Budget 2011-12 : No cheer for IT Sector

By S Sivakumar, CA

THE Budget 2011-12 comes as a major dampener for the IT sector, which, as we know, is largely export centric.

There is a huge disappointment in terms of the tax holiday provisions covered under Sections 10A and 10B of the Income tax Act, not getting extended to FY 2011-12. There was a wide expectation that the FM would oblige this highly promising sector (perhaps the only sector in which Indian can hope to be a global player) by granting one final extension of the tax holiday. The FM has surely disappointed the IT sector. Of course, the FM did not give the tax holiday extension in last year's Budget also. It was actually left to the Commerce Minister to subsequently announce the tax holiday extension for FY 2010-11. One hopes that the Commerce Minister would do a repeat act, this time also. Of course, there are no proposals for tax holiday for the STP units under the Direct Taxes Code Bill, which is all set to become law from April 1, 2012 and hence, even if there is an extension of the tax holiday, it would, perhaps, for the last time. But, still, the IT sector would feel happy to have this last extension of the tax holiday.

The next disappointment in terms of direct taxes, comes to the big guys in the IT sector, who have set up units in Special Economic Zones. As we know, the SEZ units are currently exempted from the levy of Minimum Alternate Tax (‘MAT') and Dividend Distribution Tax (‘DDT'). Sub-Section (6) of Section 115JB of the Income tax Act, 1961, had exempted SEZ Developers and SEZ Units from the operation of the Minimum Alternate Tax (‘MAT') Scheme. In a very major setback, this Sub Section is being amended to remove the exemption given to SEZ Developers and SEZ Units. Consequently, SEZ Units would now be required to pay MAT @ 18.5%, with effect from April 1, 2011. Further, in terms of an amendment to Section 115-0 of the Income tax Act, the exemption given to the SEZ Units in respect of Dividend Distribution Tax (‘DDT') is proposed to be withdrawn with effect from June 1, 2011. The withdrawal of exemption in respect of MAT and DDT comes as a major disappointment for SEZ Units in general and the IT-SEZ Units, in particular. IT centric cities like Bangalore, where a lot of investment is going into creation of IT-SEZs, could get affected in a significant manner.

With the withdrawal of the tax holiday benefit for the 100% Export Oriented Units including the STP Units, it was expected that the Budget would facilitate the migration of the STP Units to the SEZ scheme, by withdrawing the statutory provisions in Section 10AA of the Income tax Act, which disallow the tax holiday for units which are set up due to re-structuring, etc. While these provisions continue to exist, making the process of conversion of existing STP Units into SEZ Units extremely unattractive from the tax holiday point of view, the withdrawal of the exemption given to SEZ Units, in respect of MAT and DDT, could well kill the SEZ scheme and the biggest sufferer would be the big boys of the IT industry.

The Direct Taxes Code Bill has proposed that, SEZ Units set up till March 31, 2014, would be entitled for the tax holiday. However, with the withdrawal of the exemption from MAT and DDT and with the MAT rate also steadily increasing (the MAT rate has gone up to 18.5% in this Budget), the tax holiday for the SEZ Units might mean little.

A relatively smaller dampener for the IT sector is the increase in the MAT rate from 18% to 18.5%. This might not affect the STP units, as they would, in any case, have normal tax.

Another major expectation in terms of the service tax refunds has been belied by the FM. It's an open secret that the Departmental Officers have not been granting refunds to the exporters, despite that several circulars and notifications have been issued by the Government in the past. Of course, in Para 84 of his Speech, the FM makes an open admission that, “there have been considerable difficulties in the sanction of refundsrelating to tax paid on services used for export of goods”. What he has now proposed is to introduce a scheme for the refund of these taxes on the lines of drawback ofduties in a far more simplified and expeditious manner. He has also proposed to introduce a new scheme by which units in SEZs will be able to obtain tax-free receipt ofservices wholly consumed within the zone and get their refunds in a much easier. One would have wait to see for the contents of the new scheme, which the FM, assures would sanction the refunds in a ‘far more simplified and expeditious manner'. It is, of course, anybody's guess as to how the Department would actually implement the new scheme and if the past experience is any indication, issues concerning refunds are unlikely to abate.

There are several amendments to the cenvat credit scheme, which should bother the IT sector, especially in the context of the fact that, services meant primarily for the personal use or consumption of the employees would no longer be considered as an ‘input service'. It is well known that the IT sector incurs huge expenditures on its employees and cenvat credit in claimed, in respect of the service tax paid on these services, on the basis that these input services are ‘activities relating to the business'. Most of this credit would now be disallowed, due to the statutory amendment to the Cenvat Credit Rules, 2004 and the IT sector, which spends a lot on its employees, would be badly hit. There have been other significant changes related to cenvat credit rules, which would affect industry in general, including the IT sector. The other changes in the service tax law, including the significantly increased penalties for late filing of ST-3 returns and the increase in the interest rate from 13% to 18% for delayed payment of service tax, would affect IT units also.

In a welcome move, in terms of Notification No. 17/2011, the SEZ Units, importing taxable services which are wholly consumed within the SEZ would be exempted from the payment of service tax, under Section 66A of the Finance Act, 1994, under the “Reverse Charge” mechanism. However, if these imported services are not ‘wholly consumed' within the SEZ, the SEZ Units can go in a refund of the service tax paid on the reverse charge mechanism. In another welcome move, the Government has now clarified that, all services received by an SEZ unit which does not have domestic sales/DTA operations, would constitute “wholly consumed” services.

In a quiet move having manifold ramifications, the Government has proposed to amend Section 65(105)(zzzq) of the Finance Act, 1994, significantly expanding the scope of ‘Business Support Services'. IT Sector, which is known to outsource many of its functions might see most of its service providers, getting covered under the expanded definition of ‘Business Support Services'. To this extent, this might result in IT Units paying out more service tax on their input services and consequently, having claims with increased service tax refunds.

The IT sector would have expected the FM to use the Budget to drive some clarity in respect of the levy of central indirect taxes on Information Technology Software Services. This has not happened which means that the utter lack of clarity in respect of whether service tax is to be levied or central excise duty is to be charged, on packaged software licenses, continues to haunt the IT sector.

The Budget 2011-12 surely seems to be a major dampener for the IT sector, to reiterate.

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