Budget 2010 proves to be a mixed bag for the IT industry. From a Technology Policy stand-point, the resolve of the Government in setting up a ‘Technology Advisory Group’, to look into various technological and systemic issues for effective tax administration and financial governance (for certain unique e-governance projects, GST implementation, tax administration, etc), is very welcome.
In terms of tax proposals, the increase in the rate of MAT and the absence of an announcement on the extension of the STP and EOU tax holiday proves to be a dampener. The proposal to offer a higher weighted deduction for in-house R&D activities, would encourage investments in innovation and is laudable.
On the indirect tax front, while there is a partial roll-back of the stimulus package and a marginal increase in the duty structure, this appears to be in line with industry expectations. There is also some cheer for the export-oriented IT services / BPO industry, with the Government seeking to simplify the refund provisions / process for accumulated service tax credits.
At a tax policy level, the Finance Minister has expressed his continued commitment to introduce both the Direct Tax Code and the GST from 1 April 2011.
Overall, from a macro-economic stand-point, the Government seems to have adopted a balanced approach in this Budget, and sought to focus on growth, along with fiscal consolidation.
For the IT Industry, the absence of another tax holiday extension for STPs / EOUs may be a disappointment, this must however be viewed in the context of the Government’s stated policy of phasing out most tax incentives as part of its structural reforms agenda.
In this bulletin, we have discussed the key tax proposals / amendments that were announced by the Finance Minister in Budget 2010, which are relevant to the IT industry.
Key direct tax proposals
Tax rates
While there has been no change proposed in the corporate income-tax rate for Indian or foreign companies, the surcharge for domestic companies is proposed to be reduced to 7.5% from the existing rate of 10%.
Consequently, the effective tax rate for domestic companies would be 33.22% (after considering education cess and the proposed amendment to the surcharge).
MAT
While the industry has been demanding a rollback of the MAT levied on profits of STP and EOU units, the Finance Minister has proposed to increase the rate of MAT from the existing rate of 15% to 18% of “book profits” (plus applicable surcharge and education cess).
This amendment would result in an increased cash outflow for most IT companies currently enjoying the tax holiday under Section 10A and 10B of the Act.
Tax holiday under Section 10A and 10B
With the tax holiday for units established in STPs and EOUs expected to sunset by 31 March 2011, the industry was anticipating an announcement towards extending the tax holiday provisions beyond this date.
However, the Budget has not extended such tax holiday under Section 10A and 10B of the Act beyond 31 March 2011.
Tax holiday for SEZs
In the Finance Act 2009, the Finance Minister had rectified the anomaly in the formula for computing the deduction under Section 10AA of the Act (which is applicable to SEZ units), to provide for full deduction in respect of the export profits of the SEZ unit. This amendment was made in the Finance Act 2009 with effect from 1 April 2009. There however continued to be ambiguity on the computation mechanism, for the prior years (ie prior to 1 April 2009).
It has now been clarified that the revised formula for computation of SEZ unit profits, would be applicable with retrospective effect from 1 April 2006.
Investments in R&D
The weighted deduction under section 35(2AB) of the Act, in respect of expenditure incurred on approved in-house R&D, is proposed to be increased to 200%, from the existing 150%.
This would provide added incentives for companies to maintain investments in innovation and is also expected to add impetus to further R&D activity.
Income of a non resident deemed to accrue or arise in India
The Explanation to clause (v) and clause (vi) of Section 9(1) of the Act is proposed to be amended to clarify that income would be deemed to accrue or arise in India irrespective of whether the nonresident rendering services has a place of residence or business / business connection in India or the services are rendered by the non-resident in India.
This amendment comes on the back of certain judicial precedents which have held that income would be taxable in India in the hands of the nonresident service provider only in the event where such non-resident renders the services in India.
Consequent to this amendment, foreign companies rendering technical services from their respective offshore locations, to Indian companies, would not be able to argue that their income from rendering such services is not taxable under the provisions of Section 9(1)(vii) of the Act since the services are rendered from outside India.
However, the above amendment should not impact the taxability of such non-resident companies in India under the provisions of the applicable Double Taxation Avoidance Agreement.
Safe Harbour rules
In the Finance Act 2009, the Finance Minister had announced that Safe Harbour rules would be introduced under the transfer pricing regulations, to provide for circumstances in which the income-tax authorities would accept the transfer price declared by the taxpayer on cross border transactions between associated enterprises.
The IT industry was hoping that such Safe Harbour rules laying down these thresholds, or an announcement to such effect, would form part of the Budget.
However, the Government has not introduced any such proposals / rules under this Budget.
Key Indirect tax proposals
Tax rates
In the run up to the Budget, there were expectations of a gradual rollback of some of the measures undertaken as part of the past economic stimulus policy. In line with these expectations, the Finance Minister has proposed an increase in the peak rate of excise duty by 2% (ie from 8% to 10%). However, the merit rates of customs duty and service tax remain unchanged.
This increase in the rate of excise duty has resulted in a corresponding increase in import duty (in lieu of CVD). As a result of such increase in CVD, the duty rate on import of software has now increased from 8% to 10%, thus, bringing this on par with service tax applicable on e-downloads. This amendment will result in additional cash outflows to importers of software.
We have summarised below some of the other key indirect tax proposals / amendments that were announced by the Finance Minister in the Budget.
- The Budget has provided a boost to the Indian gaming industry by providing an exemption from the whole of customs duty to gaming software used in gaming consoles, not meant for retail sale.
- The excise duty / CVD exemption in relation to “transfer of right to use” canned or packaged software, has been extended to all “transfer of right to use” including transactions where such right to use is not for commercial exploitation. This is subject to the condition that the person providing such right to use shall be registered under the service tax laws. This amendment, covering duty exemption on canned / packaged software, will be beneficial to end-users of such software.
- The Budget has also exempted packaged or canned software intended for single use, from service tax, where the manufacturer, duplicator, importer or person holding copyright to software, has paid appropriate excise duty or customs duty on entire amount received from the buyer. This would eliminate dual levy of excise duty / customs duty and service tax on such software related transactions.
- The scope of ITSS has now been expanded to cover software services provided for other than business purpose. This would result in additional service tax burden on consumers who avail such services for internal consumption / other non-commercial purposes / activities, such as, educational institutions, charitable organisations, etc (and not necessarily in the course of business for onward commercial use).
- Certain capital goods and raw materials for manufacture of electronic hardware have been exempted from all customs duties. This should provide added incentive to the IT / Electronic hardware industry.
- However, exemption from excise duty which was available to goods meant for external use with computer / laptop as a plug in device (such as, micro processors, floppy disc drive, HDD, CD-ROM Drives, flash memory, etc), has been withdrawn and an excise duty of 4% has been levied on them. This would increase the duty burden on such computer peripherals / accessories.
- All pre-packaged goods intended for retail sale and which require declaration of retail sale price, as well as mobile phones, have been exempted from SAD of 4%. This would help the trading industry in avoiding the long-drawn and cumbersome process of obtaining SAD refunds from the Government.
- There has been a retrospective withdrawal of exemption, with effect from 26 June 2009, on supply of electrical energy from SEZ5 to DTA and from a processing area of a SEZ to a non-processing area, leading to levy of customs duty of 16%.
- Accelerated depreciation rates have been prescribed for computers and computer peripherals, cleared after use, while computing the amount to be paid on removal of such goods.
- In order to facilitate the process of getting refund of input service tax, the Finance Minister has amended the Export of Service Rules, 2005, to exclude the general condition of services being ‘provided from India and used outside India’. Hitherto, the interpretation of this term by the tax authorities was an impediment for IT companies in securing the refund.
- Further, procedures have been outlined and provisions have been amended to simplify refund of service tax for exporters.
- The CST rate remains unchanged at 2%.
- The Finance Minister has expressed his continued commitment to introduce GST with effect from 1 April 2011.
