Friday, June 19, 2009

WHAT IT & ITES SECTOR EXPECTS FROM THE BUDGET

Sudhir Kapadia & Chetan Mehta
The Economic Times

In the run up to Budget 2009, expectations from the Information Technology ('IT') and IT enabled Services ('ITeS') sector are running really high. For a sector, which contributes nearly 6 percent to the national GDP and employs 2.2 million people directly and 8 million indirectly, the sector is currently facing many challenges, given the current global slowdown. The sector is also seen loosing its advantage as a cost–effective outsourcing destination to new emerging countries like Philippines and Japan. Further, the recent protectionist policies of the new US administration have also made the outsourcing industry apprehensive.

Existing themes continue to dominate the sector wish list, which are discussed hereunder:

Continuance of tax holiday for the units in Software Technology Parks (‘STP’) beyond 2010 is the key concern area for the industry, particularly for SMEs, which are already operating under thin margins and cannot afford to set up units in Special Economic Zone (‘SEZ’). The industry wishes that the disparity of treatment between the STPI and the SEZ units is removed and the tax holiday is extended beyond 2010 and preferably brought in line with the SEZ scheme.

STP units no longer enjoy a pure tax-free status, since, they are also subject to minimum alternate tax (MAT) of 11.33 percent on their book profits. As the levy of MAT contradicts the original legislative intent of providing a tax-free status to the industry, it should be rolled back. This would also ensure parity between STP and SEZ scheme.

The SEZ exemption is available only to new units set up in a SEZ and there are no income tax benefits for relocating an existing unit in SEZ. This is causing enormous challenges in situations where companies have set up multiple units in SEZs in an anticipation of expansion of business, but, are now faced with under utilization of these units. Also, the law in its current form reduces the tax exemption to SEZ units as the formula for calculating benefits considers the proportion of the SEZ turnover to the entity turnover. While, the Finance Minister has indicated removing the anomaly, a clarification / amendment in the coming budget would put to rest this controversy.

Conflicting interpretations are already emerging due to the recent changes on the service tax benefit to SEZs (including units) which grants an exemption to services ‘consumed wholly within the SEZ’ and a refund on other services. The SEZs are classifying more and more services as being eligible for the exemption, while, the service providers to SEZs are seeking to levy service tax on most services. The Government should consider doing away with this dichotomy by granting a straight exemption to all services.

Further, there are multiple issues associated with existing tax holiday provisions which needs clarity like set up issues, continuance of tax holiday on corporate reorganizations through slump sale, availability of tax holiday to transferor company in the year of amalgamation / demerger, eligibility of specific types of activities and income, etc. These provisions need urgent rationalization.

In the last couple of years, the captive service providers have been faced with increased litigation on the transfer pricing front. The Revenue authorities have been contending that these companies should earn margins in the range of 25-30 percent on operating costs. This has resulted in significant transfer pricing adjustments for these companies. Moreover, under the law, additions made to income on account of transfer pricing do not qualify for tax holiday benefit.

The sector, which is supposed to enjoy a tax free status, today wishes to have certainty about it’s tax cost. In order to remove uncertainty in the approach adopted by the Revenue authorities, ‘safe harbour’ provisions should be introduced for ensuring certainty, avoiding controversies and litigations. The Government should also consider introducing advance pricing agreements (APAs) as part of its transfer pricing provisions.

Since it’s introduction, the Fringe Benefit Tax (‘FBT’), has always been a subject matter of criticism by the industry. The IT sector, in particular has been up in arms against the levy of this tax, especially on ESOP and travel costs. This is the opportune time for the Finance Minister to take the bold step of abolishing this tax, which would help improve the competitiveness of the Indian IT companies in the global market.

Even with most of the IT and ITES services being covered within the purview of the service tax since 2008, service exporters have not seen much respite on the refund of service tax promised by the Ministry of Finance. The Government would need to consider streamlining the administrative process around efficient delivery of the refunds to exporters.

Currently, the licensing of IT software for commercial use (packaged and customized) is potentially being burdened with both VAT and service tax. Since these taxes are not fungible, the potential dual coverage of such transactions is substantially increasing costs and causing unwarranted litigation. The Government should define software in a way that clearly distinguishes between software as services and software as goods.

Thus, the sector is hoping for much needed tax holiday reliefs, clarity in interpretation of contentious issues, streamlining of tax administrative procedures especially in the area of tax refunds justly belonging to the tax payer and certainty of quantum of taxation applicable to the sector.

(The authors are senior tax professionals with Ernst & Young, India)

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