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New software units in SEZs could face tax hurdles
August, 04th 2014

New software units in special economic zones (SEZ) may find it tough to avail themselves of the tax holiday benefits with the CBDT placing an onerous condition on eligibility of such units for fiscal incentives.

The Central Board of Direct Taxes (CBDT) has now through a circular introduced a bar on transfer of technical manpower to SEZ units — a move that could inhibit the growth of the software industry.

Technical manpower

It has capped the number of technical manpower that could be re-deployed or transferred to a new SEZ unit in the first year of commencement of business.

If the new SEZ unit was keen to avail itself of the tax holiday benefits under the income-tax law, it should ensure that the number of technical manpower so transferred does not exceed 20 percent of the total manpower actually engaged in developing software at any point of time in the given year in the new unit.

The silver lining is that transfer or redeployment of technical manpower from an existing unit to a SEZ unit will not be construed as splitting up or reconstruction of existing business.

This is a welcome move for the software industry as there has been litigation on the issue of whether such transfer amounted to splitting or reconstruction of business.

The income-tax law stipulates that for a software unit based in SEZ to avail itself of the tax holiday, the unit concerned should not have been formed by the splitting up or reconstruction of a business already in existence.

“While it is appreciated that the objective behind issuing the circular is to mitigate the chances of disputes which have been noticed on the field, any restriction on transfer or re-deployment of manpower appears to be introduction of a fresh condition”, Rajiv Chugh, Partner, Ernst & Young LLP, told Business Line.

The statute has specific provision to provide that transfer of second-hand plant and machinery beyond a certain permissible limit can be considered as a case giving rise to split up or re-construction of an existing undertaking.

“Any such restriction sought to be applied to manpower is wholly inapt, as the taxpayer has no control over the employees who are free to join and exit at their will – accordingly maintaining a 80/ 20 ratio at any point of time would be a daunting task”, Chugh said.

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