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IT companies cry foul as CBDT caps staff transfer to SEZs
July, 31st 2014

A recent move by the Central Board of Direct Taxes (CBDT), which has capped the transfer of existing technical employees to a new SEZ unit for tax eligibility benefit, has sent shockwaves in the technology and technology-enabled services (IT & ITeS) sector.

In its recent circular, the CBDT has clarified that transfer of existing technical manpower (employees) to an SEZ unit in its first year of operations will not result in loss of a tax holiday. However, the circular adds: "The number of technical manpower so transferred should not exceed 20% of the total technical manpower actually engaged in developing software, at any point of time in the given year in the new unit."

This circular applies to companies engaged in software development or in providing IT-enabled services from SEZ units. If the transfer of employees exceeds this limit, then the tax holiday relief will be denied to the SEZ unit. According to IT companies and tax experts, imposition of the low limit on transfer of employees is a retrograde step and reeks of retrospective tax.

"Even though the intention of the government in issuing this circular is to clarify and permit transfer of manpower up to 20% to the new SEZ units, it seems that it could have an adverse impact on past cases where the transfer has exceeded 20% (retrospective applicability). Such transfers, especially in past cases, ought to be justified as there is no law which restricted manpower transfer to a new SEZ unit," states Punit Shah, co-head (tax) at KPMG.

SEZ units are granted a graded fifteen-year tax holiday. The intent of this tax sop is to foster investment, such as in new plant and machinery. As part of eligibility conditions, under section 10AA of the Income Tax (I-T) Act, the new SEZ unit should not have been formed by splitting up or reconstruction of a business already in existence, and it should not have been formed by the transfer, to a new business, of machinery or plant previously used for any purpose in excess of 20% in value.

For human capital-intensive industries such as the IT & ITeS sector, the issue was whether tax holiday benefits would be available if existing employees were transferred to a new SEZ unit.

By issuing this circular, CBDT has not accepted an earlier instruction issued by the commerce ministry in November 2010 which stated that there is no bar on transfer of manpower to SEZ units. The ministry had pointed out that a ceiling on the value of transfer of assets applied only in respect of old plant and machinery.

"The Rangachary Committee had also examined this issue and recommended that the I-T Act should be amended prospectively to provide that only 50% of the billable employees in the SEZ unit in its first year should be new employees," adds Shah.

Ravi Mahajan, tax partner at EY, says, "Most of the cases under litigation on this issue may not benefit from CBDT's circular owing to the low threshold restrictions for transfer of technical manpower. However, for those matters where the 20% limit is met, companies could take advantage of the provisions of the circular for past years as well. Further, the CBDT clarification could be viewed as imposing a condition on transfer of existing manpower to a new SEZ unit which is not prescribed in the I-T Act. On this ground, the circular could be challenged in courts."

A CFO of a Bangalore-based IT company says that the CBDT hasn't understood the functionality of the technology segment. It is vital that all employees of a company be treated as a fungible (freely transferable) asset.

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