The second budget of the Modi government is around the corner. In many ways, this will be the first real budget and the sentiment and euphoria of change is waning and being replaced with eager anticipation of some real policy, tax and other reform initiatives.
By Abhishek Goenka
It is often said that India’s staggering growth in the information technology (IT) sector took place despite the government and only because it was a sector that was almost unregulated. Yet, over the last few years, and more recently with real and rhetorical moves around manufacturing, it almost appears as though the bellwether of the economy is being left to languish—particularly in a time when there is intense competition from other emerging economies and also criticism that India needs to move from being just a service provider to an innovation leader.
Ignoring the hotbed of entrepreneurship, the government is not doing enough to incentivise technology start-ups. Not much has happened since the government (in its 2014 Budget) announced setting up a R10,000 crore venture capital fund for the MSME sector and a R200 crore entrepreneurship/innovation fund. India always leapfrogs on technology, and with the shoots of disruptive innovation, the government should accelerate its focus and attention towards start-ups. The government could do its bit by also providing tax incentives—for example, a weighted deduction of 150% of expenses incurred in product development should be introduced. Alternatively, the government could provide “tax exemption vouchers” that can be used by these start-ups, in the form of a fixed rebate on the corporate tax for a period of, say, five years within the initial block of 15 years or by way of refund of certain percentage of tax paid by these start-ups. Similarly, the current weighted deduction that is available for “skill development expenses” is not extended to the IT sector.
On another policy front and one that impacts several sectors, the government is yet to meaningfully act on its promise of reviving SEZs. While the Minimum Alternate Tax (MAT) levy on SEZ developers and units has impacted all SEZ players, IT companies seem to be the worst hit since MAT on SEZ manufacturing units may not make a huge dent given the longer gestation time before they start making profits as compared to their IT counterparts. Most of them already have sizeable MAT credits under the earlier STP/EOU holidays. A progressive “willing-to-help” thinking will augur well, rather than being stoical and defensive.
On other tax amendments, as a run-up to the current government’s maiden Budget in July 2014, the industry expected that the government would roll back some of the controversial retrospective amendments to the definition of “royalty” in the I-T Act. Such is the harshness of these amendments that they have the potential of taxing even basic telephony services. These amendments were clearly regressive and acted as impediments to the import of certain essential technology services for the IT sector, as India continues to be a net-importer of technology.
Coupled with a high withholding tax rate of 25%, since most of the contracts tend to be net-of-tax, the effective tax rate is as high as 37%! With more and more adoption of cloud services, the lack of clarity on taxation for such payments only adds to the woes.
On the domestic withholding tax front, the withholding tax of 10% (gross basis) on IT services is again high since it does not consider the actual tax payable on the profits of IT service companies. The rate of 10% does not seem to be based on any strong empirical evidence and, therefore, there is a demand that this be reduced. This seems quite logical since a 10% withholding tax rate on gross basis means that the companies have to earn a net margin of about 30% on their revenues.
On procedural aspects, while it is not unique to the IT sector, overseas companies receiving income in the form of royalty/fees for services on which withholding tax has been done should be exempted from filing tax returns in India and making transfer pricing compliances. A similar exemption is available for interest/dividend earned and there is no reason why the exemption should not be extended to royalty/service income as well. Foreign companies feel there is no value addition in asking them to these compliances in India when their Indian affiliate companies or customers in India discharge necessary taxes. It will not cost the government anything to make these small changes, yet it will significantly enhance the ease of doing business quotient.
The government should also immediately clarify the open areas in the now-famous “Vodafone amendment” on taxing indirect share transfers. The IT sector sees several M&A deals of all sizes and with most companies having an India presence, the lack of clarity is materially impacting transactions and impeding growth.
The resilient IT sector has endured an aggressive tax environment comprising withdrawal of tax holidays, high profile demands, retrospective amendments, denial of service tax refunds and a changing SEZ policy. While some of the big bang changes in the July 2014 Budget on roll-back of the Advance Pricing Agreement mechanism and changes in transfer pricing rules were welcomed, many of these proposals are yet to be actually acted upon by the government. Simple, implementable and impactful steps that balance the revenue considerations of the government and at the same time allow for innovation, job creation and investment is what this Budget should be about. And, for once, it is hoped that the IT Inc will also roar loud along with the Make in India lion.
(With inputs from Sharath Rao, director, BMR & Associates LLP)
The author is partner, Direct Tax, BMR & Associates LLP. Views are personal