Two things which have been making news recently and are projected to have grave implications for the Indian IT industry are the proposed extension of MAT to the hitherto tax- free Special Economic Zones (SEZs), and the expiry of the Software Technology Parks of India (STPI) scheme in March 2011.
The concern about both is that they will increase the tax burden on the IT companies across the board, irrespective of size, location or turnover. The truth is that there is more to these measures than meets the eye and a deeper study shows that the situation is not as dire as is being made out to be.
Lets take the MAT increase under the DTC (Direct Tax Code) regime first. It is not the increase in the tax itself, which actually comes to less than a percentage point, which is worrying. Most IT companies, including those operating in Software Technology Parks, already pay this tax. The real cause of worry is that firstly, it it is planned to be extended to the SEZs, and secondly, tax benefits will change from being profit-linked to investment-linked.
“For SEZ, the tax benefit is for a period of 15 years,” says Raju Bhatnagar, VP, Government Relations and BPO, NASSCOM. “this is structured as a 100% tax benefit available only for the first five years, 50% tax benefit for the next five years, and the last five years has a tax benefit of 50%, provided the profits are invested in certain pre-determined avenues. So after the tax holiday is there from lets say 2006-10, you get 50% tax holiday, on the remaining 50% you have to pay full tax.
For an organisation that is halfway in the SEZ benefits, they are paying normal tax. So the normal tax paid versus the computed MAT, whichever is higher is what would be applied.” Thus the MAT increase may not impact too much after the first 5 years of tax benefit is availed.
So the real challenge seems to be the change from profit-linked to investment-linked approach to tax benefits, as the latter approach would benefit sectors with large capital investments. “If there is a tax benefit that is being allowed, let us say for the SEZ, and MAT is levied, upto two-thirds of the tax benefit gets nullified,” says Bhatnagar.
But this may not impact the big players like Infosys and TCS significantly, who have multiple units in various stages of operation in SEZs, besides subsidiaries operating outside India. “There are several non-financial charges that they are able to take credit of which are allowed as per the Income Tax law,” he says. “Besides, they have subsidiaries operating in foreign countries. So they pay tax in those countries for which they are eligible to claim credit in India. So when you talk of the effective rate of tax for a company which is a conglomerate, it is not simple, there are multiple aspects that come into play.”
Where does that leave smaller companies? “So far as those companies which are not in SEZs are concerned, they will have to in any case pay under normal income tax, and not get incentive deduction. So they will not be affected by MAT,” says Sunil Shah, a partner at Deloitte Haskins & Sells.
Thus the proposed extension of MAT to SEZs doesn’t imply an uniform increase in taxes at one go, but a phased increase according to the age of each unit of a company.
Regarding the other major concern about the expiry of the STPI exemptions in March 2011, firstly, it is the benefit provided by Section 10A of the income-tax law (100 per cent deduction for 10 years of export profits derived by units set up in any STPI, which is in accordance with the scheme notified by the Central Government) alone that is coming to an end. “Under the STPI scheme there are multiple benefits that are available, like the income tax benefit, bonded delivery center, duty free imports from within India, etc. Of these benefits, one which is the income tax benefit will expire. The rest remain open-ended, they don’t have a sunset date,” says Bhatnagar.
Besides, its end does not come as a surprise for the industry. It was known from the inception of this scheme that this particular benefit has a ten-year horizon, which was later extended to 12.
Calling for extension of benefits is not wrong. But believing that the Indian IT industry’s USP is solely the tax sops and incentives offered by the government is.”Our tax liability will go up to 25% next fiscal from around 21% in the present fiscal on account of this,” V Balakrishnan, CFO, Infosys told Financial Express regarding the end of the STPI tax benefit. But a company of Infosys’ size and spread- across services, industry verticals and geographies- can surely absorb the increase in tax outflow. After all, it was none other than Infosys’ Founder-Chairman Narayan Murthy who said that “Asking for tax exemption for 10s of years in my opinion is not the smartest thing” and believes that IT and software sector should and are capable of paying taxes just like other industry sectors.
Alternatively, they can shift operations to their delivery centers outside India. That is one advantage the services sector enjoys. “In services you can, pretty much at the drop of a hat, pick up your service delivery center and shift it,” says Bhatnagar.
Admittedly, this can work both ways, and drive away foreign companies with Indian subsidiaries to countries offering more tax benefits. But what needs to be kept in mind is that the Indian IT industry took the world by storm on the basis of its strong skill sets, talent pool and innovativeness and not solely low costs. The former, combined with India’s rising status as an IT market, continue to propel India’s IT story.
With the partial loss of their protective cocoon, companies will have to increase efficiency and become more competitive to retain customers. Smaller companies today already understand that going niche is the way forward. Companies which are good at what they are doing, especially if its specialized services, will always be in demand even if they chose to marginally increase their prices.
In short, the industry need not hassle itself over measures which will, at best, cause a marginal increase in their tax outflow. While they will, in the short term, hit the “Infosys’ and TCSs of the future which are still in the process of growing”, as Bhatnagar puts it, expecting extension of exemptions endlessly is unrealistic. In an industry where low cost is fast ceasing to be the deal clincher, all providers will eventually have to depend on the efficiency and quality of their work to survive. The sooner the Indian industry admits and adapts to this, the better.