Compliantly Engage Contractors in Pakistan

Any business hiring in Pakistan should understand the important legal distinction between who classifies as an independent contractor and who can be hired as an employee. Fines or penalties may be issued to businesses that are hiring independent contractors under the guise of employment. 

Understanding the distinctions between employees and independent contractors is critical to compliantly engaging workers in Pakistan. It is important to work with a partner like Worksuite to ensure you put in place an engagement framework that accurately classifies freelancers as independent contractors for you and lets you know when freelance talent must be engaged as an independent contractor or employed directly.

This is critical to compliantly engaging workers in Pakistan and thereby avoiding severe legal, financial, and other penalties. 

Self-employment is high in Pakistan, with a large proportion of the population increasingly using digital tools and online freelance platforms to find work. The World Bank estimates that 56% of Pakistan’s population are  self-employed (as of 2019). However, compared to many other countries, Pakistan’s employment laws (including case law and precedent) remain under-developed regarding employment classifications. 

Pakistan doesn’t legally distinguish between an “independent contractor” and  an “employee”, although it does differentiate between an “employee” and a “workman”. According to the ​​West Pakistan Industrial and Commercial Employment (Standing Orders) Ordinance of 1968, a workman is “any person employed in any industrial or commercial establishment to do any skilled or unskilled, manual or clerical work for hire or reward”. That said, employment classifications are often fluid.

Nevertheless, if the real substance of the company-contractor relationship proves to effectively be an employment relationship, the hiring company may suffer legal and financial penalties. It is especially important to leverage an employment service partner like Worksuite when hiring in Pakistan in order to ensure that independent contractors fall under the correct working relationship with your business.

Who is an independent contractor?

As explained above, the legal framework around the classification of independent contractors is under-developed in Pakistan. However, an individual is more likely to be considered a contractor than an employee if they:

• Are subject to relatively little control by the hiring company, which means they are free to decide when, where, and how they complete their tasks.
• Do not work on, or influence, the company’s core business operations.
• Provide their own equipment, rather than receive it from the hiring company.
• Are not integrated into the hiring company’s organizational structure.
• Are able to choose the location from which they work.
• Are paid for a specific project or task rather than on a recurring basis.
• Are not listed on the hiring company’s normal payroll.

There are three main categories under which independent contractors are likely to operate in Pakistan: 

• Self-employed freelancer:This is the most common category for independent contractors in Pakistan. Self-employed freelancers must file their own tax returns and pay their own taxes and social security contributions. However, as of early 2022, self-employed freelancers working in IT can register for a 0% tax rate via the Pakistan Software Export Board (PESB).
• Limited company: Contractors can set up a limited liability company (LLC), including a Public Limited Company (PLC) or a Private Limited Company (Ltd.). These companies can be registered via the Security and Exchange Commission of Pakistan (SECP).
• Non-LLC company: Contractors can also run their own Sole Proprietorship business or Partnership business. These non-LLC companies must be registered with provincial authorities in Sindh province or Punjab province. To set up a non-LLC company, the owner(s) must register for a National Tax Number (NTN) certificate with the Federal Revenue Board (FRB).

There are two main types of contracting models for working with independent contractors in Pakistan.

A. Direct engagement of the contractor as self-employed or registered via their own company. Under this model, the hiring company engages directly with the independent contractor – either as an individual sole trader or as a limited company (see above) – and establishes a direct contract for the provision of services. The hiring company then pays the independent contractor directly, in accordance with the terms of the contract.

B. Third party. These firms come in two forms and both are specially designed to vet and engage freelancers compliantly as either contract employees or independent contractors on your behalf.

1. Temp agency: Here, the hiring company engages with a staffing agency, which in turn supplies one of its own independent contractors to deliver the contracted services. The hiring company pays the staffing agency directly, in accordance with the terms of the contract. The contract is, therefore, between the hiring company and the staffing agency, while the agency pays the independent contractor through a separate contractual arrangement.
2. Umbrella company: Independent contractors can also work through an umbrella company. This turns a ‘self-employed’ individual into a legal ‘employee’ of the umbrella company itself. The contractual relationship is between the umbrella company and the client, with the umbrella company running payroll and administration for the independent contractor. The umbrella company invoices the client directly, while paying the contractor via PAYE as a standard employee. Umbrella companies levy a fee on the contractor to cover their costs.
3. Hiring partner: The hiring company can also work with a hiring partner who helps them vet potential independent contractors, set up contracts, ensure the contractor is properly classified, onboard and manage contractors, and make payments to them.

Companies hiring independent contractors in Pakistan should avoid making payments directly through their payroll system. Beyond these guidelines, there are no specific legal requirements related to paying contractors in Pakistan. The contract should stipulate the preferred payment method agreed upon by both parties.

The tax year in Pakistan is 1 July to 30 June. Pakistan has a progressive tax rate which includes a lump sum plus a percentage for each tax band, and employees are taxed at source. All individuals – including those taxed at source – are required to submit tax returns if their salary exceeds PKR 400,000, although in early 2022 the government announced a 0% tax rate for self-employed freelancers working in IT.

Independent contractors must file and pay their own income taxes or must pay business taxes if they run a registered company (LLC or non-LLC). Companies must typically file their business taxes by 31 December for the previous year and are required to pay advance tax in quarterly installments. 

Employers with more than five employees must make social security contributions to their employees’ Old-Age Pension. Other social security benefits include: Survivors’ Pension, Invalidity Pension, and Old-Age Grant, each of which has its own criteria and requirements. Companies with an income of more than PKR 500,000 must also pay 2% to Pakistan’s Workers Welfare Fund.