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
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).
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
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.