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Fiscal incentives for IT/ITes players need clear direction
May, 07th 2008

Finally the debate on Finance Bill 2008 is getting over

Last week, the lower house of Parliament passed the Finance Bill 2008 soon after the Finance Minister moved additional fiscal proposals to contain inflation.  

Among fiscal proposals announced before the Finance Bill was acceded by the house, the Finance Minister in his speech replying on the parliamentary debate proposed to extend the sunset clause for tax holidays to STPI units by one year up to March 31, 2010.

As noted from the speech, the extension of sunset clause was apparently made in the context to twin objectives phasing out tax incentives is in accordance with the report on implementation of Fiscal responsibility; however the report recommends tax holidays should be grandfathered. Secondly, parking any decision until next Union Budget would lead to uncertainty as the 2009 Budget may not be presented until after the next general elections.

Whatever be the rationale for one year extension, the proposal would be braced with open arms by IT and ITeS players who until the announcement were sitting on perch struggling with their strategies. What puzzles me is the direction with which the fiscal incentives in general, and tax holiday provisions in particular, are being implemented year-on-year basis. A closer insight suggests that the policy makers are being short sighted in their approach towards achieving economic growth potential and unleashing potential of this budging industry.

Fiscal incentives and growth imperatives

The government's philosophy of phasing out exemptions and tax incentives finds its roots in the Kelkar Task Force recommendations, however what is critical is the approach with which the phasing out of the fiscal incentives is being implemented.

An unplanned phase-out could leave the tax holiday aspirants on tenterhooks when it comes to charting out their future growth trajectory. I am afraid that transient tax holiday reprieve for STPI units may fail to yield the desired impetus for economic growth as it is unlikely to facilitate the growth planning exercise. The reason being lack of clear sense of direction on where are we moving with the policy for fiscal incentives to encourage growth.

Are we consistent in our approach?

Tax holiday for STPI units may just be an example of inconsistency in our tax policy. In 2007 Budget, the Finance Minster withdrew Minimum Alternate Tax (MAT) exemption for STPI units by providing that STPI units would be required to pay MAT enduring the tax holiday period.

Though, thankfully no such policy re-jigging has been introduced for SEZ units /developers, the risk prevails as to what happens if the legislature decides in its wisdom to rip SEZ units /developer of MAT exemption by amending the provisions of the IT Act and the SEZ law. Recent debate amongst members of the PM Economic advisory council and ongoing difference of views between Commerce and Finance suggests that the debate is far from over.

The 2007 Budget extended tax holiday for industrial units set up in Jammu & Kashmir until 2012; however, no such benefit was extended to units set up in other backward states including North Eastern states. Though, the proposal was widely touted as politically sensitive, fundamentally, it highlights the skewness in the fiscal policy framework.

Do tax collection trends justify a relook at incentives policy

Coming back to the government's philosophy of phasing out all fiscal concessions and exemptions partially to achieve Fiscal responsibility targets for budgetary deficits, it is worthwhile looking at recent statistics which don't seem to support rational for a complete phase out.

Statistics reveal that tax-to-GDP ratio has been consistently rising for the last three years, largely owing to efficiency in tax administration and enhanced voluntary compliance. Historical inadequacy of direct tax collections have been a bane to India's progress on public Finance.

However, we have come a long way from a dismal figure of 19 per cent in 90-91 to over 50 per cent share of direct tax collections. Also, a major chunk of the fiscal deficit still comprise of government subsidies for food and oil. Such statistics may be worth looking at to justify a case for prolonged tax incentives to sunrise industries.

Even otherwise, given the wide coverage of Indirect tax on IT and ITeS, a case could be made out to shift focus to indirect tax system. Levy of service tax on customised software coupled with state governments desire to levy VAT on sales should adequately reflect the tax contribution made to the IT & ITES industry. The voluntary tax compliance for the industry is relatively high and delinquency is low. In addition, employment generation is contributing to the overall direct tax collection by way of enhanced personal tax.

In conclusion, there is a strong case for a stable and consistent policy with clear direction for dealing with fiscal concessions and incentives. Any untoward or rushed clamp down or curtailment on fiscal concessions may see negative ripple effects on this industry which continues to be a growth engine. Tax policy is no longer the sole preserve of the annual budgeting exercise and I expect that the working paper on new tax code would address the medium to long-term effects of such changes.

Mukesh Butani
The author is a partner with BMR Advisors and views are personal

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