Much Ado about Nothing

“The Budget presented by the finance minister does little to spur IT usage and growth. Given the business environment last year, the government was expected to unveil a set of measures that would boost sentiment and grow the domestic IT industry in India. No such measures have been forthcoming. Also, the sops and protection given to the hardware industry will do little or nothing to PC prices, but will only give manufacturers a temporary lifeline. It’s also doubtful whether the reduction in customs duty will be passed on to the consumer. While it will be easier for companies to invest and acquire companies abroad, realistically, few have made use of this facility in the past few years, even though opportunities have been aplenty. The only positive aspect of the Budget seems to be the establishment of the ‘SEZ’, but the details of this initiative are yet to be seen.”

Sujay Chohan



GVP and country manager, Gartner India

We were tempted to finish this write-up right here and now with this Budget reaction from Gartner India–it sums up finance minister Yashwant Sinha’s fifth essay pretty accurately. To add to the woes listed above, there’s little in the Budget in the way of greater economic initiatives. There’s no aggressive push to expedite the reform process and revive the economy. There are no indications of opening up the Indian market and increasing FDI inflow. There are no moves toward beefing up the sagging infrastructure. Nothing’s been done to open up sectors like retail to foreign companies. There are no procedural simplifications in the areas of customs bonding, softex forms and withholding tax.

Capping all these omissions are some heart-stopping inclusions–there’s the introduction of 10% corporate income tax, which will hit small and medium IT companies. Then there’s the new tax regime for the middle-class, this year’s fall guys–the 2% Gujarat surcharge has been replaced by a 5% defense surcharge, interest on small savings has been snipped by 0.5%, and dividends paid out by mutual funds will now have an in-built at-source tax element of 10%.

In Nucleus Software Exports managing director Vishnu Dusad’s words, “The Budget shows extremely limited innovation to wake up the economy from deep slumber, giving it a long-term direction and short-term fillip. The Budget proposals demonstrate the ‘well vision’, rather than that vision of true global leadership. The way the defence ministry’s bureaucrats had their mental fog cleared by spending a month in Siachen, the finance ministry and bureaucracy should consider travelling to China to understand how misleading ‘growing by leaps and bounds’ can be.” Cognizant Tech—nology’s COO N Lakshmi Narayanan concurs–“There hasn’t been anything positive for the IT industry at large and for software in specific. Barring the 10% reduction in customs duty for setting up earth stations and the mild concession for hardware and IT products, there’s nothing noteworthy in the Budget.”

Let’s take a closer look at the Budget and what it holds for the IT and telecom sectors…

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Customs duty on a number of hardware inputs has been reduced to 5% (on certain capital goods, it is 15%). Duty on some IT goods has been reduced to 10% or 5%, as per WTO norms. The government had earlier planned to pre-pone nil custom duty on IT hardware equipment to 2003, but as recommended by MAIT, it opted to implement it by 2005, giving domestic manufacturer enough time to become globally competitive. The reduction in duties and postponement of the WTO regime will, however, have limited impact on the hardware sector as it fights the general economic slowdown and recent increases in memory prices.

Sections 10 and 10 provided 100% tax exemption to software export-oriented units. This has now been amended and only 90% of profits will be exempt from tax, instead of 100%. Software companies, therefore, will have to pay 10% tax on profits. It is unclear if the amendment is only for a single year or will remain till 2008. More than the 10% tax, the uncertainty regarding taxation in future years is something that software exporters will have to factor in while charting out future plans. Also, Section 80 has been revised, with 30% of software exporters’ profits becoming eligible for tax exemption, against 20% earlier.

Good news is at hand for telecom companies, which will now be eligible for deduction under Section 80, wherein they would be given the benefit of carry forward and set-off of past losses in cases of merger of companies owning industrial undertakings. For the telecom sector, which has probably seen the maximum number of mergers and acquisitions in the past few months, this comes as a positive step.

Also, countervailing duty on cellular phones and pagers has been removed, whereas the custom duty has been increased from 5% to 10%. The cellular industry had been demanding a cut in duties due to the dominant network of gray market players. However, even here, the quantum of reduction is unlikely to have a major impact on the menace. Optic fiber companies are also likely to gain by the announcement of an additional 75,000-route km of optic fiber cable network in 2002-03.

Budget and IT: The real picture



To pay tax has never been a joy for anybody. The 142nd Budget announcement deprives the software industry of the joy of 100% tax holiday, restricting it to 90% in view of the need for resource mobilization in the short run. There are also some special taxation dispensation for the IT sector like:

• Tax holiday benefits under Section 10 and 10 of the Income Tax Act as are available to STP units till 31 March 2009 have been partially withdrawn for one year (assessment year 2003-04) with an intent to mobilize resources in the short run. The deduction of 100% allowable under the prevalent provision has now been restricted to 90%. This may be a precedent to the process of taxation of the STP regime in the years to come.

• Profits from export of on-site services by STPs continue to be eligible for deduction (like other export income) under Section 10 and 10 of Income Tax Act. On-site services include development of software at the client site abroad. On-site services make up over 60% of revenues generated from software exports by STP units.

• The condition with regard to transfer of ownership of companies to avail tax exemption under Section 10 and 10 of the Income Tax Act remains unaltered. Benefits under the Section in circumstances of transfer of ownership are available only to companies in those the general public is substantially interested. These provisions have accelerated the process of industrial restructuring, amalgamations and mergers.

However, the benefits under this Section are not available in circumstances of transfer of ownership in companies where the general public is not substantially interested. This has been a long standing demand but has not been accepted by the finance minister.

• Income from DTA sales by STP, EOU and EPZ units remain non-tax exempt.

Exemptions as allowed under Section 80 of the Income Tax Act remain unaltered and will be phased out by March 31, 2004 (see table).

Overseas acquisitions by Indian companies



The finance minister has encouraged Indian companies to grow into strong India-based multinationals. To promote this trend, Indian companies wishing to invest abroad may now invest up to $100 million on an annual basis through the automatic route, without being subject to the three-year profitability condition (up from the existing limit of $50 million). Also, Indian companies making overseas investments in JVs abroad by market purchases may now do so without prior approval of up to 50% of their net worth, up from the current limit of 25%.

Promotion of IT education



The comprehensive education loan scheme to cover all courses in India and abroad, under which loans are available up to Rs 7.5 lakh for studies in India and Rs 15 lakh for studies abroad (without collateral or margin for loans up to Rs 4 lakh), has served the student fraternity extremely well. Loans of Rs 670 crore have been disbursed to over 50,000 students, serving as an important input in development of Indian ‘brain power’.

Tax on dividends



The finance minister has reintroduced the tax on dividends distributed by companies and mutual funds. Such income will be taxed at the recipients’ end at the rate of 10% at source. In order to avoid a cascading effect, the erstwhile Section 80 will be re-inducted in the Income Tax Act. As per this Section, domestic companies receiving such income will be entitled to claim a deduction for the amount, in turn distributed by them as dividend. Conversely, distribution tax of 10%, as applicable to companies and mutual funds on dividends and income distributed, has been withdrawn. This is targeted in realizing either higher dividends or higher reserves.

Capital account liberalization



This is a front where the FM is treading with caution. Non-resident Indians will be free to repatriate their current earnings such as rent, dividend, pension and interest earnings in foreign currency. Furthermore, there will be full convertibility of deposit schemes for NRIs. The finance minister has stressed on the need for vigilance in curbing illegal capital flows in support of terrorist activities. The government is proposing a suitable legislation during the current session itself to empower enforcement agencies to arrest and prosecute hawala operators and other forms of money-launderers. There are also reports that the government has decided to bring back some of Fera’s stringent legal provisions by extending the sunset clause of Fera in

Fema.

Corporate and individual taxes



The rates of corporate tax for domestic companies remain unaltered at 35%. However, the rate of tax applicable to foreign companies has been reduced from 48% to 40%.

In the case of personal income tax, the existing slab rates remain unaltered at 10%, 20% and 30%. However, the surcharge of 2% is being increased to 5%. The tax rebate of 20% on investments under Section 88 of the Income Tax Act will be admissible, but in different slabs–for taxable income above Rs 5 lakh, the rebate is 0%, for taxable income between Rs 1.5 lakh and Rs 5 lakh, it will be 10%, between Rs 1 lakh and Rs 1.5 lakh will enjoy a rebate of 20%, while those with taxable income below Rs 1 lakh will have a 30% rebate. The benefit for tax exemption on interest payable on home loans by individuals remains unaltered at Rs 1.5 lakh. This will now be available in cases where such acquisition or construction is completed on or after April 1, 2003, provided that the acquisition or construction is completed within three years from the end of the financial year in which the capital was borrowed.

Service tax



Computer software continues to remain exempted from the purview of service tax, but service tax had been imposed in the last financial year on related services like scientific and technical consulting services and online information and leased circuit providers. Scientific and technical consulting service (other then computer software) has been defined as “any advice, consul—tancy, scientific or technical assistance, rendered in any manner, by a scientist or a technocrat, or any science or technology institution or organization, to a client, in one or more discipline of science or technology”.

Online information and database access on retrieval service has been defined as “providing data or information, retrievable or otherwise to a consumer in electronic form through a computer network”. With this, domestic Web-based services (including call centers) come under the purview of online information and database access and/or retrievable services. However, domestic voice-based services (voice-based call centers, for instance) shall not qualify as an activity under on-line information and data base access and/or retrieval services.

Customs and excise

• Customs duty on import of software remains unaltered at 0%

• The earlier decision to implement a zero duty regime under the ITA-1 agreement on IT products withdrawn due to strong representations by manufacturers. It will now be implemented from FY Year 2005

• Customs duty on import of computers under EPCG scheme remains unaltered at 5%

• Customs duty on import of computer systems and peripherals remains unaltered at 33.4%. CD writers, however, will now attract 16% duty

• Custom duty rates against items of personal use on ‘transfer of residence’ reduced from 35% to 30%. The overall limit is being raised from Rs 1.5 lakh to Rs 5 lakh and a few more items (laptops, portable photocopying machines, digital video disk players, video cassette disk players etc) are to be included in the eligible list of items

• Excise on software remains unaltered at 0%

• Excise on computer systems and peripherals remains unaltered at 16%.

Rajeev Narayan in New Delhi



Budget analysis and inputs from Mohan Khanna, GM, Zensar Technologies For Nasscom chairman Phiroz Vandrevala’s.

STOCKS/When the Bottom Fell Out

As the implications of the Budget 2002 filtered in, the stock market went into a nosedive.

It wasn’t just IT stocks that got battered… even telecom scrips closed lower

Last year’s budget was hailed as ‘revolutionary’, expected to  usher new generation reforms, reduce government holding in

PSUs, cut government borrowings, lower non-plan expenditure–in short, just the right medicine for India. Like everyone else, the stock markets too believed the story.

Reality was different. With the technology slowdown, the stock market scam and 9.11, all calculations went awry. While the government deserves praise for going ahead with the sale of stake in PSUs such as

Balco, CMC, VSNL and IBP, the future is challenging even on this front. The economic marksheet released by CSA for 2001-02 is disappointing, and the actual numbers are way behind targets.

The Economic Survey, announced a day before the Budget, reflected a grim picture of the economy, even as global recovery was close at hand. GDP growth rate has been estimated at just 4% in 2000-01, against 6.1% in 1999-2000. GDP is estimated at 5.4% for 2001-02. On the other side, despite pledges of fiscal discipline, fiscal deficit as a percentage of the GDP is estimated at 5.1%, against the target of 4.7%. The 5.7% growth rate in 2001-02 in the agriculture and allied sectors, compared to de-growth of 0.20% last year, is a positive sign even though distribution remains a cause of concern. By January, the annual inflation as measured by the WPI was only 2.9%, the lowest in two decades.

The latest Budget, meanwhile, had no positives, though the finance minister reiterated the continuance of second-generation

reforms, laid thrust on agriculture and focussed on further rationalization of customs and excise duties. Overall, the Budget was a damp squib, with salaried individuals having to suffer more than they would have imagined. The direct tax will hit them hard, as will the imposition of tax on dividend from companies to recipients.

Stock market blues



The Sensex opened on a positive note but was subdued for most of the morning, as the Budget was being presented. As the implications of finance minister Yashwant Sinha’s Budget proposals started filtering in, the benchmark index dipped, starting with removal of 10% tax on dividends, hitherto paid by the paying company and shifting the onus on to the investor. The next announcement of amendment of Section 10 and , of reducing the tax exemption of EOUs from 100% to 90% of the earnings had a major negative impact on software stocks. Large scale selling on software and cement counters pulled the Sensex down sharply as it touched an intra-day low of 3,537.19 points, down 168.47 points over the previous close and 194.09 points over the day’s high of 3,731.28. The Sensex eventually closed the day 143.35 points down, at 3,562.31 points–a clear reflection of the overall disappointment over the Budget.

IT stocks were under pressure from word go, and as negative news (both market- and IT sector-related) started coming in, these scrips witnessed heavy selling. Almost all IT stocks closed in the red. Among the major losers were Infosys (down 8% to Rs 3,530), Satyam (down 10% to Rs 268), NIIT (down 7% to Rs 211.25), Digital (down 9% to Rs 530), Wipro (down 5% to Rs 1,582) and HCL Technologies (down 7% to Rs 211). Other major losers were Aftek

Infosys, RS Software, Tata Elxsi, Trigyn Technologies and Mastek. Surprisingly, even telecom stocks witnessed selling

pressure–HFCL, Krone Communications, GTL, Tata Telecom, Shyam Telecom, MTNL and VSNL closed negative.

The annual ritual of the Budget is slowly losing its relevance and impact on the economy, what with successive finance ministers only tinkering with duties here and there, with little effect on the real issues. Over the last few years, little has been done to address problems like lack of infrastructure, a low tax base and rising non-plan governmental expenditure. For the software sector, this is the latest body blow… and some serious thinking needs to be done before new strategies can be charted out.

Sushanto Mitra