Taxing times: Service providers, the next golden goose for government

tax2KARACHI: The minimum tax on service providers is unjust, counter-intuitive and against the principle of free market economy, the Pakistan Software Houses Association (P@SHA) for information technology and IT-enabled services said on Thursday while referring to the recently imposed 8% minimum tax on services companies.

According to a press release issued by the IT sector’s representative body, the new tax would have disastrous effects on the development of technology and entrepreneurial innovation, which would make many business models unviable and cause unemployment in the IT sector.

While seeking its removal from the Finance Act 2015, P@SHA stated the tax rate under the new regime would range between 94% and 188% as opposed to the normal corporate tax rate of 32%. This is a very serious anomaly and must be quickly addressed, it said.

Giving details, the organisation said under the new regime, the tax withheld would be the minimum tax liability of a services company regardless of whether it made a profit or booked a loss during that year.

With the imposition of minimum tax, P@SHA said even loss-making companies will have to pay 8% of their gross revenue in taxes, which means they would be forced to use their capital reserves or fresh capital injection to make this payment. It would, therefore, be tantamount to imposing a penalty on services companies that are reporting losses, which is unjust and against the norms of free market economy – it’s confiscation of private capital, in other words.

Moreover, P@SHA said the new tax will be a disincentive for foreign investors looking to invest in the country’s services sector because such kind of minimum or revenue-based taxes are not practised in leading marketplaces in the world or in emerging investment destinations.

Outlining the proposal’s impact, P@SHA said net profit margins of leading IT services companies of Pakistan are less than 10%. Even in case of extremely well-run IT companies, an 8% minimum tax would result in an effective income tax rate of 80% – that is 80% of the profits going in taxes.

For companies operating below 10% margin (which are in large numbers), the operations would become unsustainable leading to the closure of business. In other words, the IT sector will nosedive, which would severely hurt economic development and employment in the country.

Using the example of business process outsourcing (BPO) companies – which constitute almost all of the country’s IT sector – the P@SHA statement said despite the high volume of man hours, the BPO model operates at lower net margins that is between 8% and 12%. In Pakistan, many BPO companies operate at even less than 8% net margin.

Given the rising inflationary costs, the imposition of 8% minimum tax would render the local BPO business model unviable.

The 8% minimum tax liability came into effect after the government made changes to the finance bill at the last minute. It was swiftly approved in the lower house without taking the private sector’s input, P@SHA said, adding the government should immediately review the matter and suspend the amendment by taking necessary action.

Published in The Express Tribune, July 3rd, 2015.