SEZ Scheme benefits need to Be extended to IT, ITeS Sector beyond March 31, 2011 : 22-03-2010

By S Sivakumar, CA

IT would seem that the tax holiday being enjoyed by IT and ITeS under Sections 10A and 10B of the Income tax Act would finally end, as of March 31, 2011. This becomes clear from the fact that the Budget 2010-11 does not have any proposal for the extension of the tax holiday. The Finance Minister, in his post Budget appearances has also been talking of the need for profit based incentives to go, a concept fully imbibed in the Direct Tax Code, proposed to be implemented from April 1, 2011. Despite that Mr Anand Sharma, the Commerce Minister has been making a rather feeble plea to the FM to extend the tax holiday for STP Units by one more year, it looks all certain that there would be no tax holiday for STP Units beyond FY 2011-11. Though the draft DTC released by the Government does not specifically talk of any tax incentives, the body language of the Finance Ministry officials including the FM, does make it look like that the tax holiday for SEZ Units would continue under the DTC, in some form or other. Of course, the DTC does talk of grandfathering of the tax exemptions and perhaps, this is meant to cover the tax holiday for SEZ Units. The Electronics and Software Export Council has also asked for the Finance Ministry to clarify on the availability of the tax holiday for SEZ Units, under the DTC and hence, there is every hope that the tax holiday for the existing SEZ Units would be protected beyond March 31, 2011, as well.

There is no denying the fact that, as a tax holiday benefit, the STPI scheme was quite unique. Even a small room could be treated as an exporting unit and the tax holiday claimed. There is no denying the fact that the STPI scheme was instrumental in enabling many tiny and small companies to get into software development. Things were going very well for the STP units till the Minimum Alternate Tax got levied with effect from April 1, 2007. SEZ Units are much better off as compared to their STP counterparts for the simple reason that that the Minimum Alternate Tax (which is currently at 15% and which is now proposed to be increased in FY 2010-11 to 18% plus surcharge of 10% for book profits over Rs 1 crore plus education cess of 3%). Moreover, the total tax holiday for SEZ Units spans a total period of 15 years, with some strings.

Talking of the justification for the tax holiday for STP Units, we must always keep in mind the fact that, the banks have been loath to extend loans to the IT/ITeS sector. Till date, neither the Government nor the banking sector has exactly understood the funding needs of the IT/ITeS sector. The staring fact remains, that this sector has grown by leaps and bounds, without any help from the Government or the Governmental agencies. Most small and mid sized companies, and there are tens of thousands of these all over the country but concentrated in the major cities, have used internal accruals for growing their business, and thanks to the tax holiday, much of the cash had been conserved for growth purposes. We must further bear in mind that, unlike manufacturing companies, companies in the IT/ITeS sector are largely employee driven and typically, personnel costs accounts for anywhere between 50 to 60% of the cost of sales. Most of the developments that we see in cities like Bangalore, Chennai, Hyderabad and, of course, NCR, is largely attributable to the phenomenal growth of the IT/ITeS sector.

The withdrawal of the tax holiday under Sections 10A and 10B would be a big blow to the smaller and the mid cap companies, for sure, especially at a time when these exporters have already seen about 10% of their top line getting wiped out due to the appreciation of the rupee. If the rupee appreciates further and touches the 42 levels, one can expect big time trouble for the small and mid sized companies and some of these could even close shop.

The option of moving into SEZs however, is not going to be easy for the STP Units.

Firstly, SEZ Developers insist on minimal space to be taken, which are typically in the region of 10,000 to 15,000 square feet. This requirement could be beyond the reach of most small software exporters.

Secondly, under the SEZ scheme, space can only be leased out to the software units, unless the software companies are themselves developing SEZs. Many small STP Units are operating out of their own premises and moving to leased premises might be difficult.

Thirdly, most SEZ complexes are coming far outside the city and could only suit the medium to large exporters and small to medium enterprises operating from within the city might find it difficult to move base to a place far outside the city.

And, lastly and more importantly, the existing tax holiday provisions contained under Section 10AA (4) do not allow for tax exemption in cases where the SEZ Unit is formed is formed by the splitting up, or the reconstruction, of a business already in existence or when it is formed by the transfer to a new business, of machinery or plant previously used for any purpose. It is here that the existing STP Units would get stuck, unless they execute a clear strategy of having a new business in the SEZ Unit.

Be that as it may� the SEZ scheme is the only tax holiday that would be available under the DTC, post March 31, 2011 and given the current indications that the tax holiday is unlikely to be made available for units moving into the SEZs after April 1, 2011, a SEZ related strategy becomes very important.

On its part, the Government needs to come up with amendments to the SEZ Scheme, to accommodate the STP units, in one way or another. The existing restrictions contained in Sub Section (4) of Section 10AA dealing with the negative conditions could be waived for the IT/ITeS units. The minimal area requirements for IT/ITeS SEZs could be significantly reduced which would allow SEZs to come up at nearly places. The existing IT/ITeS industrial parks could be allowed to be converted into SEZs.

Most large IT/ITeS exporters have already moved their operations to SEZs and many large exporters have already set up SEZs of their own. It is the tens of thousands of the small and mid sized players who would be left high and dry, when the STP scheme shuts shop.

India has been able to achieve a dominant global role, in the IT/ITeS sector, largely due to the exports achieved by the small and mid sized players. If the Government is serious about retaining India’s rightly place in the global services industry, it badly needs to modify the SEZ scheme to accommodate the units currently operating under the STPI scheme so that, these units can continue to grow and contribute to India’s continued success. The Government needs to act fast on this, as March 31, 2011, the date proposed for the introduction of the Direct Tax Code, coinciding with the expiry of the tax holiday scheme for the STP Units, is fast approaching.

As for the mid sized IT/ITeS exporters operating as STP Units, a properly executed strategy of moving into the SEZ scheme before March 31, 2011 would deliver handsome results.

The ball then is squarely, in the court of the Government.

Before concluding.

The Government’s slated objective of extending the benefits of the IT/ITeS services led export growth to Tier 2 cities /towns could just not take off, as one cannot imagine an SEZ coming up in the Tier 2 cities/towns. On the other hand, some of the STP units operating out of the Tier 2 cities/towns might shift base to the larger cities post March 31, 2011, once the tax holiday is withdrawn.

Talking of the preferential treatment meted to SEZ Units by the Government, in contrast to the STP Units, apart from continuing to exempt SEZ Units from MAT, the Government has also been kind to exempt SEZ Units from the levy of service tax so long as the input services have been �consumed’ within the SEZ. One does not quite understand the need for treating SEZ Units on a different footing, as contrasted to the STP Units.

Will the Government please bear in mind the fact the SEZ scheme would contribute further, to the growth of the large IT/ITeS exporters, at the cost of the small and medium units. Even as per the current data, the top exporters account for about 85% of the country’s total IT exports and with most these top players going in, all out, for SEZs, one could predict the virtual death of the tiny and small IT exporter, post March 31, 2011.

(The Author is Director, S3 Solutions Pvt Ltd, Bangalore)

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