The Finance Minister (FM) presented the Union Budget 2010 in the backdrop of a resilient, yet challenging Indian environment. He had the rather onerous task of maintaining the recent growth momentum, garnering more revenues for sustainable and inclusive growth, addressing soaring inflation, and at the same time, balancing the stress on the fiscal deficit, primarily, due to the economic stimulus packages.
On the other hand, the Indian IT industry, which has continued to show resilience and demonstrated its ability to achieve sustainable growth in this challenging economic environment, was seeking continued policy and fiscal support from the Government, to enable it to cope with pricing pressures, appreciation of the Indian Rupee and also retain their competitiveness in the current economic environment.
On top of the IT industrys agenda were long pending demands, particularly around extension of the software technology park (STP) /export oriented undertaking (EOU) tax holiday beyond 31 March 2011, rollback of minimum alternate tax (MAT), dispensing with multiplicity of taxes and streamlining of tax administrative procedures, especially around service tax refunds and credits.
The key proposal / amendments of the Budget 2010 have been discussed below.
Key direct tax proposals
Corporate tax and MAT rate: While there has been no change proposed in the corporate income-tax rate for Indian or foreign companies, the surcharge for domestic companies has been proposed to be reduced to 7.5% from the existing rate of 10%.
Consequently, the effective tax rate for domestic companies has reduced marginally from 33.99 to 33.22%.
However, the FMs proposal to increase the MAT rate from 15 to 18% (plus applicable surcharge and education cess) has surprised the IT industry, which has been demanding a rollback of the MAT levied on profits of STP and EOU units.
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. Furthermore, this amendment would also increase the disparity between IT companies operating out of STP / EOU units and those operating out of special economic zones (SEZs), as units operating out of SEZs are not subject to MAT.
Tax holiday under Section 10A and 10B: With the tax holiday for units established in STPs and EOUs expected to expire by 31 March 2011, the industry was hoping for an announcement from the FM extending the tax holiday provisions beyond this date. Such an extension was especially sought by the small and medium enterprises which operate on wafer thin margins and cannot afford to set up operations in SEZs to be eligible to enjoy the tax holiday beyond 31 March 2011.
However, there was no announcement to extend the tax holiday under Section 10A and 10B of the Act beyond 31 March 2011, which would disappoint the IT industry.
Clarification on tax holiday for SEZs: The FM in the Budget had rectified the anomaly in the formula for computing the deduction under Section 10AA of the Act applicable to SEZ units to provide for full deduction in respect of the export profits of the SEZ unit. However, this amendment was made effective from 1 April 2009. Thus, there continued to be ambiguity on the computation mechanism of the tax holiday for the prior years.
The FM has now clarified in this years Budget, that the revised formula for computation of profits would be applicable with retrospective effect from 1 April 2006. This clarification should bring some relief to the IT industry, which was otherwise gearing up to face possible litigation with the tax authorities on this front.
Investments in research and development (R&D): The FM, in the Budget has reaffirmed his commitment to encourage investment in innovation. He has proposed that the weighted deduction in respect of expenditure incurred on in house R&D be increased to 200%, from the existing 150%.
This is a laudable move on the part of the Finance Minster which should provide added incentives for companies to invest in innovation and should provide a fillip to the IT industrys long standing goal to move up the value chain in the global IT products and solutions market.
Income of a non resident deemed to accrue or arise in India: The FM also proposed an amendment in the Budget to clarify that the income of a non-resident service provider would be deemed to accrue or arise in India, irrespective of whether 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 non-resident service provider only in the event where such non-resident renders the services in India.
Consequent to this amendment, foreign IT companies rendering technical services from their respective offshore location to Indian companies would not be able to argue that their income from rendering such services is not taxable under the provisions of the Indian tax law since the services are rendered from outside India.
However, the above amendment should not impact the taxability of such non-resident IT companies in India under the provisions of the applicable Double Taxation Avoidance Agreement.
Key indirect tax proposals
Tax rates: 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 peak rate of excise duty has been proposed to be increased by 2%. 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 countervailing duty of customs (CVD)]. As a result of such increase in CVD, the duty rate of import of software has now increased from 8 to 10%, bringing this on par with service tax applicable on e-downloads. This amendment will result in additional cash outflows to importers of software.
Service tax refunds: In order to facilitate the process of getting refund of input service tax, the FM has amended the Export of Service Rules, 2005, to exclude the general condition of services being provided from India and used outside India. Prior to this amendment, the interpretation of this condition by the tax authorities was a key impediment for IT companies in securing the refund.
Further, procedures have been outlined and provisions have been amended to simplify refund of service tax for exporters. Dual levy on packaged / canned software: The excise duty / CVD exemption in relation to transfer of right to use canned or packaged software has been extended to all transfer of right to use transactions, including transactions where such right to use is not for commercial exploitation. This is subject to the condition that the person providing such right to use shall be registered under the service tax laws. This amendment, covering duty exemption on canned / packaged software, will be beneficial to end users of such software.
Packaged or canned software intended for single use when the enduser license is packed together with the software, has also been exempted from service tax, where the manufacturer, duplicator, importer or person holding copyright to software, has paid appropriate excise duty or customs duty on entire amount received from the buyer. This move would help eliminate dual levy of excise duty / customs duty and service tax on such software related transactions and should bring cheer to the IT industry.
Increased duty burden on computer peripherals / accessories: Exemption from excise duty which was available to goods meant for external use with computer / laptop as a plug in device (such as, micro processors, floppy disc drive, HDD, CD ROM Drives, flash memory, etc), has been withdrawn and an excise duty of 4% has been levied on them. This would increase the duty burden on such computer peripherals / accessories.
At an overall tax policy level, the FM has also expressed his commitment to introduce the Direct Tax Code and the GST from 1 April 2011.
Budget 2010 has proven to be a mixed bag for the IT industry. While the increase in the rate of MAT and the absence of an announcement on the extension of the STP and EOU tax holiday proved to be a dampener, there was some cheer from an indirect tax standpoint with an amendment to the Export of Service Rules, to facilitate the refund process of input tax credits, exemption for certain packaged software, etc.
From a macro-economic standpoint, the FM seems to have adopted a balanced approach in this Budget to achieve focus on growth along with fiscal consolidation.
The author is senior tax professional, Ernst & Young. The views expressed in this article are personal