Dying... but not Dead Yet

The Indian software industry did not ask for much and it did not get anything

noteworthy in the Union Budget 2002-03. In fact, it did not even get what it had

asked for. And when the finance minister pulled the rabbit out of the hat,

everybody was taken aback–perhaps shocked is a better word.

So what did Yashwant Sinha do to draw the flak? Well, if you have not got it

by now, we are talking about his proposal in the Finance Bill 2002 to limit the

100% tax exemption on export profits to 90% under section 10(A) and 10(B) of the

Income Tax Act. The surprise move means that a majority of software companies

will now have to pay a corporate tax of 35% on the remaining 10% portion to

raise additional funds for the cash-strapped government. This, despite the fact

that Nasscom had in its pre-budget memorandum urged the government to maintain a

status quo on the tax incentives to the software and service sector, which is

likely to emerge as the largest exporter during 2002-03.

Reacting sharply to the IT industry’s demand to withdraw the provision, the

finance minister maintains that with the imposition of 5% surcharge on the rest

of the economy, it would not be equitable to leave out companies in free trade

zones from contributing to national security. Therefore, the reduction in

benefits available under section 10A and 10B of the income tax Act was

justified. The tax imposed is so small–assuming that the profit on exports is

30%, (the software industry would still be paying a mere 3.66% tax on the

overall profit as compared to 36.75% by others) that it may not have much impact

on the bottomline.

But is that the issue? Nasscom and the entire IT industry unanimously say it

is not. Rather, it’s the going back on the earlier promise of a 10-year tax

holiday that has really irked the industry. India’s export-oriented software

companies are mostly located in technology parks and export zones. The

government had announced a 10-year tax holiday for such units in April 2000

under a policy aimed at encouraging growth in the sector and in order to provide

a stable policy regime. This had resulted in a large number of overseas

investors making India a preferred destination to set up software and back

office operations. The change in the government’s stance would make it

difficult for domestic companies to plan their future strategies and investments

in the light of the uncertainties created by inconsistent policies. This, argue

experts, also sends a wrong signal to global investors.

To quote Phiroz Vandrewala, chairman, Nasscom "Such inconsistencies in

the tax regime will affect the confidence of overseas investors in the Indian

software industry; especially since other countries such as China are pulling

out all stops in providing incentives to attract FDI in this sector." Adds

Kiran Karnik, president Nasscom, ‘‘In the current challenging global

environment, Indian companies, especially SMEs and ITES companies are making

significant investments in setting up sales and marketing infrastructure in the

overseas markets. This withdrawal of tax exemptions would reduce the surplus

available for investment and affect marketing efforts during the year FY

2002-03.’’ To make things worse, there are other demands that Nasscom had

put forward, but the finance minister did not oblige. The association is also

disappointed because the finance minister has decided to continue with

sub-section (9) under Section 10(A) and Section 10(B). As per this clause, if

during the year, more than 51% of shareholding (beneficial interest) changes in

a 100% EOU, STP, or EPZ, then the company will cease to get Income Tax exemption

from that year. This provision adversely affects the ability of companies to

raise funds either from capital markets or venture capitalists. Explains Karnik,

‘‘It hits all companies especially SMEs and start-ups in the software and

ITES space, where the shareholding pattern may change with the exit of venture

capitalists. This may constrain venture capital funding. Moreover, this

provision is acting as a deterrent to mergers and acquisitions, which is today

seen as an important step for future growth in the industry.’’

But is the budget provision really as bad as it has been made out to be?

Perhaps not, and that’s the main reason why Nasscom cautiously welcomed the

Budget as one that "consolidates the ongoing reform process, focuses hard

on key infrastructure issues and recognizes the need to strengthen agriculture

and rural development." While the association has termed the proposed

changes as a retrograde step, Nasscom isn’t crying murder is because it knows

that even with this new step, the Indian software industry will remain the

government’s blue-eyed boy.

SHUBHENDU PARTH in New Delhi