The information technology (IT) and information technology enabled services (ITeS) industry has performed splendidly well over the past decade.

Availability of high quality skilled labour, low cost base and increasing advantage accruing from the learning curve have been the key driving force behind this sector. In addition, the conducive tax environment in the form of tax holiday benefits given to the industry under the Software Technology Park of India (STPI) and the Ex port Oriented Unit (EOU) schemes have also acted as a catalyst to the growth.

The IT/ITeS industry today constitutes an integral part of the Indian social-economic chain. The sectors contribution to GDP has increased manifold, now contributing more than 5 per cent of the GDP. With exports of $40 billion in 2007-08, the sector accounts for one-fourth of the countrys total exports. Further, according to the Ministry of Labour and Employment, IT services account for 12 per cent of Indias total employment, thus making it the largest employer in the organised sector.

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Tax benefits

At present, units operating under STPI or EOU schemes can enjoy income-tax deductions under Sections 10A and 10B of the Income-tax Act, 1961 in respect of export profits.

These deductions initially had a sunset clause of March 31, 2009, which meant the deductions would not be available beyond March 31, 2009. Based on the concerns raised by this sector, the tax holiday was extended by another year (that is, till March 2010).

However, the provisions of Minimum Alternative Tax (MAT) currently are applicable to companies operating under the STPI/EOU regime and, accordingly, tax at 11.33 per cent of book profit is payable by such companies. The STPI and EOU schemes also provide various indirect tax benefits (that is, exemption from excise, customs, etc.) which would continue to be available even beyond 2010.

Separately, the Government also introduced the SEZ scheme, whereby the units operating out of an approved Special Economic Zone (SEZ) are eligible for a deduction under Section 10AA of the I-T Act.

The provisions of MAT currently, as applicable to STPI/ EOU units, are not applicable in respect of profits of an SEZ unit.

The underlying objective of the SEZ scheme is to promote capital formation, generate employment and promote exports.

Though the SEZ scheme has been dubbed as a substitute for the STPI/EOU schemes, there is a concern that the policies under the SEZ scheme may not suit small- and medium-sized companies in the IT/ITeS sector, primarily due to large capital outlays and also because of the absence of large-scale operations required for reaping the benefits under the SEZ scheme.

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Contribution to exchequer

As per the Finance Ministers speech in Budget 2007-08, the effective corporate tax rate in India is at 19.2 per cent.

In contrast, there has always been a perception that the IT/ITeS companies are zero tax companies, which does not appear to be correct. The IT/ITeS industry is typically paying taxes with an effective tax rate of 11-14 per cent.

Over and above this, one cannot also ignore the impact of the dividend distribution tax (DDT) of 17 per cent which is applicable on disbursements of dividends, the fringe benefit tax (FBT) paid by such service-driven companies and the contribution in the form of personal income-tax through the vast employment generated. Clearly, the industry is contributing its might to the national exchequer by paying significant taxes, a withdrawal of the tax holiday would increase the burden on such companies, especially in these challenging times.

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The challenges

The most important issue before the industry is the matter of extension of the income-tax holiday. The following challenges make out a case in favour of why the extension of the tax holiday has to be extended beyond March 31, 2010:

The outlook for the global economic condition does not appear to be very promising, and one can expect tremendous operational and financial pressure in this sector in the coming days;

The cost advantage that India offers is fast depleting, and any increase in the tax cost would certainly increase the cost of doing business in India;

Other jurisdictions, such as China, the Philippines, Malaysia, Vietnam, and Central and Eastern European countries, which are competing with India for a larger share in the global business, continue to provide incentives. Absence of fiscal support to the Indian IT/ITeS sector would put the industry on the back-foot;

The personnel cost as a percentage of revenue in IT/ITeS companies is approximately 50 per cent compared to other industry average of 10 per cent. This clearly demonstrates the tremendous amount of employment that this industry generates. Withdrawal of the income-tax holiday could have an impact on the recruitment and compensation levels.

Considering the overall economic scenario, one cannot also lose sight of the disposable income generated by the IT/ITeS industry, which acts as a stimulant for other consumer-led sectors.

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An impetus at this juncture in the form of extension of the tax holiday under Sections 10A/10B would certainly go a long way in propelling the growth of the industry.

There is a clear expectation that a package would be introduced in the Interim Budget which will help the country to maintain the edge created by this sector and not let go the dominance created by India in the global market.