss-making companies, this tax will be paid from their capital reserves or induction of new capital, effectively becoming a ‘capital tax’ and a ‘loss penalty’ or capital confiscation by GOP for those investing in the services sector in the country.

This change was not included in the Finance Bill 2015 presented on 5 June 2015 but was instead included in the Finance Act at the end of the month and was swiftly approved in the lower house thereafter. Hence no opportunity was given to the industry and other relevant stakeholders to raise their concern and debate this matter prior to its approval.

PASHA has  urged GOP to review this matter immediately and suspend this amendment through taking necessary action.

Impact of 8% Minimum Tax

The concept of Minimum Tax in itself is both counter-intuitive and unjust. As a basic principle of taxation, charges are levied on the profit earned by companies – that is to say that if their revenues exceed their costs in a given year, and resultantly they create new wealth, the payable tax should be a portion of the newly created wealth.

In the case of a loss, the company’s costs exceed their revenue. With the imposition of Minimum Tax, loss making companies will be paying tax at 8% of their gross revenue.

As they incurred a loss during the year and do not have the excess funds to pay this tax, they shall be forced to use their capital reserves or fresh capital injection to make the payments. Hence in this manner this can be construed to be a penalty imposed by the government for services companies who are making losses.

Resultantly, in addition to the loss incurred by the company, it will also be required to pay this Loss Penalty to the government which is both unjust to him and also against the norms of a free market economy. In other words, it is tantamount to confiscation of private capital by GOP – indeed a draconian law.

Furthermore, this will be a most debilitating disincentive for attracting foreign investment in the services sector in the country. Such Minimum or even Revenue based taxes are not practiced in any of the leading marketplaces in the world and neither in any of the emerging investment destinations.

Such an unjust and counter-intuitive measure would lose both the trust and interest of the foreign investor. In a time the country needs maximum participation of foreign investment, this amendment must not be allowed to stand.

Impact on IT Services Companies (Providing Services in Pakistan)

In the challenging economic conditions prevailing in the world markets, the leading companies in the Technology Services sectors average below 15% (Accenture, the global technology leader in the industry reported a net margin of around 15% over the past 2 years).

In Pakistan, net profit margins of the leading IT Services companies may be even less than 10%. Even in the case of extremely well-run IT service companies in Pakistan that earn 10% net margin from services provided in Pakistan, an 8% Minimum Tax results in an effective Income Tax rate of 80% – that is, 80% of profits earned are to be paid by IT Services companies as taxes.

For companies who operate at below 10% net margin, and there will be many, the operations will become unsustainable and they will be forced closure of businesses in this sector. IT Sector will take a nose-dive and will seriously hurt the economic development and employment,

Impact on Business Process Outsourcing (BPO) Companies (Providing Services in Pakistan)

By definition the BPO business model depends on high-volume of man-hours of services provided but at a much lower gross margin from other professional services. Globally speaking, well run BPO businesses are expected to turn over between 8% to 12% as their net margin before taxes.

For example, Teleperformance, a global leader in the call center outsourcing business currently operates at a Net Margin before taxes of 9% over the past three years.

In Pakistan, many BPO providers are operating at even below 8% net margin and with large volumes of business are able to sustain well maintained operations. Given the ever rising inflationary costs mainly due to high cost of energy, the imposition of 8% Minimum Tax will render the local BPO business model unviable and this will likely result in a catastrophic collapse of the industry leading to the loss of livelihood for many individual working in BPO companies.

Furthermore, it will destroy years of hard work and development that the BPO sector has accomplished in positioning Pakistan as a potential BPO supplier.

Impact on Tech Innovation and Entrepreneurship in Pakistan 

Over the past two years, we have seen great emphasis on the development of technology based innovation and entrepreneurship in Pakistan. Many incubators and civil society organizations have emerged who have worked relentlessly to promote and encourage young people who venture into this space.

We have many ecommerce businesses being set-up and with the support of the ecosystem around them, these fledgling businesses are now beginning to grow and may become a future source of revenue and employment in Pakistan.

The government of Punjab has also championed this cause under the PITB run projects Plan 9 and Plan X. In the last one year especially, leading private equity organizations have invested considerable sums in Pakistani commerce ventures and the industry has hailed this as the opening-up of a huge landscape of investments in the sector.

In Pakistan, many e-commerce businesses are working now with no plans to be profitable for the next 3 to 5 years

Sadly, the imposition of this Minimum Tax will stunt this momentum and undo much great work done by so many people. Many of these start-ups do not plan for profitability in the short-term. For example, Amazon.com, the global leader in e-commerce, remained in losses since its inception and for 20 years prior until 2014. Yet they are seen as an icon the US economy and especially of its technology and innovation sector.

In Pakistan, many e-commerce businesses are working now with no plans to be profitable for the next 3 to 5 years. If Minimum Revenue Tax is imposed on them, these service companies will be required to pay this tax from their capital.

Thus, this will reduce the incentive for investors, both local and international to continue to support this sector. And, it will be a great failure for the country to see such a promising sector being dis-installed by illadvised taxation schemes.

Conclusion

The Minimum Tax is unjust, counter-intuitive, against the principle of free market and contrary to practices of the better marketplaces in the world.

Furthermore, it will have disastrous effects on the development of technology and innovation in the country rendering many business models unviable and thereby causing contraction in the sector unemployment.

With this in mind, PASHA pleaded that it be reversed from the Finance Act 2015 and that it be not brought into discussion again at any time in the future.