How does a software house split expenses, depreciation and losses between export income under final tax and local income?

What does the law say about expenses against export income?

When a software house’s export proceeds are taxed as final under section 154A(2), section 169 applies to that income. Section 169(2) says:

• (a) the income “shall not be chargeable to tax under any head of income in computing the taxable income of the person”;
• (b) no deduction is allowable for any expenditure incurred in deriving the income;
• (c) the income is not reduced by any deductible allowance under Part IX of Chapter III, or by the set off of any loss.

In plain words, the 0.25% or 1% deducted on export proceeds is the whole tax on that income. The costs of earning it cannot be used anywhere else.

How are shared costs split?

Most costs in a software house are shared: developers work on foreign and local projects, and the office, laptops and software licences serve both. Section 67(1)(ab) covers expenditure, deductions and allowances relating to the “derivation of income comprising of taxable income and any class of income to which sub-sections (4) and (5) of section 4 apply”. Section 4(4)(b) covers income on which tax deducted is a final tax. Such amounts “shall be apportioned on any reasonable basis taking account of the relative nature and size of the activities to which the amount relates”.

Section 67(2) lets the Board make rules, and rule 13 of the Income Tax Rules, 2002 does so:

• Rule 13(2): a cost incurred for a particular class of income is allocated to that class. A subcontractor hired only for a Lahore client’s project goes to local income.
• Rule 13(3)(a): common expenditure “shall be allocated to each class of income according to the following formula”: A x B / C, where A is the common expenditure, B is the gross receipts of the class, and C is the gross receipts and net gains of all classes.
• Rule 13(4): allocation must consider the nature and source of each class, on a reasonable basis, particularly for selling expenses.
• Rule 13(6): the classes include Pakistan-source and foreign-source business income, exempt income, and “amounts to which section 169 applies”.

Depreciation is a deduction, so the words “expenditures, deductions and allowances” in section 67 and rule 13 bring it into the same split.

Worked example (illustrative figures)

A software company in Lahore, PSEB-registered, tax year 2027:

• Export proceeds (final tax under section 154A): Rs. 150,000,000
• Local fees: Rs. 50,000,000
• Cost used only for a local project (subcontractor): Rs. 10,000,000
• Common costs (salaries, rent, utilities, depreciation on laptops and servers): Rs. 120,000,000

1. Direct local cost under rule 13(2): Rs. 10,000,000 to local income.
2. C = Rs. 150,000,000 + Rs. 50,000,000 = Rs. 200,000,000.
3. Local share of common costs: Rs. 120,000,000 x 50,000,000 / 200,000,000 = Rs. 30,000,000.
4. Export share: Rs. 120,000,000 x 150,000,000 / 200,000,000 = Rs. 90,000,000. Not deductible anywhere, under section 169(2)(b).
5. Local taxable income: Rs. 50,000,000 minus Rs. 10,000,000 minus Rs. 30,000,000 = Rs. 10,000,000.
6. Tax at the 29% Division II company rate: Rs. 2,900,000, against which tax deducted by local clients under section 153 is credited.

If the company had deducted all Rs. 130,000,000 of costs against local fees, it would have shown a loss of Rs. 80,000,000. That is the result section 169 and rule 13 are designed to prevent.

What if …?

Local work makes a loss after apportionment. Section 57(1) carries a business loss that cannot be set off in the year to the following tax year, and section 57(2) says “no loss can be carried forward to more than six tax years immediately succeeding the tax year for which the loss was first computed”. It cannot be set against final-tax export income because of section 169(2)(c)(ii). Minimum tax under section 113 on local turnover may still apply in a loss year.

Depreciation is unabsorbed. Section 57(4) sets the loss attributable to depreciation and amortisation against 50% of later business income, or 100% if taxable income is below Rs. 10 million. Only the local share of depreciation enters that loss.

The company opts out of final taxation. Under section 154A(3) a person can opt out each year when filing the return. Section 169 then does not apply to the export income, and it is taxed with local income under the normal rules.

Common mistakes

• Charging all salaries to local income because export income “has no expenses”. Section 169 disallows them; it does not move them.
• Using headcount or hours when the rules give a formula. Rule 13(3) sets gross receipts as the basis for common costs. Rule 13(4) allows the nature of each class to be considered, and rule 13(5) accepts a certified basis unless significant variations are found.
• Setting a local loss against export income. Section 169(2)(c)(ii) blocks it.

What to check in the official text

Read sections 67, 169 and 57 of the Ordinance amended to 30 June 2026, and rule 13 of the Income Tax Rules, 2002. The rules in this corpus are amended only to 24 November 2023, so check for later changes to rule 13. Rule 13(5) refers to a tolerance for “significant variations”, whose printed wording in the source is unclear; read it in the official PDF.