In mature economies, tax policy doesn’t just aim to finance public expenditure but also to promote growth as its primary function. In Pakistan, tax policy focuses only on revenue collection through very high tax rates without base broadening.
Even when the intentions are honest and the tax policy focuses on the promotion of investments and growth in a particular sector of the country’s economy, it more often than not ends up inducing unintended distortions, which, in turn, neutralise the growth objective, partially or fully. The country’s emerging IT industry is one such sector where these two main tax policy goals of revenue collection and growth appear to be at odds with each other.
On the one hand, the government has cut tax on IT firms to a negligible 0.25 per cent to help boost their expansion and growth. But at the same time, another good policy incentive of allowing income tax exemptions to freelance tech workers earning in foreign exchange has created a big challenge for IT companies to hire new talent, grow big, and even retain their existing employee base.
The reason is obvious: the earnings of the tech freelancers are tax-free, but the salaries of those employed by the IT firms are subject to personal income tax of up to 35pc. The budget for the ongoing fiscal year of 2023-24 has increased their tax rate burden by an additional 2.5pc on annual income of more than Rs2.4 million.
Tax exemptions are offered to IT firms and tech freelancers, but the salaries of those employed by the IT firms are subject to high personal income tax, resulting in the dearth of local talent
“This tax disparity between freelancers and salaried tech workers is a major challenge for the IT companies to attract and retain talent at a time when the skilled Pakistanis are leaving the country in droves for better opportunities abroad, with global demand for skilled workers increasing rapidly.
“There’s a kind of an economic war ongoing in the world, and those nations with skilled people will drive the world economy. Tech will lead the next global wave of economic revolution and industrialisation,” Usman Asif, the CEO of DevsInc, argues.
DevsInc claims to be Pakistan’s “fastest growing” software company, with an employee base of over 1,500. “Our mission is to grow our employee base to 80,000-plus in Pakistan by 2030,” Mr Asif says, adding the company has already expanded out of Pakistan to San Francisco, Dubai and Saudi Arabia and will soon be venturing into Norway.
As if the widening skill gap in the country and brain drain aren’t enough challenges for the firms, the personal income tax disparity between freelance and salaried tech workers has emerged as yet another headache for the IT companies as they struggle to retain their employees.
“The rising employee turnover rate in the emergent IT industry is just becoming a big worry for every company because of an ever-increasing shortage of tech workers in the market and rising job opportunities for them outside Pakistan. The industry’s overall average employee turnover ratio is less than 50pc at the moment,” claims Mr Asif.
His company’s employee retention rate at 94pc, on the other hand, is almost double the industry average because it generously shares growth in the firm’s profits with its employees and exposes them to international training and experiences. Unlike many other companies, DevsInc values its old employees and ensures that they stay with it no matter what.
“We do appreciate that the government has reduced tax on IT companies to nearly zero. It is also a very good initiative to exempt the earnings of freelancers from tax as they are bringing in a lot of foreign exchange at a time when we are facing a liquidity crunch. These policy measures underscore the government’s deep commitment to encouraging this industry as its potential to help the moribund economy recover and rebound.
“However, we also need to resolve the issue of high tax on salaried tech engineers — and fast as it is now starting to hamper industry growth and employee retention,” Mr Asif argued.
The solution, according to him, is easy and should be acceptable to all stakeholders. IT companies typically earn 20pc profits on their services to foreign clients. These firms can easily pay 3-5pc tax instead of the existing 0.25pc provided the government agrees to pass on the benefit to their salaries employees.
“If this proposal is implemented, the government will continue to collect the same amount of revenues ‘at source’ if not greater, the tax burden on the employees will be mitigated significantly, and the industry’s ability to attract and retain talent will be enhanced,” Mr Asif, who graduated from Lahore’s FAST University in 2009, contends.
He agrees that not every IT company will choose to opt for this ‘scheme’, adding the government could offer the family of lower tax rates or exemptions only to the employees of those firms that decide to pay a higher tax.
He firmly believes in continuous growth. “It is important for you to grow if you want to achieve your targets and mission. Our mission is to turn this company into an 80,000-plus employees entity. If we reach that goal, we will become Pakistan’s first $10bn company by 2030. If that’s to happen, we will need to uplift the entire industry in the country and attract talent for that. Our firm has now reached a stage where we need to attract experienced talent from abroad, the engineers who have worked for firms like Microsoft, Apple, Amazon, Google, etc, and contributed to their rise as tech giants for further growth.
“We already have four Europeans working at our Lahore office, and several Pakistani engineers working with global giants are being hired. But, the high personal taxation is a concern for everyone who is returning home. The other concern is the state-led bias against holders of dual nationality, which wrongly, and maybe unintentionally, makes their loyalty to Pakistan suspect in the eyes of the public at large.
“Why would someone earning large money in the United States return home to work here if his loyalty to his country of origin is suspect and if a substantial portion of his income is deducted in taxes, first as income tax and then heavy indirect taxes on everything he uses or consumes?
“So these are the issues that need to be looked into.If my proposal is accepted, it will not affect the government revenue in any way while facilitating the software service providers to grow bigger like India’s Infosys and Tata Consulting Services.”
His message to the industry is clear: all Pakistani IT companies are confronting the same issues like scarcity of software engineers, lack of IT training and education facilities, academia gap, etc, as well as competing for the same goals. Hence, we should sit together to find solutions to uplift this industry and exploit the growth opportunity provided by the emergence of new technologies that have once again levelled the field of IT for every country.
“The emergence of new technologies means that no country has an edge over the other at the moment; all are at ground zero. It offers an excellent opportunity to Pakistan to take over the global tech scene provided we are able to tackle issues of skill shortage, academia gap, excessive taxation and such as quickly as possible to uplift the country’s IT industry.”
Published in Dawn, The Business and Finance Weekly, September 18th, 2023