Due to the current regulatory environment it is not easy for entrepreneurs to do business in Pakistan, but there is general discontent when it comes to taxation.
This has been stated in a joint report of World Bank (WB) and invest2Innovate “Pakistan Startup Ecosystem Report 2019.
Entrepreneurs In Pakistan are Discontent When it Comes to Taxation
The report stated that issues such as opening a bank account, receiving credit, paying taxes, enforcing contracts, etc. are still identified as areas that need to be refined. There is a lack of an efficient taxation process to save time and resources of entrepreneurs and investors.
Illango Patchamuthu World Bank’s Country Director for Pakistan while sharing the report on social media, tweeted, “Old & tedious procedures barred the Entrepreneur’s way in successfully Trading Across Borders – till the Reformer brought in the reforms to make this integral part of #DoingBiz a much easier, less costly & time intensive procedure!.
According to the report in 2019, the time required to start a business was reduced by three days while time required to register a property was reduced by 13 days. However, issues such as opening a bank account, receiving credit, paying taxes, enforcing contracts, etc. are still identified as areas that need to be refined.
The report maintained that another important aspect of taxation is the difference among provinces owing to federal taxes and provincial taxes. Each province has its own revenue authority that administers sales tax on services and other provincial duties. Where in reality the recent federal tax exemption for tech startups only meant exemption from taxes at the federal level, many perceived it as an all-encompassing exemption. This exemption (from paying Corporate Income Tax) still meant that startups in different provinces were paying other types of taxes such as (GST, property taxes, Provincial Sales Tax, etc.) and that also at different rates.
Additionally, startups are currently taxed on revenue rather than profits, which create a common misconception that startups do not qualify for corporate income tax because they are not profitable up until a certain point in their lifecycle.
There is a major need for the government to not only make the regulatory processes simpler but to also focus on creating a better user experience for entrepreneurs; i.e., a one window solution.
The report maintained that while Pakistan’s digital startup landscape has grown significantly in the past seven years, the ecosystem has its share of challenges, particularly when it comes to regulations, access to early stage capital, and the gender gap in the entrepreneurship space.
The current policy environment is not favorable for investors. Investors point to unfavorable policies and regulations as a major obstacle for their activities in the Pakistan startup ecosystem.
Currently there are approximately 20 formal investors in the Pakistan ecosystem and many of these funders cater to startups ranging from pre-seed to pre-Series A stages. Despite this notable increase in activity and players, there are still a number of challenges and gaps that make it difficult for early stage firms to grow and succeed in Pakistan.
Over the past five years, (2015-19), there were a total of 101 deals in Pakistan-based companies, constituting over $165 million, which was raised by 82 companies. While this is positive, Pakistan still has a long way to go compared to its neighbors in South Asia. Based on a score given to the number of venture capital deals per year in 2019, Pakistan ranked 72, which was below India, at 30, and Sri Lanka, at 45, but was higher than Bangladesh, at 73.
There are a growing number of tech hubs and labs, but there is a need for more infrastructure, as well as expansion of the innovation economy into tier 2 and tier 3 cities. Support organizations need to provide more tailored and rigorous guidance on business skills development, mentorship, access to investors, tax compliance etc. These organizations should be evaluated based on outcomes; i.e., the value created for startups, versus outputs; i.e., the number of startups graduated. There is a scarcity of resources for support organizations and a reliance on grants, which is challenging for their long-term sustainability.
While local venture capital funds are not incentivized to domicile their funds inside Pakistan, foreign investors also need to be provided with further incentives to enter and invest in startups in the country. This, in addition to the stringency and complexity of the regulatory processes, poses a serious challenge to all stakeholders in the ecosystem.
While Pakistan officially has introduced a one window facility, it can be improved and more processes can be folded into the facility to make running a business less cumbersome. Startups run by men also raise investment more often than their female counterparts, a statistic mirrored globally. Moreover, when female-led startups do raise funding, they predominantly raise angel and grant money (and little to no venture capital funding).
The report recommended that the government needs to continue to improve the business environment, such as those areas covered by Doing Business, to make doing business less cumbersome for investors and startups. Improving fund legislation and compliance, as well as registration and compliance for start-ups is key. Pakistan’s government can play a strong role in providing high-risk no-return capital to startups to reduce the pre-seed and early-stage gap and mitigate risk for investors, to help crowd in private sector investors. Support players need to customize their curriculum keeping local realities in mind and focus on industry-specific mentor matching. A one-window operation for startups to register their businesses and consolidate compliance requirements could avoid delays and additional costs
According to 2018-19 deal flow figures, of the funding raised by female-led companies, 63% was via angel investment, and 25% was from development programs (donors/grants). At the same time, of the 17 investors interviewed for this study, 75% noted there was no difference in the quality of companies led by women versus those run by men. Many, however, did note that they would like to review more deals led by women. This gap is interesting and while there may be deeper conversations around implicit and gender bias in deal sourcing, there is also a need to increase the overall funnel of women-led companies, whether by encouraging incubators and accelerators to actively seek more female founders for their programs or providing more hands-on support to women-led companies at the early-stage and improving their access to investors operating post-seed stage.
The report recommended for improving the current regulatory environment for doing business to help startups and investors alike. The government can also do more to improve the environment for local venture capital funds. It can iterate on the current Private Funds legislation to make it more flexible and cost-effective for venture capital funds to set up inside the country and run their operations more seamlessly.