What Businesses Qualify as Start-ups?

In Pakistan’s economy, both startups and Small and Medium Enterprises (SMEs) are recognized as vital engines for innovation, job creation, and overall economic progress.

Defining the “Startup”Â

Pakistan’s definition of a “startup,” found in clause 2(62A), carves out two distinct pathways for businesses to attain this classification. This framework is designed to capture technology-driven innovation and foster entrepreneurial growth.

Two Avenues to Startup Status:

• Technology-Driven Resident Entity: This is the primary route, focusing on innovation and technological advancement.
  • Eligibility: Open to resident individuals, Associations of Persons (AOPs), or companies established on or after July 1st, 2012. This emphasizes relatively newer ventures.
  • Focus: Businesses must be actively engaged in, or demonstrably intending to offer, technology-driven products or services. This broad scope spans across all economic sectors, acknowledging technology’s pervasive impact.
  • Certification & Registration: Crucially, these entities must undergo a formal registration and certification process managed by the Pakistan Software Export Board (PSEB). This step acts as a gatekeeper to ensure genuine technology focus.
  • Turnover Threshold: To remain classified as a startup, the entity’s annual turnover must remain below Rs. 100 million for each of the preceding five tax years. This threshold is designed to target smaller, growth-oriented businesses.
• Ministerial Discretionary Category: Recognizing the evolving nature of business and innovation, the definition includes a flexible clause.
  • Flexibility: The Federal Board, with the approval of the Federal Minister-in-charge, holds the power to designate additional categories of businesses or individuals as “startups.”
  • Notification Required: Any such expansion of the “startup” definition must be formally outlined in an official notification, ensuring transparency and clarity.

Implications and Opportunities for Startups:

Achieving “startup” status unlocks a range of potential advantages, designed to nurture nascent businesses:

• Tax Incentives: Access to potential tax exemptions or reduced tax rates on income and investments, easing the financial burden in early stages.
• Regulatory Streamlining: Simplified compliance requirements and streamlined business processes, reducing bureaucratic hurdles and allowing startups to focus on growth.
• Government Support Ecosystem: Eligibility for dedicated government funding programs, access to business infrastructure (like incubators and accelerators), and mentorship initiatives, providing crucial resources and guidance.
• Investor Attraction: The “startup” label, coupled with the clear definition, assists investors in identifying and evaluating promising investment opportunities within Pakistan’s emerging startup scene.
• Academic & Talent Synergies: Recognition of “startups” fosters collaboration with universities, encouraging talent development, knowledge transfer, and entrepreneurial spirit among younger generations.

Challenges and Considerations for the Startup Definition:

While the definition provides a valuable framework, some challenges and considerations remain:

• Verification and Misuse: Robust verification and monitoring are essential to prevent businesses from misrepresenting themselves as “startups” solely to access benefits, potentially undermining the integrity of the system.
• Transparency in Ministerial Discretion: Clear, publicly available guidelines and transparent criteria are needed for the ministerial discretionary category to ensure consistent and fair application, avoiding ambiguity and potential biases.
• Adapting to Technological Change: The rapid pace of technological evolution necessitates periodic review and potential updates to the “startup” definition to ensure it remains relevant and encompasses new business models and emerging technologies effectively.

Income Tax Benefits for SMEs

The government of Pakistan offers a number of income tax benefits for SMEs, including:

• Tax-free threshold: SMEs with an annual turnover of less than PKR 10 million are exempt from income tax.
• Lower tax rates: SMEs with an annual turnover of between PKR 10 million and PKR 250 million are subject to lower income tax rates than other businesses.
• Investment allowance: SMEs that invest in new plant and machinery are eligible for an investment allowance of 50% of the cost of the investment.
• Relief on export income: SMEs that export goods or services are eligible for a relief on export income of 10%.
• Waiver of advance tax: SMEs are not required to pay advance tax on their income.

Defining the Small and Medium Enterprise (SME) Landscape

In contrast to the future-focused definition of startups, the SME definition, as per clause 2(59A), provides a framework for understanding and supporting established smaller businesses, particularly within the manufacturing sector.

Core Criteria for SME Classification:

• Manufacturing Focus: The SME definition is explicitly limited to individuals and entities engaged in “manufacturing.” This is further defined by section 153(7)(iv) of the Income Tax Ordinance, generally encompassing the transformation of raw materials into finished goods. This focus highlights the importance of the manufacturing sector within the SME landscape.
• Business Turnover Threshold: A quantitative parameter is set: the annual business turnover must not exceed Rs. 250 million in a given tax year. This provides a clear, measurable benchmark for SME classification.
• Loss of SME Status: Crucially, the definition stipulates that exceeding the Rs. 250 million turnover threshold in any tax year permanently disqualifies an entity from SME status, not just for that year but for all subsequent years. This creates a clear demarcation and incentivizes growth within the SME bracket while acknowledging a natural progression to larger business categories.

Implications and Opportunities for SMEs:

A well-defined SME sector benefits various stakeholders:

• Targeted Government Support: The definition allows the government to effectively identify and support SMEs through tailored policies, including specific tax benefits, improved access to finance, and simplified regulatory environments, fostering their growth and contributing to a more dynamic economy.
• Financial Sector Tailoring: Financial institutions can leverage the SME definition to develop and offer customized financial products and services that better meet the unique needs and challenges of this sector, improving access to capital.
• Entrepreneurial Navigation: Aspiring and existing entrepreneurs gain clarity on legal requirements and can better understand their eligibility for SME-specific benefits and support programs, aiding in business planning and growth strategies.
• Data-Driven Policy and Research: A standardized definition enables researchers and analysts to collect more accurate data, conduct meaningful analysis of the SME sector, and inform evidence-based policy formulation for its continued development.

Challenges and Considerations for the SME Definition:

Despite its clear turnover-based approach, the SME definition also faces certain challenges:

• Subjectivity of “Manufacturing”: Reliance on a separate definition of “manufacturing” (section 153(7)(iv)) can introduce subjectivity and potential inconsistencies in interpretation and application.
• Inflation and Threshold Adjustment: The fixed Rs. 250 million turnover threshold may need periodic adjustments to account for inflation and economic growth over time to maintain its relevance and effectiveness in capturing the intended size of SMEs.
• Limited Sectoral Scope: The exclusive focus on manufacturing excludes service-based SMEs, a significant and growing segment of the economy. This raises the question of whether broader definitions are needed to encompass the full spectrum of small and medium-sized businesses, particularly in a diversifying economy.

Fostering Growth through Clear Definitions

Both the “startup” and “SME” definitions are crucial building blocks for Pakistan’s economic development strategy. The “startup” definition aims to cultivate a vibrant innovation ecosystem, while the “SME” definition provides a framework to support the backbone of the economy.