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Budget '09: Need for indirect tax reforms
July, 04th 2009

The world is grappling with economic crisis and the major economies of the world are in recession. India is not insulated and is feeling the impact with a slowdown in economic growth. However, the clear mandate given to the UPA government in the recent elections has given the industry reason to be optimistic. The expectation is that the Government will now fast-track the process of economic reforms and would provide the stimulus needed for economic recovery.

Reforms in the area of Indirect taxes can play a significant role in giving the much needed impetus to economy. The broad policy reforms that the industry looks forward to would include abolition of Special Additional Duty (SAD) in lieu of VAT, levied @ 4%. This duty is levied on goods that are imported into the country. As no Central Sales tax or Value Added tax (VAT) is levied on imports, the levy of SAD is intended to create a level playing field for the goods produced by the domestic industry vis--vis imports.

However, SAD is proving to be extremely cumbersome to administer. Traders are entitled to a refund of SAD after having paid the duty in the first place. This has created a mountain of paperwork and a large administrative burden for the importer and the Government.

There is a need for the Government to consider, whether, SAD is really a countervailing tax or can it be completely done away with. Abolishment of this levy will greatly benefit the industry by releasing cash flows and also provide some relief to the trading community from administrative difficulties of claiming refunds etc.

Another area, specific to the IT industry that requires clarity is the matter of tax on software. The Union Budget 2008 has introduced service tax on information technology software service (ITSS) making the services in relation to software development taxable. This change was welcomed by the software export industry, as it entitled them to get a refund of input taxes (both for input services and for equipment), which was not available under the exemption regime. However, the definition of ITSS has created a lot of ambiguity regarding the scope and coverage resulting in confusion and multiplicity of taxes.

There is a great degree of overlap between Excise duty and Service tax on software. Packaged software attracts Excise duty and the duty rate was increased to 12% to bring the taxation of packaged software at par with customized software. While the intent of the legislature at the time of introduction of this levy was to have alternate coverage under Excise and Service tax law, the exclusion for packaged software from ITSS is not evident.

Moreover, the classification of the software as either packaged or customized is itself a subject matter of debate. This has resulted in duplicity of taxes on packaged software which could not have been the intention of the legislature. It is therefore recommended that appropriate clarifications be issued in this regard, not only to address the issue going forward, but also to resolve the litigation already troubling the software industry.

Another issue which the industry has been grappling with is that Service tax law recognises only cash system of accounting, whereas as per the Companies Act, companies are required to maintain their accounts on accrual basis. Generally, the IT systems of companies are not geared up to address this issue and this necessitates manual reconciliations and administrative difficulties. It is recommended that Service tax law should recognize accrual system of accounting for the administrative convenience as well as to be in line with the accounting principles and other taxes.

The issue of exemption from Service tax on supplies of services from the Domestic Tariff Area to developers/ units of Special Economic Zones (SEZs) has been a subject matter of much controversy and debate. The SEZ Act authorizes the Central Government to prescribe the manner in which the exemption from payment of Service tax on taxable services rendered to SEZs by any service provider shall be available.

However, the manner in which this exemption has been made available has resulted in resistance from the industry at large. The Government in its response has issued a series of notifications. Presently, an unconditional exemption is available to the services utilized within the SEZs without following the refund route. The exemption by way of refund is available when taxable services provided to SEZ are consumed partially or wholly outside SEZ. However, what constitutes services utilized within SEZ is not clearly defined or clarified and could initiate another series of litigation.

Exemption for all taxable services availed/received by the SEZ Units/Developer irrespective of the fact whether they are provided from/consumed outside SEZ would bring great respite to the industry.

Another important change that the industry is waiting for is complete phase out of the CST, as this is important for the smooth functioning of VAT system. It now appears that this step change is inextricably linked to the implementation of GST. Implementation of GST would probably be one of the most significant indirect tax reforms for the country.

One more issue that can be looked at in the current budget is providing abatement or a composition scheme for service tax payments in case of comprehensive annual maintenance contracts. Currently the service provider needs to maintain a bifurcation of goods and service, else the service provider ends up paying both VAT and Service tax on the same consideration resulting on a higher tax cost to the consumers. This abatement or a composition scheme would result in simplification of compliances for the service providers and would be a more tax efficient method of taxing comprehensive annual maintenance contracts.

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