Spotlight
Budget 2011
Great Expectations
While nothing would be more welcome than long term clarity and stability on the government’s policies, the immediate concerns on direct and indirect taxes remain
O
ver the last 2 decades, India’s information technology industry has grown in leaps and bounds, propelling the economy forward and contributing substantially to its GDP, urban employment, and exports. After the challenges faced by the industry in 2010, the Indian IT industry is poised to have a promising outlook for 2011. The growth and maturity of the domestic market, rollout of the ambitious Unique Identification Number (UID) project and the assurances provided by President Obama during his visit to India have all given a fillip to the sentiments of the industry players. However, the exposure of the industry to the uncertain global economic scenario, ever rising inflation, stiff competition from the low cost jurisdictions such as Philippines, Japan, etc, and uncertainty in government policies are acting as dampeners to this sentiment. While nothing would be more welcome than long term clarity and stability on the policies intended by the government for the industry, the immediate concerns on the direct and indirect tax front remains largely similar to what the industry has been long faced with for last couple of years. With the tax holiday for Software Technology Parks (STP) slated to expire on March 31, 2011, the industry players are in a dilemma as regards their future expansion plans. The expiry of the tax holiday benefit for the STP unit has put the small and medi-
um players at a disadvantage as compared to the larger players who have set up operations in Special Economic Zones (SEZs) and would continue to enjoy a tax holiday for a comparatively longer period. In spite of several recommendations being made on withdrawal of levy of MAT on the units located in STP, Budget 2010 surprised industry players by increasing the levy of MAT from 15% to 18% on book profits (with effect from financial year 2010-11). This has further increased the disparity of tax treatment of units operating in STPs vis-a-vis units operating in SEZs. The abolition of MAT on book profits of units operating in a STP would certainly be a welcome step. Thus, the plea of the small and medium sized players in the industry is the extension of the STP tax holi-
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day scheme by at least another year till March 31, 2012. The DTC which calls for investment linked, rather than profit linked allowances is expected to be in effect from April 1, 2012. The taxability of payments made for purchase/licensing of software continues to be a vexed issue for the industry players. Litigation on the taxability of software payments has become a common point for industry players due to different interpretations given by the tribunals regarding the taxability of software purchase/ licensing transactions. As the stakes are high, the industry would like to get clarification on whether payments made for the use of ‘off-the-shelf’ or ‘shrink-wrapped’ software would be taxable as ‘royalty’ or not. Since the last few years, captive IT service providers of MNCs have been facing increased litigation on the February 15, 2011 | 27
Spotlight transfer pricing front. The revenue authorities have been making transfer pricing adjustment on the ground that these companies should earn margins in the range of 25-30% on operating costs. The FM did make an effort to implement certain positive measures such as the introduction of the assessee friendly provisions, ie ‘safe harbor’ and ‘Dispute Resolution Panel’ (DRP) as announced by the FM in budget 2009. The industry awaits the definition and implementation of the safe harbor rules which provide that the taxpayers meeting the safe harbor thresholds laid down in these provisions would not be subject to transfer pricing scrutiny. An early clarity on the safe harbor would certainly be welcomed by the industry. The introduction of the DRP to fast track and resolve transfer pricing litigation also does not appear to have met its objectives, although we have only seen 1 year of the DRP’s functioning. On the indirect tax front, the comprehensive coverage of the industry, chiefly through service tax and stateVAT has led to several conflicts, ambiguities and concerns which have caused complex challenges in operating businesses efficiently and tax administration and compliance. Some of the key indirect tax challenges and conflicts are disclosed below. The industry undertakes distribution of standard software through a licensing arrangement with distributors and customers. Recently, the central government provided some relief from the ‘dual-tax’ levy of service tax and central excise duty on distribution of standard software through an exemption notification dated December 21, 2010. Principally, the notification permits exemption from service tax in cases where the importer/distributor of software pays customs duty or excise duty on the maximum retail price of such shrink wrapped software products. While the intention was to pre-
vent such dual-tax levies, the central government would need to address the inherent ambiguities of providing such exemption from service tax on software distribution. Service exporters in India are entitled a refund of input tax credits (CENVAT credits) relatable to the services exported outside India. While the intention is clearly stated through provisions made in the rules and through notifications, several IT players are suffering in the uncertainty caused due to delays and denials of CENVAT credits and/or export refunds by revenue authorities. Units and developers of SEZs in India have been promised direct and indirect tax exemptions, including ex-
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With the tax holiday for Software Technology Parks (STP) slated to expire on March 31, 2011, the industry players are in a dilemma as regards their future expansion plans emption from service tax. However, the service tax exemption notification requires input services for SEZ units to be ‘consumed within the SEZ’ in order to claim such exemption. Alternatively, the input service provider may charge service tax on the SEZ units, who need to claim a refund from the revenue authorities. This leads to interpretation conflicts as to what constitutes a service ‘consumed within an SEZ’. Further, any service vendor claiming such exemption are restricted from utilizing CENVAT credits proportionate to services provided to SEZ Units. It may be more prudent for the central government to equate supplies to SEZ as akin to exports outside India either through ‘zero rating’ the services to SEZ units or by considering such services as ‘deemed exports’. The Indian constitution permits state governments to levy taxes on
sale of goods (including deemed sale such as transfer of right to use goods) and the central government to levy taxes on services. In this regard, the Supreme Court held standard or packaged software to be ‘goods’ since it displays the essential characteristics of movable property, intrinsic value, marketability, etc. Accordingly, state governments have always levied stateVAT on sale of standard software, including licensing of software products. From May 2008 onwards, the central government, through the service tax legislation, has introduced service tax on IT software services, encompassing licensing of standard software as a taxable service. This led to conflicts between the industry and revenue authorities as both the center and state authorities attempted to recover service tax and state-VAT from the same transaction. Recent judicial precedents and amendments (such as the Madras High Court ruling for Infosys, amendments in the Karnataka stateVAT law, etc) have further expanded the debate as to whether service tax or state-VAT is applicable on customized software transactions. As a result of such center state conflicts, effective indirect tax burden on software has gone as high as 14-15% in recent years, which was never the intention. It was expected that introduction of Goods and Services Tax (GST) in India would minimize conflicts between center and state levies and address many of the above concerns. We remain hopeful that GST implementation would occur as soon as possible, given the disparities and avoidable conflicts in the present indirect tax structure. The industry really hopes that the FM would give them their due consideration this time around and foster their growth by facilitating long term planning. —Ravi Mahajan The author is tax partner, technology practice, Ernst & Young and views expressed here are personal maildqindia@cybermedia.co.in