Pakistan is generally not considered a good business environment, but the State Bank’s February 2021 regulatory framework allows Pakistani residents and firms to make equity-based investment in entities abroad on a repatriable basis, subject to some terms and conditions. This has generated considerable chatter that things may be changing for the better.
The large sums of venture capital in seed funding acquired by a number of Pakistani startups has certainly contributed to the optimism and led to a greater public interest in how these startups are progressing, but then pivots and shutdowns also come under stricter scrutiny. Due to rampant cases of corruption at every level of governance and bureaucracy, one might carry some preconceived notions about the role and purpose of a holding company.
Interestingly, a number of startups have been launched in Pakistan, targeting Pakistanis, but are incorporated offshore… as well. This does not mean they aren’t ‘Pakistani companies.’ Firstly, because they aren’t even operational in the country they are incorporated in, and secondly they primarily operate in Pakistan. But this does raise curious eyebrows about the regulatory framework of startups and the role of offshore holding companies in it.
In an interview with Profit last month, CEO of Sadapay Brandon Timinsky confirmed that the FinTech startup is also incorporated in the UAE. He believed this is a step that helped him build greater confidence with investors abroad. Before the 2021 policy change, this was not a possibility for Pakistani residents, legally. A Pakistani tax resident could not own shares in a company outside the country without prior approval from the SBP which was a long and arduous process. At the very least, it required the investor to have incorporated the firm for quite some time which was a difficult and often impossible task for a lot of start-ups.
So what does this policy really say?
First and foremost, this policy is only applicable for the incorporation of holding companies in countries which allow repatriation of profits, dividends and capital back to Pakistan (except equity investment in India, of course) and it is only for investors and firms which have no record of being involved in a money laundering or terrorism financing investigation. The policy’s intention is to help export-oriented companies flourish.
A resident company (OpCo), is allowed to incorporate a holding company (HoldCo) abroad where an SBP assigned Designated Authorized Dealer (DAD) would allow an initial incorporation expense of under $10,000. After this, the OpCo shareholding pattern must be mapped on the HoldCo within 30 days by the founders acquiring shares in the HoldCo against transfer of shares in OpCo to the non-resident HoldCo on repatriation basis. Resident OpCo shareholders are allowed to purchase HoldCo shares by paying in PKR to OpCo and OpCo can issue an equal value of shares to the non resident HoldCo on repatriation basis.
Delivery Hero is a German multinational online food ordering company which owns Foodpanda through an arm incorporated in Singapore. This allows Foodpanda Singapore to function as a local start-up despite bringing back home profits and dividends.
Similarly this policy allows repatriation of funds from abroad through equity or borrowing in Pakistan as equity-based investment in OpCp such that 80% of the funds raised on an annual basis up to $1 million are remitted back to Pakistan. And all this is supposed to happen through DAD, which is also supposed to ensure compliance.
Mubariz Siddiqui, Founding Partner at Carbon Law wrote a comprehensive Twitter thread in December 2021 explaining the policy and how it would work. “The point of the HoldCo is to act as a vehicle of ownership for the OpCo” he wrote.
“Look at it this way, consider you are job offers from both Singapore and Congo – you are more likely to take up the job in Singapore because there is little desire to relocate to Congo. Similarly, investors are concerned with a market’s reputation, its accessibility and its assessment as a destination for investing money,” Mubariz Siddiqui spoke to Profit discussing the need for this policy.
The logic is intuitive: if a global investor wants to invest, they are most likely to consider markets they have already or regularly invested in, or jurisdictions which are particularly favorable to foreign investors.
“Investors’ desire for a HoldCo represents that Pakistan is not a favorable jurisdiction, but this would still mean that at least Pakistan has a fighting chance at raising capital abroad, which is what the parameters of this policy safeguard,” he concludes.
Why is there a demand for HoldCos to be set up abroad in the first place?
Profit spoke to lawyer Abdul Moiz Jafferi about the need for this policy.
“It is a bureaucratic nightmare to have to answer for why you want to move money abroad especially in times like this when a conman like Ishaq Dar is a judge”, said Jafferi in response to a the same question, arguing that the policy provides a much-needed reassurance to foreign investors that their capital and profits will not be subjected to the winds of local political instability.
On the other hand, he accepts there is merit to the government’s concerns too, “Now the [government] is wary because whenever you allow legitimate operations abroad, what people do is they start hoarding their profits abroad and they start under-invoicing themselves”.
Jafferi explained to Profit how profits are hidden and withheld abroad.
“They set up a company in the gulf, they take all the real orders there, and then they set up another company in the gulf and that company is not declared,” after which the company can begin to under-report their earnings, parking the additional wealth in the undeclared company abroad.’
“You will create this footprint abroad and then you start to under-invoice your own company, so if you are selling software abroad, and you got a contract for $10,000 in Dubai, instead of sending the entire $10k to your company back in Pakistan, you bill your own company a $1000, and you retain the $9k abroad,” he added.
This is the reason offshoring in this form was banned in the first place. The new policy addresses these challenges in a number of ways.
According to Jafferi, legitimate industry players argue that since the bigwigs have been investing abroad anyway, the government should create a legal framework that allows them to maximize their potential. This circular is a result of that demand.
It says that if you operate in the same sector in your country, you can invest a certain amount abroad, as long as you provide your financial statements for the last three years and meet some criteria. It also ensures that you are not just setting up a holding company abroad just to transfer money. The idea is to let people have their own presence abroad rather than relying on intermediaries. This policy is more relaxed for the IT sector, which only needs to show one year of operation, considering that startups are new companies and don’t have much history.
On the other hand, the monitoring is laid out as follows: the policy specifies what you can and can not do, and your audited accounts will reflect that. If you violate the policy, the tax authorities will detect it and charge you with money laundering, tax evasion or tax avoidance under the applicable tax laws.
Lawyer Mirza Moiz Baig told Profit that as long as structural reasons underlying the poor business environment are addressed, companies will continue to want to distance themselves from it. He opines that continuity of policy decisions is especially important, and the success of the circular will depend on the government’s ability to consistently implement it and improve upon it with time.
“There is an absolute need to ease a lot of restrictions into businesses and there is also a need for continuity of policies – you often see the govt issue an SRO and then a couple of months later the SRO is withdrawn so you need to have continuity of policy. You don’t just set up a manufacturing plant and start exporting tomorrow, first you set it up then you develop skills and expertise that will allow your products to thrive in the intl markets. So as an investor I would only invest if I know that there is going to be some continuity,” he said highlighting the importance of continuity.