The government may be on the verge of bringing to an end a long-running and high-stakes tax dispute with software companies, causing consternation in the income-tax department, which believes it will lose out on revenue.

Tax officials believe that the outgoing government will soon clearly spell out the conditions under which revenue earned at client locations onsite can be taxed, putting at risk several hundred crore rupees the department has already collected.

At issue is the establishment of a "direct and intimate nexus" between software developed overseas and the India unit eligible for the tax break under the STPI scheme that ran for a decade until 2011. If the government accepts the idea put forward by software industry group Nasscom, the nexus will be established if the eligible unit in India has control and supervision, besides bearing all the expenses of offshore unit.

Further, it will apply when software developed offshore is also exported from the eligible unit to the same customers.

"A fresh circular with retrospective effect would result in government paying hundreds of crores as refunds leading to substantial loss of revenue," said a senior tax official who is directly involved in preparing a report on the tax benefits given to Indian IT companies' offshore units.

Such a report, which the Central Board of Direct Taxes sought on April 29 and wants by May 15, will establish the basis for a rule change which will allow the tax break to software companies, officials fear.

A number of large software companies, among them Infosys and IBM, are being investigated by the income tax authorities.

A Nasscom representative told ET that refunds to companies that are anyway eligible for the tax benefits that could not be claimed because of lacunae in implementation cannot be termed as revenue loss to the government. "We have been raising the issue for last two years and it would be difficult to comment on why the government has initiated the process now," the person said.

The STPI, or Software Technology Parks of India, programme is for 100 per cent export-oriented units to help boost the country's foreign exchange revenue.

Under this, IT companies are eligible for full tax exemption on income generated from software exports if they are located in special economic zones. But the rules weren't clear on revenue generated by the offshore units of Indian IT companies registered under STPI.

Following the industry's repeated request, the CBDT in January 2013 issued a circular stating that the software developed by an Indian IT company's offshore unit would amount to "deemed exports" and would be eligible for tax benefits. It also said there must exist a "direct and intimate nexus" of development of software developed abroad with the eligible units in India.

But, after the department issued tax notices to several IT companies, Nasscom approached the CBDT again and requested for further amendment, claiming confusion in the interpretation of the earlier circular.

Officials objecting to the move said the points suggested by Nasscom to establish the direct connection between the Indian business and the offshore unit aren't enough as assessments differ from case to case. "There are many companies that are not able to establish direct connection between their India and offshore units and if this circular is implemented, most of the IT companies would become eligible for tax exemptions saving them from further investigation into their revenue," said the officer.

"I don't have any specific information on companies being investigated by the I-T department," said the Nasscom spokesperson. The tax department did not respond to queries sent by ET.

The law is very clear with regard to the objection raised by Nasscom, and if at all there is any confusion, there are multiple forums to interpret the law, an income tax officer privy to the matter said.