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IT-ITeS industry: Rising gap between policy and implementation
December, 22nd 2011

The information technology-information technology-enabled services (IT-ITeS) industry is worried. Not just by the unfolding financial crisis and economic slowdown in the West, but also by the rising gap between policy and its implementation, between intent and bureaucratic interpretation.

There is a perception in industry that revenue targets are chased and demands made even when eventual legal reversal is certain. Meanwhile, business growth is hobbled. New business models and new technology are sought to be understood through the prism of the old world. At some level, there seems to be lack of understanding of how the IT sector operates.

Issues about onsite services, transfer pricing, service-tax refunds, denial of legitimate tax benefits and exemption/refund to SEZ units have become major frustrations for the industry. If an Indian company or the Indian arm of an MNC is contracted to work for a foreign customer/partner, then it has to deliver part of the work onsite at customer premises overseas. In recent years, revenue authorities have begun to deny tax exemption to IT companies in respect of onsite services treating this as 'manpower services'. When it is a part of customer engagement, such services do not qualify as 'manpower services' just because they are charged by the effort. It is time that we stop disparaging India's success - which is far beyond labour arbitrage and involves deep skills, unique processes and value creation.

A large number of global companies undertake servicing, back-office work and product development through their own captive centres in India. Similarly, Indian companies, too, have subsidiary operations overseas and use transfer price mechanism for cross-border invoicing. Transfer pricing issues are well-known but international practices and standards have evolved to meet the needs of a rapidly-globalising and interconnected world.

These can be suitably customised and adapted to serve the national interests without discouraging and frustrating firms that choose to locate their activity in India. Possible instruments include 'safe harbour' provisions and advance pricing agreements. Unfortunately, as yet we do not make use of these mechanisms, nor has the Dispute Resolution Process been effective.

Indian tax rates are lower than those of major developed nations that receive services from India, so there is no incentive to understate income from Indian operations. The India advantage of value and process maturity is leading to sophisticated analytical work, product development being carried out by MNCs through their subsidiaries.

This is important for India for two reasons: to move up the value chain and, more importantly, build an R&D culture in the country. A Nasscom survey has highlighted that more than 50% of product entrepreneurs in the country have worked in the R&D labs of these global organisations. In such centres, the business risk is entirely borne by the parents who typically also hold the intellectual property. Any attempt to attribute part of the global profit of the parent to the assigned R&D effort has no economic basis.

While India is today the leading global sourcing destination, many other countries are emulating the Indian model and building a strong incentive framework for attracting global investment. Tax sops, training grants, access to domestic contracts, subsidised infrastructure - the list creates a very strong 'pull' in an era of cost cuts. The Philippines already claims that it is the global leader in the call-centre business; the R&D investments in China exceed those of India.

Our nation cannot tolerate a fundamental mistrust between business and government that is seen by some as shaping the current issues! Consistent with international practice, export of goods and services from India also are relieved wholly from the burden of domestic indirect taxes. Accordingly, exporters of IT services have sought legitimate refund of the service tax paid on input services. But unfortunately, the refund claims are rejected repeatedly.

One of the major incentives in SEZs was that of incometax exemption on profits from exports. But what the government gave with one hand, it seeks to take away from the other. And that was imposition of minimum alternate tax (MAT), which has virtually made the SEZ scheme dysfunctional particularly for the small enterprises that are already cashstrapped.

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