A recent 'clarification' by incometax authorities is causing heartburn among many software companies establishing units in special economic zones (SEZs). It has also exposed differences of opinion between the major companies, with Infosys agreeing with the government and others disagreeing on whether or not companies are eligible to claim tax breaks.

Late last month, the Central Board of Direct Taxes came up with its interpretation of what is known as the '80/20' rule, leading companies such as Wipro and Tata Consultancy Services to the conclusion that the government is making it "extremely restrictive" for them to claim tax deductions on profits from SEZ units.

"Every single IT firm in the past 10 years that has set up an SEZ unit would be impacted," said Dinesh Kanabar, deputy CEO of KPMG in India, adding the financial impact could be "very huge". KPMG said since there is no publicly available data on the number of employees operating out of SEZs, it is difficult to put a number on the impact it will have on a firm or the industry.

Under Section 10AA of the income-tax law, units relocating to SEZs can claim tax deductions on profit only if 80% of plant and machinery is new. Software companies wanted the government to say that in the case of people, moving manpower to the SEZ should not be counted because there is only a limited pool of talent available.

But CBDT instead clarified that technical manpower transferred to SEZs cannot exceed 20% of the total in the first year.

'All software companies will be impacted'

"Flexibility (of movement) should be allowed. It is normal in the technology sector, and one cannot penalise people. This will lead to a distortion in hiring practices," said a Nasscom spokeswoman.
Infosys backs CBDT’s decision on manpower deployment, Wipro & TCS oppose directive Kanabar said he expects almost all IT companies to challenge this circular in court. India is estimated to have exported software worth $85 billion (Rs 5 lakh crore) in 2013-14. "All companies would be impacted as they have availed the benefits of operating out of a SEZ," said a Mumbai-based consultant.

Moreover, since the circular is silent on the date it comes into effect, there is added confusion. Rajiv Bansal, the chief financial officer of Infosys, told ET that the CBDT clarification is true to the letter and spirit of the government's intention when it provides tax breaks to companies. Technical manpower must be counted in the 80/20 rule because human resources are the backbone of the software industry.

On the other hand, the finance head of MindTree is of the view the underlying principle of setting up SEZs is to encourage employment and the CBDT clarification will only serve to restrict the mobility of software employees.

"It is a huge disappointment," said Rostow Ravanan-.Wipro CFO Suresh Senapaty, ET learns, has written to the finance ministry asking for the circular to be withdrawn.

A Wipro spokesman declined comment for the report. A KPMG note on July 29 said, "Given the highly technical and competitive nature of software development, some technical persons having prior experience are required to manage the critical functions of software development in a new unit."