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Tax holiday and the IT sector
February, 26th 2007
The sunset of the tax holiday under Section 10A, apart from impacting the business of the STP units, might have larger economic consequences.

The Indian information technology (IT) and IT-enabled Services (ITeS) industry continues to chart a remarkable double-digit growth. Led by a string of high growth years, the industry, according to Nasscom, has set itself an ambitious target of $60 billion in exports by 2010.

The role of nearly 4,200 units registered under the Software Technology Park (STP) scheme in India's IT/ITeS growth has been substantial as they account for nearly 40 per cent of the country's share of exports.

One of the driving factors for the success of this sector is the supportive fiscal policy, which has provided a significant cost advantage on the pricing. It is in this background that a question arises as to whether the cessation of the tax holiday under Section 10A of the Income-Tax Act, 1961 after March 31, 2009, would act as a dampener to the growth of the IT/ITeS sector.

Rationale for extension

of tax holiday

The sunset of the tax holiday under Section 10A, apart from impacting the existing business of the STPI units in terms of higher pricing, might have larger economic consequences, such as shifting of outsourcing to alternative low cost jurisdictions such as Romania, the Philippines, Hungary, China, Vietnam, etc., drop in the foreign exchange reserves, and so on.

Considering the macroeconomic consequences, there have been requests from the industry to extend the tax holiday under Section 10A beyond March 31, 2009. The latest is a proposal that has come in the form of a Cabinet Note to the Finance Minister.

The other rationale for extension of the tax holiday to STP units comes in the wake of extended tax holiday benefits to the units set up in Special Economic Zones (SEZs) and STP's possible and consequent inability to compete with the SEZ units. It is argued that extension would help in providing a level-playing field, especially to the SME sector; as the SEZ primarily benefits the big players.

Migration of STP units to SEZ

One option which the STP units are considering is the possible migration to the SEZ regime. The issue has already generated a lot of debate in the industry and the different wings of the government, and the opinion is clearly divided.

Significantly, the SEZ provisions expressly facilitate migration of an existing unit from a non-SEZ area to an SEZ area. Unlike the law relating to STPI/EOUs, there are no specific provisions in the SEZ Act restricting new SEZ units from being formed by splitting up or reconstruction of existing units or with the use of second-hand plant or machinery. Hence, on a prima facie reading, it appears that there is nothing in the SEZ Act which restricts the migration aspect.

However, the provisions in the current SEZ Act (through the amendment in the SEZ Rules on August 10, 2006) have sparked off a controversy on the migration matter. Based on recent reservations expressed by the Finance Minister, particularly on the intended leakage of revenue, it is learnt from media releases that the migration of existing EOU/DTA units may not be allowed.

A comparative analysis of some of the arguments for and against the migration aspect is presented in the Table.

Way forward

It is hoped the Finance Minister would address the following issues in the 2007 Budget:

Possibility of extension of the tax holiday under Section 10A of the Act; and

Clarity on the migration of STP units to SEZ regime, which should enable the IT/ITeS industry plan their `vision beyond 2009'.

Krishnan Narayanan
Himanshu Patel

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