The government is on course to make tax rules easier for the $70-billion information technology industry to make India a much more attractive destination for software development. A high-level panel appointed by Prime Minister Manmohan Singh and chaired by former CBDT chairman N Rangachary has recommended favourable tax treatment and a stable tax regime for software sector, said a senior government official privy to the report, which comes at a time when the outlook for the export-focussed industry has worsened.

Certainty in the tax regime and more clarity on the interpretation of tax law will encourage multinational companies to ship more work to their captive units here, said Som Mittal, president of the National Association of Software and Services Companies. "Nearly 35 per cent of our export revenues come from MNCs and captives and, therefore, we need to encourage them to set up their development centers in India rather than move to the Philippines or China," he said.

The panel had extensive consultations with the software industry grouping before finalising the first of its three reports.

"This (tax issues) is a big distraction for the industry when there is a need to focus on the growth in the backdrop of a challenging global economic environment," said V Balakrishnan, chief financial officer at Bangalore-based InfosysBSE -0.10 %.

"Hope the recommendations would bring in greater certainty to tax issues faced by the industry." The Rangachary panel's recommendations are of a piece with attempts in recent weeks to revive flagging investment. The Parthasarathi Shome committee in its draft report has said that rules relating to tax avoidance should be made less onerous; sectors such as multi-brand retail and aviation have been opened to foreign investors, and diesel prices have been increased to try and bring the fiscal deficit under control.

Nasscom is of the view that transfer pricing rules, meant to prevent multinational companies from mis-pricing their products and services to shift profits out of India, are far too stringent and hurt the profitability of the sector. The government will now fix a markup, or an acceptable level of deviation from the market price, also called 'safe harbour'.

The Rangachari panel will finalise safe-harbour rules individually for each sector by December this year. Tax authorities would then accept transfer prices declared by these companies and the move will bring more predictability in tax dues and reduce disputes.

Another big complaint for Indian software companies relates to tax treatment of profits earned from onsite activities work that these companies do at their clients' sites.

Tax authorities have raised demands on these companies, saying that onsite activities cannot be treated as exports and hence do not qualify for a tax exemption. They have also argued that deputation and technical manpower contracts cannot be treated a software exports.