Budget 2013: IT expects Tax Policy Amendments

The Indian technology sector continues to depict a steady growth in the face of volatility in the current economic environment and in currency. Not to forget, the sector is significantly contributing to India’s GDP and exports, generating employment, bringing about economic change and social transformation.

Unabated by challenges on policies, the Indian telecom sector has continued to remain attractive with contribution to significant inflows of foreign direct investment (FDI) into the economy. The largely untapped rural market is expected to be the next growth frontier for telecom service providers. 

The technology and telecom sectors however do have their share of challenges– the key ones being the global economic conditions, pricing pressures and stiff competition between players as well as from the low cost South East Asian countries. After Chidambaram assuming office as the Finance Minister, changes like operationalization of the Advance Pricing Agreement (APA), deferral of the controversial General Anti Avoidance Rules (GAAR) and significant beneficial clarifications in relation to export of software have been announced. These changes demonstrate an intent of providing a boost to the sentiment of the industry in relation to tax policies. Given this, the technology and the telecom sectors look forward to the following other significant tax amendments for the sectors in the Union Budget 2013-14. 

Technology Sector

Minimum Alternate Tax (MAT), which is currently at 18.5% of the book profits, was introduced in Budget 2011 on units as well as developers of the Special Economic Zone (SEZ). MAT has materially reduced the benefits which were factored in by the developers and units while evaluating investments into SEZ. The industry is hopeful that, in Budget 2013, MAT would be removed to restore the benefits expected by investors from investments in SEZ. Budget 2012 included within the definition of royalty, income from transfer of all and any form of rights in computer software with a retroactive effect from the date of enactment of the income tax law. This amendment leads to income from sale of shrink wrapped software to be considered as royalty under the income tax law. While this amendment brings to rest the taxability of income from sale of shrink wrapped software under the domestic law as royalty, it contradicts internationally accepted principles that such income is not in the nature of royalty (as being in the nature of copyrighted article). The industry therefore expects an alignment on the taxability of these payments with the internationally accepted principles of taxability. While, introduction of the APA in Budget 2012 has been a step in the right direction, transfer pricing controversies continue to haunt the industry. Budget 2012 also introduced transfer pricing on domestic transactions of companies which avail tax holiday in SEZ. With the material tax incentives from SEZ being reduced on account of MAT, additional transfer pricing compliances on domestic transactions add to the woes of the investors. Reforms providing respite on this aspect would certainly be a welcome move for the industry. As far as indirect taxes are concerned, India’s indirect tax regulations have generally struggled to define clear taxing principles for the technology sector, especially when intangibles are involved. On the indirect tax front, the issues surrounding the dual levy of VAT and service tax on licensing of electronic software have remained unresolved even after the introduction of ‘Negative List’ based taxation of services in Budget 2012. Multiple levies have also led to complicated definitions. The result is a convoluted tax structure that is governed by several notifications and clarifications. The government needs to take the lead in formulating a clear approach to taxation of the technology sector and eliminate the domino effect of dual taxation.

Telecom Sector

Allocation of 3G spectrum has resulted in significant outflows for players in the form of massive upfront spectrum fee and interest costs on capital borrowed for spectrum fee payments. The Income-Tax law, as it stands currently, does not provide the exact tax treatment for these expenses. A specific amendment to provide for the tax treatment could help reduction in potential litigation on these payments.

One potential treatment on spectrum fees could be to allow a depreciation claim on upfront spectrum fee payments. Considering that telecom is a capital intensive sector, tax holiday benefits under Section 80IA of the Income-Tax Act (‘Act’), should also be extended to telecom operators who have started providing services after March 31, 2005. The case for such holiday benefits is definitely strong given the huge investments in 3G and the broadband internet sector, which is in its initial stages.

Further, for increasing the reach in rural areas where penetration levels are still low, tax breaks should be provided to telecom infrastructure providers for bringing down the costs of investments in rural areas. Due to increasing costs and intense competition for survival, a consolidation phase in the sector seems inevitable in the near future. However the restrictive provisions of Section 80IA(12A) of the Act, which seems to restrict the carry forward tax holiday to bonafide business successors which would adversely affect such consolidations and hence should be deleted.

In addition, there is a need to expressly clarify that MAT credit under Section 115JAA of the Act, would continue to be available in case of such consolidation. Similar to the technology sector, the telecom sector is also impacted by a retrospective change in the definition of royalty in Budget 2012 to include payment for transmission by satellite, cable, and optic fiber, etc, within the purview of the definition of royalty. This change retrospectively brings roaming charges and inter-connectivity charges within the meaning of royalty. The industry is hopeful that these retrospective changes be reversed or at best, be made prospective. From an overall transfer pricing perspective, the industry still awaits detailed rules to operationalize the safe harbor provisions which were announced in Budget 2009, which could help reducing compliance and litigation costs of players. The industry is hopeful that safe harbor rules are issued in Budget 2013 to ensure its expeditious implementation.