The National Board of Revenue (NBR) is wiling to withdraw the tax exemption facilities currently enjoyed by the IT/ITES sector of Bangladesh. What are the advantages and disadvantages of such a sudden imposition of taxes?
Since 2011, the Information Technology (IT) and Information Technology Enabled Service (ITES) companies are enjoying tax exemption on a total of 28 categories. In other words, the non-listed companies that fail under these 28 categories do not have to pay the corporate tax rate of 30% till now.
This 13-year tax exemption for the IT/ITES industry is set to expire on June 30, 2024, which will potentially expose this emerging industry to a standstill. The National Board of Revenue (NBR), with its ambitious revenue collection target and IMF’s prescription of ending all tax exemptions, including the IT/ITES sector, needs to make a decisive call that may define the future of the startup ecosystem in Bangladesh. This article looks into how Bangladesh can build a startup friendly tax regime incorporating both business and policy perspectives to make Bangladesh one of the leading startup ecosystems in the world.
Existing Tax Regime for Startups and IT/ITES Sector
Two of the most critical and pertinent tax policies for the startups are the tax exemption for IT/ITES industry and the startup sandbox.
Transaction, Expenses and Investment over BDT 3.6 Million
Using banks or MFS in order to be considered cashless
0.6% Tax on Cash Receipts
If gross receipts exceed BDT 5 Million
At present, the corporate income tax rate for non-listed companies in Bangladesh is 30%. However, in order to promote a cashless, smart Bangladesh, the government provides a tax reduction of 2.5% to companies for being cashless. In simple terms, if companies are using banking channels and Mobile Financial Services for conducting all types of their transactions as well as their expenses and investments over BDT 3.6 million, they will be able to pay 27.5% as corporate income tax as they will receive 2.5% of tax reduction. Companies also have to pay a minimum tax of 0.6% on gross receipts from all sources if the gross receipts exceeds over BDT 5 million, irrespective of profit or loss.
However, the Government of Bangladesh with its commitment to build a ‘Digital Bangladesh’ and a subsequently new commitment to establish a ‘Smart Bangladesh’ by 2041, has offered tax exemption to IT/ITES companies to promote this industry. (Tax free Income under 6th Schedule of the Income Tax Act 2023)
Following 28 types of businesses are receiving the benefits of tax exemption:
- Software Development;
- Customization of software or application;
- Nationwide telecommunication transmission network (NTTN);
- Digital content development & management;
- Digital animation development;
- Website development;
- Website services;
- Web listing;
- IT process outsourcing;
- Website hosting;
- Digital graphics design;
- Digital data entry and processing;
- Digital data analytics;
- Geographic information service (GIS);
- IT support and maintenance services;
- Software test lab services;
- Call center service;
- Overseas medical transcription;
- Search engine optimization service,
- Document conversion, imaging and digital archiving;
- Robotics process outsourcing;
- Cyber security services;
- Cloud service;
- System integration;
- E-learning platform;
- E-book publication;
- Mobile application development service; and
- IT free launching.
In addition, to support the startups of the country, the government has developed ‘Startup Sandbox’. The special provisions given by NBR for startups provide the very first definition of startups in Bangladesh by any government body. As per the Sandbox, startup means a company with annual turnover not exceeding BDT 1 billion in any financial year. The company also-
- Have to be incorporated under Company Act 1994; and
- Works towards deployment/commercialization of new products/process or service driven by innovation, development and technology or intellectual property
For the purposes of sandbox, innovation means the process of creating value by offering novel solutions or making a significant improvement to any prevailing solution to any significant problem or a set of problems.
Also, only registration under the Company Act won’t suffice. The startup also has to register with the NBR.
The taxation policy mentions three reasons for ineligibility of registration, if the startup-
- Is incorporated prior to first day of July 2017, or
- Is incorporated between first day of July 2017 and thirtieth day of June 2023 and fails to get registration by the thirtieth day of June 2024; or
- Is incorporated on or after July 1, 2023 and fails to get registration under this section by thirtieth June of every year following the year of its incorporation.
Benefits
- If a startup gets registered in the Sandbox, they have to pay the rate of minimum tax which is 0.1%.
- Losses incurred by the business which cannot be set off in any particular year can be carried forward over 9 successive assessment years.
- No reporting obligation will be applicable except the annual return of income if the company grants permanent access to its system or books of accounts to the income tax authority.
Case for Discontinuation: Perspective of NBR
Now, we need to assess why the government or NBR is considering discontinuing the existing tax exemption for the IT/ITES industry and what are their rationale behind such a step. Broadly, 3 arguments can be made in favor of the tax exemption withdrawal.
Loss of Revenue Collection
As per NBR’s assessment, the IT/ITES sector is receiving a massive tax benefit of nearly BDT 14.77 billion per annum. According to that assessment, the profit generated by this industry should be over BDT 50 billion annually.
However, according to BASIS, the IT/ITES industry is not near to that figure of earnings. Instead, BASIS estimates that the government is losing around BDT 200-300 crore per annum due to the tax exemption.
IMF’s Prescription
The International Monetary Fund (IMF) has advised the Bangladesh government to scrap all tax exemption policies from the taxation policies to increase revenue collection. This will also include the IT/ITES industry’s tax exemption policy and if implemented, from the next fiscal year, which will start from July 2024, this industry will come under taxation.
In FY 2022-23, Bangladesh’s debt-to-GDP ratio was 39.8% which is estimated to reach 41.41% at the end of FY 2023-24. To service this debt, the government needs to increase its revenue collection, i.e. tax-to-GDP ratio which is pretty low in the status quo – around 8% (Nov 2023). IMF has prescribed to increase the country’s revenue collection significantly to service its outstanding debt.
Other Businesses Masquerading as IT/ITES Company
Since IT/ITES businesses enjoy tax exemption, many companies tried to masquerade themselves as tech companies. As the provisions do not clearly define what an IT/ITES company is, so many businesses have claimed themselves as IT/ITES company and filed tax in that category to evade paying taxes to the government. Due to such unscrupulous businesspersons, the government is losing its rightful revenue that these businesses owe to the government.
Case for Continuation: Perspective of IT/ITES Industry
The thesis of this case is the infant industry argument. The IT/ITES industry has just entered into the growth stage which can be potentially halted by the withdrawal of tax exemption. Following are the four large adverse effects that could be caused in an absence of tax exemption in this sector.
Access to Finance
Raising funding or investment as a company is an herculean task, especially when investments are not large in supply. During a company’s lifecycle, from pre-seed or idea stage, when the founders just have an idea, doing market research and other things to start something to Initial Public Offering (IPO), or even after IPO, companies need investment. There are two ways founders fund their companies, either through equity or debt financing, or a combination of both.
26% decrease in startup funding worldwide
Last quarter of 2023
70% decrease in startup funding in Bangladesh
Quarter-on-quarter
Large Fixed Asset Collateral
Required for Bank loans
Why is funding critical to consider for IT/ITES companies, especially in the context of Bangladesh? For 2 key reasons:
- Venture Capital (VC) funding has significantly plummeted over the years both globally and locally. Globally, startup funding has dropped around 26% from the first quarter of 2023 to the last quarter of 2023. As per the Bangladesh Startup Investment Report 2024 by LightCastle Partners, Bangladesh’s startup ecosystem witnessed a 70% quarter-on-quarter fall in investment. Thus, it’s a huge challenge for the IT/ITES companies of Bangladesh to attract more investment, especially foreign capital.
- When the option of equity financing is shrinking, the only way left for companies to raise capital is leverage or debt, borrowing money from financial institutions like banks. However, the current lending policies of banks are not favorable for businesses, those which do not have huge assets. Banks lend money based on the fixed asset based collateral. In the case of IT companies, their softwares, intellectual properties, and manpower are the largest asset classes on which banks simply are not interested in providing loans. This means debt financing is not a viable option for IT/ITES companies.
This is really important because when there is a crunch in funds, the only way companies can survive and expand their business is through reinvesting their profit in the company. Profits have become a last resort for a lot of tech startups in Bangladesh due to a lack of access to finance.
When the NBR will start taxing the IT/ITES companies, these companies will have to share a part of their profits as corporate taxes are paid on the company’s profits (after deducting expenses from revenue). This means these companies will have less money from their earnings to reinvest into their business which may potentially halt not only the growth of some companies but also put their existence at risk.
Access to Finance
Foreign Direct Investment has started to flow in this infant sector in the past couple of years. A lot of foreign investors are positioning themselves in Bangladesh’s IT/ITES sector for the long run. Due to the government’s existing policy support, including the tax exemption, this infant industry is just making itself globally competitive. At this critical phase of Bangladesh’s IT/ITES sector’s life cycle, a sudden tax burden may discourage FDI. Foreign investors who were incentivized to earn more by investing in the IT/ITES industry of Bangladesh due to tax exemption, will perceive that their earnings from Bangladesh will be significantly lower.
More importantly, when IT/ITES startups will ask for a competitive valuation of their company while raising investments, some investors may ask for more equity for less investment, resulting in a drop of company’s valuation. Because the long term Return on Investment (ROI) for the investors will be lower. Investors will perceive that if they have to pay tax from the profits, they better ask for more equity, which will coerce founders to dilute more, resulting in losing attractiveness of local IT/ITES startups.
Adverse Impacts on the Macro Economy
IT/ITES industry has created massive employment in Bangladesh. As a nation that suffers from the plague of brain drain, the IT/ITES industry has attracted so many local talents to stay in the country and build something greater than themselves for their nation. Some businesses may experience closure due to the tax burden which will create unemployment. High tax burden will deincentivize entrepreneurs to enter the industry which will potentially halt new job creation. Some founders will be more likely to register their company offshore in Singapore, or any other country, which is in fact becoming a trend among Bangladeshi entrepreneurs. Also, adding to the wounds – the increased risk of tax evasion.
Why is this important? Even though the IT/ITES industry is not paying the corporate tax of 27.5%, they are still paying VAT, some companies are sharing revenue with the government, and all of them are indirectly facilitating personal income tax earnings for the government. For a tech company, usually capital expenditure remains very low, especially when they are building softwares or developing a website. However, for IT/ITES companies attracting the best employees is pivotal as these employees will build the products or offerings of the company. Thus, hiring cost and salaries remain one of the largest expenditures for these companies.
The government is receiving personal income tax in the form of Tax Deducted at Source (TDS) from these employees who are able to pay these income tax because of the employment created by these companies in the first place. Every time the company pays salaries to its employees through formal channels like a bank, a part of the salary directly goes to the government as TDS. Moreover, this same employee performs consumption in the country – buys products, eats in restaurants etc. where they have to pay VAT to the government. Therefore, the IT/ITES is indirectly contributing to the national revenue earnings. But when this industry will shrink, the government will lose these revenue that were indirectly generated by this sector due to employment creation. In addition, amidst the dollar crisis in Bangladesh, these companies earn huge amounts of foreign currency for the nation which could be disrupted.
Another key aspect of the IT/ITES industry in relation to the local context of the Bangladeshi market is the industry’s constant fight against a heavily informal market. The major competition of IT/ITES or any other tech company in Bangladesh is the informal local players who do not pay tax. The IT/ITES companies are helping the government by formalizing many informal markets, which in turn increases traceability of NBR. These taxes would have otherwise disappeared in the informal market which now are going to the NBR in the form of TDS, VAT, etc.
Potential Loss of Competitiveness of Local Companies
Due to the tax exemption, the local IT/ITES companies can offer their products, services or offerings at a much lower price than other foreign companies to both local and foreign customers in both B2B and B2C segments. The tax imposition will coerce some of the companies to increase the prices of their offerings, which will reduce the attractiveness and competitiveness of Bangladeshi companies.
A tax exemption withdrawal not only increases tax expenses but also compliance costs. The companies will have to maintain compliance of tax which requires huge administrative costs. And sometimes the compliance costs can be higher than the actual tax liability.
The rising tax and compliance cost in absence of tax exemption will have a multiplier effect on the macro economy. Foreign companies will more likely to offer a relatively lower price, then, as local Bangladeshi companies may have lost their cost advantage. The increasing cost of doing business due to the tax exemption withdrawal will make Bangladeshi companies suffer in the face of fierce global competition. Also, Bangladesh will be more reliant on foreign IT/ITES companies who will have massive data that may potentially raise security concerns for the country in the long run.
Has our IT/ITES Industry Become Adult Enough? Can We Reach a Middle Ground?
The Government of Bangladesh’s vision of Digital Bangladesh and subsequently Smart Bangladesh, with a set of favorable policies massively contributed in building the IT/ITES sector from the scratch and accelerating this industry’s growth. The policy of tax exemption for the IT/ITES industry is one such favorable policy that resulted in a drive of entrepreneurship in this sector.
The Awami League government’s one of the top political commitments is to build a Smart Bangladesh enabled by technology. This means the ruling government has political will to build an IT/ITES industry friendly tax regime as demonstrated by past efforts and policies undertaken by the government such as tax exemption, hi-tech parks and so on.
The real question we need to ask by deviating from the infant-industry is whether the IT/ITES industry has become “adult” enough to withdraw tax exemption. The IT/ITES sector has just started to take off. According to BASIS, if the information technology sector is brought under tax, it will not even be 1% of the total revenue income of NBR. At this stage, it is not right to threaten a potential sector only for this small income of the government.
Following are the recommendations that can be considered while navigating this debacle:
- There is a large disconnect between the IT/ITES industry and the regulatory authorities. Both the regulators and the trade associations like BASIS should play a proactive role in bridging the industry-government gap. The representatives from the authorities should actively participate in talks, discussions, seminars where industry leaders, representatives and associations are involved to understand the struggles and needs of the industry. Regular communication with the industry stakeholder can create an enabling environment not just for the IT/ITES industry but for any industry in Bangladesh.
- Without prior announcement, such a change should not be implemented. Because when you announce it beforehand, it allows the companies to prepare beforehand and plan ahead to take necessary steps to adjust with the new tax regime. Leaving companies unprepared jeopardizes their business operations.
- ICT Trade Bodies and Entrepreneurs are urging the government to extend the tax exemption till June 2031. The NBR needs to carefully assess the needs of the industry while keeping their overall fiscal policy in mind.
- A detailed discussion can be done about building a startup friendly tax regime or fiscal policy in Bangladesh addressing the existing bottlenecks. However, it is critical to note that companies, at present, are not enjoying the startup sandbox as they are not registered with NBR. Separate cells or units should be formed for startups at NBR which will also reduce the hassle of startups by addressing bureaucratic red tapism and inefficiencies in the system.
About the Author
Shah Adaan Uzzaman is the Blog Administrator at The Confluence. A former Bangladesh Television Debate Champion and winner of several policy & debate competitions, he is currently a student of IBA, University of Dhaka.