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Double taxation a headache for Indias product startups
January, 23rd 2015

India's software product startups plan to approach the finance ministry this week to get the ambiguity cleared in this Union Budget on the pending issue of whether software sold in the country should be classified as a product or service.

Tax officials have been levying both value-added tax and service tax on sales of software products in the country, a move that's prompting many companies to shift their registered offices overseas.

"Today, anything intangible is classified as a service for the purpose of levying a direct or indirect tax. Software products, while intangible, are not a service. Unless direct and indirect tax laws are urgently upgraded, we will not be able to build a product industry in India," said Sharad Sharma, cofounder of iSpirt, a software product think-tank.

Largest product startups from India such as Druva, AdNear, Freshdesk, In-Mobi have shifted their domicile outside the country. According to iSpirt, India's software product industry can gross $100 billion in revenues by 2025 if favourable laws are in place. Currently, the industry is just 2% of India's total Indian IT industry, which is expected to gross $118 billion this year.

"As we are investing in cloud-based software products, our biggest nightmare is an unfavourable tax regime that creates barrier for small-sized channel partners, mostly owing to service tax compliance," said Shoaib Ahmed, president of the largest accounting software maker Tally Solutions.

Government officials levy a 12.36% service tax on income of most product software, coupled with a 4-5% VAT, depending on the state. This double taxation, however, doesn't apply to MNC companies which often sell to consumers online.

A senior official with the department of revenue, ministry of finance, whom ET spoke to said the government is looking into the matter. "There are several of legal cases going on in this matter. If a software is sold in a CD, it will be counted as a product, but if it's downloaded, there is an ambiguity which is left to the discretion of the tax inspectors," he admitted. "Charging VAT and service tax penalises us as well as the other startups which form the bulk of our customers," said Jo Pattabiraman, senior V-P, marketing, at Gurgaon-based cloud telephony provider Knowlarity Communications.

Pune-based Quick Heal, which supplies its India made anti-virus software product to Africa, the Middle East and Japan, is also struggling with the tax rules. "Indian market has adopted our product against global brands, but our struggle here comes from the complex tax law that is detrimental to software product companies," said Rajesh Ghonasgi, CFO - Quick Heal.

Since a number of software products come with an annual maintenance package, a few officials have also advised the industry to break up invoices into two parts — mentioning the price attributable to the product versus the service.

iSpirt also claimed that despite the ambiguity, large MNC product and IT services companies have not taken it up seriously as they are able to fight this in the tribunal and get taxes reversed. "They can live with the ambiguity. It helps them keep the domestic players at bay. Tell me one software product startup that can afford to go to the tribunal?" asked Sharma of iSpirt.

India's apex software association Nasscom, which has large IT companies such as Microsoft, Infosys and TCS as members, said the demand to remove ambiguity is priority for the association this year. Historically, packaged software was treated as product and customised one was treated as services. "But with the lines burring (with cloud-based customisable software), we have had a whole range of issues and a lot of companies are facing tax issues for many years now. We are engaged with the government to get it resolved within or outside the Budget," said Sangeeta Gupta, Nasscom's senior vice-president.

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