FEBRUARY 26, 2010

IT Sector expectations from FM today

By S Sivakumar, CA

INDIA's export-centric IT industry has been the jewel in the crown of India's economic progress in the last few years. India's dominance as a global services provider is so well acknowledged that, even President Obama, of late, seems to have developed some sort of a jealousy at India's progress. In recent weeks, he has been repeatedly referring to China as the manufacturing superpower and India as, of course, the superpower in global services. In a recent address, he has threatened to penalize the US MNCs which have set up offices and software development centres back in India, on a reasoning, which seems to be largely incorrect.

Be that as it may… it's Budget time and it is but natural that the IT industry has its own wish list.

1. The most important expectation from the IT sector, relates, of course, to the extension of the tax holiday under Sections 10A and 10B of the Income tax Act, 1961, which is set to expire as of March 31, 2011. As is known, the Direct Tax Code (‘DTC') which is set to get introduced with effect from April 1, 2011, in its present draft form, does not talk of a tax holiday. One of the main reasons behind the success of India's IT's sector over the years has indeed been the tax holiday which has enabled the IT Companies especially in the SME segment, plough back their earnings and fund their growth, especially given the fact that the banks have been loath to funding IT companies. It's true that, while most large Indian IT Companies and MNCs have already moved into the SEZs or have set up or are in the process of setting up their own SEZs, the situation looks quite bleak for the IT companies in the SME segment. Of course, the Government has been obliging the IT sector by giving tax holiday extensions in the Budgets, but this time around, one would expect the FM to take a view, on a longer horizon. I would suggest that the FM gives one final extension say of say, five years, to the tax holiday scheme so that the smaller companies operating as STP Units can better plan their future operations. Should there the announcement of another extension of the tax holiday under Sections 10A and 10B, one would also expect the 10 year period covering the tax holiday under these Sections, to be extended to 15 years.

The extension of the tax holiday would also help the IT companies to move to the Tier 2 and Tier 3 cities/towns. Given the fact that much of this sector is concentrated on the Tier 1 cities, the Government must look at extending the tax holiday in order to ensure that the benefits arising out of the tremendous growth of this sector is also extended to the Tier 2 and Tier 3 cities/towns, as a tool for balanced economic development.

Should the FM decide not to oblige the IT sector by extending the tax holiday beyond March 31, 2011, he would, at least, need to facilitate the migration of IT Companies from the STPI scheme to the SEZ scheme, which many of us expect to survive under the DTC. Due to an amendment to Section 10AA of the Income tax Act introduced by the Finance Act of 2007-08, in terms of introduction of Sub-section (4), the tax exemption for SEZ Units is available only if the SEZ Unit is not formed by the splitting up, or the reconstruction, of a business already in existence. For claiming tax holiday under Section 10AA, the SEZ Unit should not have been formed by the transfer of 80% or more of the machinery or plant previously used for any purpose, for availing of tax holiday under Section 10AA. This provision, which could work well for manufacturing companies, could create a lot of trouble for existing IT companies getting into or setting up, SEZs. The concept of plant and machinery which is very relevant for manufacturing companies is largely irrelevant for IT companies. One would expect the FM to exempt IT SEZs from the mischief created by Sub-section (4) of Section 10AA, which would allow existing STP Units to shift to SEZs as when the tax holiday for STP Units gets withdrawn. This would also help in the creation of IT specific SEZs and also would also ensure that the SEZ scheme, as a concept, remains relevant even under the DTC.

There has a considerable amount of confusion, in terms of the time limit for realizing export proceeds, from the point of availment of the exemption under Section 10A and Section 10B by the STP Units. Though under the FEMA, a one year period is given the STP Units to bring in the foreign exchange from the date of the export, the Income tax Department is still going by the provisions of Sub Section (3) of Section 10A which states that the exemption is available only if the sale proceeds of the computer software exported out of India are received in, or brought into, India by the assessee in convertible foreign exchange, within a period of six months from the end of the previous year or, within such further period as the competent authority may allow in this behalf. The Income tax Department is interpreting Section 10(3) in a rather restrictive manner and is rejecting the exemption benefits in cases where the export proceeds are received beyond September 30 of the subsequent year, though, the proceeds might still have come within the one year period prescribed under FEMA. There is a need for the FM to intervene to ensure that Sections 10A and 10B are amended with the substitution of the one year period, for the present six month period.

The software sector has been subject to double taxation, in terms of levy of VAT by the State Governments and service tax by the Central Government, on the transfer/sale of software licenses, which are treated as ‘goods' under the VAT and central excise law. Notwithstanding the confusion on the levy of service tax on software licenses effective May 18, 2008, the Government, it would seem, has further complicated matters by issuing Notification No. 22/2009-CE dated dated July 7, 2009, as per which, an exemption was given in respect of central excise duty / CVD levy on Packaged/Canned software to the extent of value / consideration paid or payable for the right to use such packaged/canned software, provided the software was transferred for commercial exploitation. How can the levy of a tax on the service provider/manufacturer be made dependent on the ‘commercial exploitation' of the service receiver/purchaser, is anybody's guess. The FM would need to completely re-visit the definition of ‘Information Technology Software Service' contained in Section 65(105)(zzzze) of the Finance Act, 1994, by removing the sub-clause (vi) which deals providing the right to use information technology software supplied electronically.

The IT sector has also been suffering heavily due the whimsical interpretation of the transfer pricing provisions by the Income tax Department, especially, over the last two or three years. Most of the Indian affiliates of MNCs have been asked to pay income tax on reworked profits worked by the Transfer Pricing Officers, under Section 92C of the Income tax Act. It could never have been the intention of the Parliament to have the Government collect tax from the STP units, on the incremental profits as worked out by the Transfer Pricing Officers, as these are also profits attributable to the STP Units. This unfortunate situation, which has arisen due to a few judicial decisions would need to be set right by the FM by amending the Income tax Act to provide that, in respect of companies claiming exemption under Sections 10A and 10B, no tax would still be required to paid on the incremental profits arising out of the transfer pricing regulations.

And, lastly, the IT sector needs some support from the FM to handle the situation arising out of the significant appreciation of the rupee, over the last few weeks. At around Rs 46- to the USD, most small and medium IT exporters are already feeling the pinch.

Before concluding........

The IT sector represents the only global industry in which India can hope to play a leader's role, a fact, repeatedly stressed by President Obama. The Government would do well to realize that the IT sector has not grown because of the Government, but, despite it. The IT sector is at cross roads now, given the globally depressed conditions, the appreciating rupee and, of course, the new tax measures being implemented by President Obama and needs a helping hand from the FM.

Irrespective of whether the FM extends the tax holiday beyond March 31, 2011 or not, one would expect some clarity come out this Budget so that, IT companies can have one full year to plan out their tax strategies.

So, it's up to you, Mr FM Sir.

(The Author is Director, S3 Solutions Pvt Ltd, Bangalore)