How is a software house taxed when it earns both export and local income, and how are expenses split between them?

What does the law say about each kind of income?

The Ordinance puts the two income streams of a mixed software house on separate tracks.

Local IT income. Fees from Pakistani clients for development, maintenance, hosting or support are “the profits and gains of any business” under section 18(1)(a), chargeable under the head “Income from Business”. The company computes taxable income in the usual way and applies the Division II rate. For tax year 2027 that is 29% for “any other company” and 20% for a small company, as defined in the Ordinance.

Export proceeds. When a bank realises foreign exchange proceeds for “exports of computer software or IT services or IT enabled services” by a Pakistan Software Export Board registered exporter, it deducts tax under section 154A(1)(a). Section 154A(2) makes that deduction a final tax, provided the return and any required withholding statements are filed.

Once the tax is final, section 169(2) sets the rules: the income is not chargeable under any head in computing taxable income, no deduction is allowed for expenditure incurred in deriving it, and the tax deducted is not reduced by any tax credit.

How are shared expenses split?

Most software houses have costs that serve both kinds of work: office rent, electricity, internet, admin salaries, HR, accounts, laptops. Section 67(1) covers expenditure, deductions and allowances that relate to taxable income and a class of income taxed separately or as a final tax. It says these “shall be apportioned on any reasonable basis taking account of the relative nature and size of the activities to which the amount relates”.

Rule 13 of the Income Tax Rules, 2002 sets out how:

• Direct costs (rule 13(2)): expenditure incurred for a particular class of income is allocated to that class. A developer team that works only on a foreign client’s project is an export cost. A team working only for local clients is a local cost.
• Common costs (rule 13(3)(a)): common expenditure is allocated to each class using A x B/C, where A is the expense, B is the gross receipts of that class for the tax year and C is the gross receipts and net gains of all classes. Financial expenses tied to non-business loans are left out of the pool.
• Gross receipts are taken net of sales tax, under the Explanation to rule 13.

Only the local share, direct and apportioned, is deducted in computing taxable income. The export share is simply not deductible, because the final tax already covers that income.

Worked example (illustrative figures)

A software house in Rawalpindi, a private company that is not a small company, for tax year 2027:

• Export proceeds: Rs. 80,000,000 (section 154A tax final).
• Local fees, excluding sales tax: Rs. 20,000,000.
• Direct costs of local projects: Rs. 6,000,000.
• Direct costs of export projects: Rs. 30,000,000.
• Common costs (rent, admin staff, utilities): Rs. 25,000,000.

1. C, total gross receipts: Rs. 80,000,000 + Rs. 20,000,000 = Rs. 100,000,000.
2. B, local gross receipts: Rs. 20,000,000. B/C = 20%.
3. Local share of common costs: Rs. 25,000,000 x 20% = Rs. 5,000,000.
4. Export share of common costs: Rs. 25,000,000 minus Rs. 5,000,000 = Rs. 20,000,000, not deductible.
5. Local taxable income: Rs. 20,000,000 minus Rs. 6,000,000 minus Rs. 5,000,000 = Rs. 9,000,000.
6. Tax at 29%: Rs. 9,000,000 x 29% = Rs. 2,610,000.

The Rs. 30,000,000 of direct export costs are also not deductible. The bank’s deduction on the export proceeds stays as the final tax on that income; it is not credited against the Rs. 2,610,000.

What if …?

The exporter is not registered with the Pakistan Software Export Board. Section 154A(1)(b) still covers services rendered outside Pakistan or exported from Pakistan, so a deduction is made, but at the rate for “any other case”. The companion page on export rates covers the difference.

The conditions for final tax are not met. Section 154A(3) says section 154A(2) does not apply to a person who does not fulfil the conditions, or who opts out. The export income then does not get final treatment under section 169, and the apportionment question changes because both streams would be computed as business income.

The local business makes a loss. A loss on the local side cannot be absorbed by export income, because section 169(2) keeps that income out of taxable income. Minimum tax on local turnover is covered on the minimum tax page.

Common mistakes

• Deducting the full payroll against local income. Section 169(2)(b) denies deductions for costs of final-tax income, and section 67 requires the split.
• Using headcount or a round figure instead of the rule 13 formula for common costs without a basis. Rule 13(3)(a) uses gross receipts.
• Including sales tax in the receipts figures. The Explanation to rule 13 uses receipts net of sales tax.
• Crediting export tax against local tax. Under section 154A(2) and section 169 the bank’s deduction is the final tax on the export income itself, not a payment on account of tax on local income.

What to check in the official text

Read sections 18, 67, 154A and 169 of the Ordinance as amended to 30 June 2026, and rule 13 of the Income Tax Rules, 2002 as amended to 24 November 2023. Provincial sales tax on local IT services is charged under provincial laws not covered on this site.