Pakistan’s Investment Incentives: Opportunities in 2023
The Pakistani government offers several investment incentives to companies, one of which is the provision of an initial depreciation allowance. This applies at 25% of the cost of assets that are wholly and exclusively used for the first time in Pakistan during the year. Notably, this includes second-hand machinery being used for the first time within the country. This allowance is in addition to regular depreciation, however, it’s not applicable to furniture or road transport vehicles unless they’re meant for hire.
In the realm of sustainable energy, special allowances exist. Companies that install plant, machinery, and equipment (PME) for alternative energy generation can claim a first-year allowance (FYA) instead of the initial depreciation allowance. The rate of this FYA is 90% of PME cost. This benefit extended to companies establishing in specific rural and underdeveloped areas, as well as mobile phone manufacturers that began commercial production during the two years leading up to mid-2017. However, this benefit was discontinued in March 2021.
In alignment with the International Monetary Fund (IMF), the government in 2021 removed several tax exemptions as part of a strategy to boost revenues. Also, in March 2021, the government replaced numerous tax exemptions with full tax credits. These measures aimed to stimulate sectors such as coal mining projects in Sindh province, software exporters, and start-ups.
As part of the March 2021 tax reform, tax credits were removed for unlisted companies planning to list on a stock exchange by the end of June 2022. Initially, these credits were set at 20% for two years and then 10% for the following two years. The government also eliminated a credit that incentivized the employment of recent graduates, which could be claimed on top of salary expenses. This credit was available in the year of employment, equating to the annual salary of the employee, and was capped at 5% of the employer’s taxable income or 15% of the total number of employees.
The fiscal year 2021/22 budget, announced in June 2021, removed a five-year income tax credit that was applicable to new manufacturing companies and corporate dairy farms set up during the decade leading up to mid-2021. This provision was only valid if these entities raised 70% of equity through new shares for cash.
On the positive side, the 2021/22 budget introduced a new tax credit equal to 25% of any investments in new machinery, buildings, equipment, hardware, and software (excluding self-created software and used capital goods). This applied to greenfield industrial undertakings that either manufactured goods or materials, added value to them, or shipbuilding companies that incorporated between 2019 and 2024. These entities were expected not to result from the splitting up or reconstitution of an existing undertaking and not to be part of an expansion project. This credit can be carried forward for two years.
Encouraging employment, companies establishing a new manufacturing unit within the four years leading up to mid-2019 could take advantage of a ten-year credit. This incentive allowed such firms to reduce their payable tax by 2% annually for every 50 employees registered with the social-security organizations.
With the introduction of the Income Tax (Amendment) Ordinance 2022 in March 2022, a new tax credit became available to any Pakistani individual who had been a nonresident for over five years or a resident individual with foreign assets declared up to the end of December 2021. This provision applied if they invested more than PRs50m in a new industrial undertaking through funds remitted from outside the country. The resulting company would be entitled to a one-time tax credit of the amount remitted into the firm’s bank account. However, another key provision of the amendment, which offered loss-carry-forward incentives to companies acquiring “sick” industrial units, was withdrawn under the Finance Act 2022.
Customs duty exemptions or concessional customs duty of up to 5% applies to most imports of PME by manufacturers. For the non-manufacturing sector, a 5% customs duty is usually applied to imported PME not manufactured locally. Additionally, customs duties on most agricultural machinery, cool-chain machinery, and related capital goods and machinery for the dairy, livestock, and poultry sectors range from 0-5%. Sales tax exemptions or concessions are also available for the imports of machinery for numerous sectors such as agricultural equipment, equipment for use in export-processing zones, and equipment used in the manufacture of mobile phones.
In response to the Covid-19 pandemic, the State Bank of Pakistan offered refinanced loans for wage payments and allowed borrowers to restructure loans until March 2021. Other measures included allowing borrowers in certain sectors to defer principal repayments until the end of September 2020 and offering a temporary economic refinance facility to stimulate investments in new plants and machinery. By the end of September 2022, most of these coronavirus relief measures for businesses had expired, and due to a severe fiscal crisis, the government has been unable to provide new funds for companies affected by the floods in September 2022.
Incentives By Sector
Agriculture
In Pakistan, the agriculture and food sector benefits from various tax incentives and concessions. Notably, income derived from agriculture, including rental income from agricultural land, is tax-exempt. Additionally, a reduced sales tax is applied to tractors and a broad range of agricultural equipment at 5% and 2% on fertilizers, which is significantly lower than the standard 17% rate. Further, concessional customs duties ranging from 0% to 5% are applicable to imports of an extensive range of machinery for agriculture and allied sectors, as well as cool-chain machinery and related capital goods. Previously, the fiscal year 2015/16 budget had reduced customs duties on all agricultural machinery and eliminated withholding tax on such imports.
In an effort to improve the delivery of subsidies and reduce corruption, the government introduced Kisan (farmer) cards in April 2021. Through these cards, subsidies for seeds, pesticides, fertilizers, and agricultural machinery are directly transferred as cash to farmers. Beyond providing access to subsidies, these cards also facilitate easy loans for farmers and extend financial support during natural disasters.
As part of the 2021/22 budget, the government rolled out an offer for eligible farming households. Each household was provided with interest-free loans of PRs250,000 for farming activities and PRs200,000 for tractors and machinery. Despite its potential benefits, this incentive expired and was not renewed in the 2022/23 budget. Since 2014, the government has run a credit guarantee scheme to encourage financial institutions to provide loans to farmers without adequate collateral for working capital. Moreover, since 2008, a mandatory crop loan insurance scheme has been in place for five major crops, with the government partially bearing the insurance premium. In the 2019/20 budget, a new crop insurance scheme was announced.
The government has been implementing a substantial PRs309bn agriculture emergency programme since mid-2019. This initiative aims to bolster food security, agricultural productivity, and exports. As part of the programme, the government is investing in improving extension services and agricultural infrastructure, such as water conservation structures, and in distributing subsidized seeds, weedicides, and machinery. Simultaneously, the central bank continues to require banks to meet specific agricultural credit targets annually.
Real Estates
The housing sector in Pakistan has various tax exemptions and deductions, with borrowing costs for housing loans being deductible up to PRs2m or 50% of the taxpayer’s income, whichever is lower. In the 2021/22 budget, a tax exemption was broadened to include profits from any sale of property to a real-estate investment trust (REIT) until the end of June 2023. However, this replaced earlier exemptions that applied solely to sales to REITs developing residential buildings and to rental REITs. Furthermore, the 2019/20 budget removed a benefit whereby the tax on dividends from REIT schemes that develop and construct residential buildings by June 30th, 2020 was reduced by 50% for three years. REITs are not viewed as industrial establishments; hence, they are not liable to contribute to the Workers’ Welfare Fund. The 2016/17 budget made builders subject to final tax, removing an exemption for builders from the minimum tax.
Affordable housing initiatives were introduced in the 2014/15 budget through a low-cost housing guarantee scheme. Under this scheme, banks provide loans of up to PRs1m, with the government guaranteeing 40% of the portfolio amount. The scheme grants loans worth PRs20bn to low- and middle-income families. In line with this, the central bank established the Pakistan Mortgage Refinance Corporation in 2016. In 2019, the government launched the Naya Pakistan housing scheme for the construction of 5 million low-cost houses over five years. Under this scheme, banks can fund houses costing up to PRs10m, providing loans of up to 90% of the cost. An interest rate subsidy for loans under this scheme was added in October 2020, and a Credit Guarantee Trust was established in December 2020 to provide a risk cover of up to 40% to primary mortgage financiers for low-cost housing.
The government responded to the Covid-19 pandemic in 2020 by announcing a stimulus package for the construction sector. This package offers the option to pay reduced taxes on projects completed by the end of September 2023. It also provides a 90% income tax reduction on the incomes and profits of approved low-cost housing projects, and in March 2021, the government specified that this would apply to projects starting before June 30th, 2024. In a permanent change, the government granted industry status to the sector in May 2020, making it eligible for additional benefits. The State Bank of Pakistan made it mandatory in July 2020 for banks to ensure that loans to construction activities account for at least 5% of their private-sector portfolios by the end of 2021. Furthermore, in April 2021, it set monthly targets for banks for housing loans and in July, announced penalties for shortfalls.
Information Technology
The 2021/22 budget in Pakistan introduced a significant incentive for the Information Technology sector: a 100% tax credit on income derived from the export of computer software or IT services until the end of June 2025. However, this benefit was contingent on the fulfillment of specific conditions. Interestingly, this tax credit was removed in the 2022/23 budget, which also lessened the final tax from 1% to 0.25% on all proceeds from the export of IT and IT-enabled services. However, a 100% tax credit incentive remains for technology start-ups for three years. Additionally, the authorities allow an enhanced depreciation of 30% (where normal rates range from 5-20%) for computer hardware and similar items.
Changes have also been made to customs duty over time. Initially, the 2006/07 budget eliminated the 5% customs duty on computer hardware and parts. However, this levy was subsequently reinstated and modified several times, with a 3% rate applied from 2021/22 onwards. Additionally, the 2006/07 budget revoked the sales-tax exemption on IT hardware, but later budgets brought back exemptions on certain items. For example, the 2016/17 budget exempted sales tax on imports of personal computers and laptops, while the 2018/19 budget exempted 21 parts for their assembly and manufacture if imported by certified manufacturers and assemblers. Software continues to enjoy exemption from sales tax. Furthermore, IT companies are permitted to open foreign-exchange accounts in Pakistan, named special exporter foreign-currency accounts, which can be fed by up to 35% of their export earnings for business payments abroad. Lastly, the 2021/22 budget reduced the withholding tax on telecoms services from 8% to 3%.
Energy
The oil sector in Pakistan saw several tax changes in March 2021. The government abolished a tax exemption that applied to the profits of petroleum companies engaged in refining business up to 10% of the refining business’s capital. Additionally, the five-year tax exemption granted to liquefied natural gas terminal operators and owners from the commencement date of their commercial operations was terminated. Furthermore, the government modified a 20-year tax exemption (introduced by the 2018/19 budget) so it would now apply to profits of a refinery established before December 31st, 2021, with a minimum production capacity of 100,000 barrels per day. However, this benefit was removed from existing deep conversion refineries that enhanced production capacity by at least 100,000 b/d. Instead, a new ten-year tax exemption was extended to existing deep conversion refineries that commit, before December 2021, to upgrade, modernize, or expand. Both exemptions were specified to apply only to refineries whose products meet Euro 5 standards. As per the 2019/20 budget, all petroleum imports by oil marketing companies are exempt from the 3% value-added tax (VAT).
As for the power sector, profits from new electric power generation projects that are at least 50% privately owned and established after July 1st, 1988, enjoy tax exemption. However, the 2021/22 budget curtailed this exemption, limiting it to those projects that had signed their agreements before June 30th, 2021. The 2015/16 budget granted a ten-year tax exemption to profits from transmission line projects established during the three years leading up to mid-2018, provided they were not created by splitting or reconstructing existing units and were at least 50% privately owned. This exemption was extended until 2022 in March 2021. Moreover, the 2018/19 budget stipulated that dividends from transmission line projects would be exempt from withholding requirements.
Textile
In the fiscal year of 2020/21, the government abolished customs duties on 316 textile-related commodities and regulatory duties on another 164 items to stimulate textile exports. A drawback scheme, initially due to expire in June 2021, was extended until June 2026, and the drawback rates were enhanced from a range of 2-4% to 2-5%. There is an extra 2% drawback granted for exports to non-traditional markets including countries in Africa, Latin America, non-European Union European countries, Commonwealth nations, and those in Oceania. Half of the drawback rate is available unconditionally, while to be eligible for the remaining 50%, the exporter must demonstrate a 10% increase in exports in the relevant financial year compared to the preceding year. There’s an exemption from sales tax for raw cotton. However, the 2019/20 budget annulled an exemption for ginned cotton, thereby imposing a 10% rate on it.
Export Incentives & Zones
The State Bank of Pakistan implemented a scheme in 2001 whereby companies showing at least a 10% annual growth in exports can retain up to 50% of the additional export proceeds in foreign currency accounts. Also, service exporters can retain 35% of their net foreign-exchange earnings in such accounts in Pakistan, to be utilized solely for specified business expenses abroad. This list of expenses was broadened in February 2021.
The budget for fiscal year 2021/22 lowered the tax rate to 10% from the previous 12% on the retail sales of textile and leather goods. The other three main categories of exports from Pakistan – carpets, sports goods, and surgical goods – are subject to a standard 17% rate.
Numerous export development initiatives and programs are accessible to exporters in Pakistan. These were initially announced in annual trade policies, but since 2013, the government shifted to a three-year Strategic Trade Policy Framework. The latest Strategic Trade Policy Framework 2020–25, unveiled in late 2021, calls for policy support for 18 priority sectors, including traditional exports and several developmental sectors.
In August 2021, a new Export Facilitation Scheme 2021 (EFS) was made effective by the government. The programme aims to subsume and replace existing export schemes, which will be phased out over two years. During this transition period, exporters can choose between the new and old schemes. The EFS is open to several types of exporters, fulfilling certain conditions.
The EFS is set to replace the four main existing schemes available to exporters. One of these is a scheme providing duty drawbacks of local taxes and levies to non-textile sectors, which expired in June 2021. An identical scheme applies to the textile sector, and it was extended up to June 2026, with the drawback rates increased from 2–4% to 2–5%.
Pakistan houses several industrial clusters of small and medium-sized businesses operating in similar industries. As of the end of September 2022, there were seven functioning export-processing zones (EPZs) in Pakistan. In March 2021, the government abolished the tax exemption on capital gains earned by units in these export-processing zones.
The Gwadar port has been designated as a free-trade zone by the government, so imports here are free of customs duties, sales taxes, and other levies. In 2019, two ordinances were passed to clarify these benefits and provide exemptions from income tax, sales tax, and customs duties to the Gwadar port and free zone until 2039.
Special economic zones (SEZs) are being developed by the government, conceived as large areas with special incentives for businesses. The Special Economic Zones Act of 2012 gives legal backing to the SEZ provisions, allowing the establishment of SEZs anywhere in the country. Developers receive various benefits, including tax holidays.
As of the end of September 2022, several SEZs were being planned or were under development, with participation from companies from China, South Korea, Turkey, and the UK. These included nine SEZs that are part of the China-Pakistan Economic Corridor. However, a relatively low-skilled labour force, high energy costs, and a poor overall business environment are expected to limit the level of investment in these zones, at least until 2026.
Special technology zones (STZs) are another category of zones the government is working on, in partnership with private companies. Two such zones, Technopolis in Lahore and Pakistan Digital STZ in Haripur, have already commenced operations.
In December 2020, the government issued the Special Technology Zones Authority Ordinance, and the State Bank of Pakistan issued special foreign-exchange regulations for entities that will operate in the zones. In January 2021, the government established the Special Technology Zones Authority (STZA) to develop these STZs.
The government envisages that these STZs will provide special incentives to attract investors, builders, and technology companies and will provide one-window facilitation to local and international companies. The 2021/22 budget has announced several of these incentives, such as ten-year tax exemptions for developers and enterprises in the zones, tax exemptions on capital goods imports, and exemptions on the dividend income of private funds from investments in such enterprises.
