UNION BUDGET 2003-04: What he Didn’t Do and Why...

Political compulsions in an election year, the niggling fiscal deficit situation, and the absence of focussed lobbying…

4/10... that is the rating Dataquest’s editors have decided is right for
finance minister Jaswant Singh’s maiden Budget. Sounds harsh? Especially in
light of the fact that Singh has stuck to the government’s commitment on the
Section 10A/B tax holiday, exempted duties on pre-loaded software, reduced
duties on components and import of capital goods for both IT and telecom
products? Perhaps, especially at first glance...

But
look at the larger picture–Singh’s Budget has failed to address any of the
issues afflicting Indian IT where it matters most... Hardware, e-governance and
manufacturing–all of them getting together to stunt any hopes of growth for
the languishing domestic IT market–have been ignored. All the accolades coming
Singh’s way are from the software sector–presumably because it is software
that has made up Indian IT’s magic numbers for long. With this new Budget, the
domestic market–critical not just for overall Indian economic growth but also
for that of the software industry, has now been sentenced to yet another year of
inaction.

Check out this statement from Ingram Micro COO NY Prasad–"At the end
of his speech, it was almost as if the Budget had never happened at all..."
He was speaking from a hardware and domestic industry perspective. MAIT, while
hailing the Budget, subtly hinted at the treatment meted out to hardware–"We
wish the Budget had not ignored our recommendation on lowering of excise duty on
IT products from 16% to 8%."

On the exports front, key issues were left untouched–totalization
agreements with the US and the UK, strengthening double tax treaties... But
before we elaborate on the misses, let’s ring in the happy tidings.

First, the good news

"Before we dwell on what could have been done, we have to emphasize
that the FM acknowledged that IT is a star performer and that he will support
it. The industry is certainly happy with the Budget this year," says
Nasscom President Kiran Karnik, echoing what every other representative of the
Indian IT industry has to say.

The great Indian software services exports story has always overshadowed India’s struggling domestic IT industry. On the other hand, the IT industry has leapfrogged in China and Taiwan, primarily due to burgeoning domestic IT consumption. February 28, 2003 saw one more Union Budget go past, with no initiatives to boost IT spending by organizations and individuals within the country The hardware industry had eagerly awaited the Finance Minister’s announcement on cutting excise duty on IT products from 16% to 8%. This would have countered the gray market and more important, PC (personal computer) prices would have dropped by about 5%. But, it was not meant to be… Apart from a handful of sterling projects, e-governance in most Indian states still means the purchase of PCs at the end of the financial year and of course, a photo opportunity. The Budget has no specific rewards and punitive measures to enhance the pace and scope of e-governance initiatives and computerization across state governments

This year, Singh addressed better infrastructure, an issue that all industry
segments have been clamoring for. The Budget had announcements on road, rail,
airport, power, and water-related projects. "Market capitalization has been
an integral part of the currency in the IT industry. The meltdown burned several
investors. The Budget abolished dividend tax and long-term capital gains
tax," says Mohan Khanna, general manager (corporate affairs), Zensar
Technologies.

This could trigger renewed interest in tech stocks. As Day I at the bourses
showed, it did. "The amendments made in Sections 10A and 10B are likely to
result in consolidation in the software services sector and create an
environment conducive for mergers and acquisitions and boost venture capital
funding for new and existing IT projects," says Khanna.

More good news–Indian companies with a proven track record will be
permitted overseas investments under the automatic route, even where investment
is not in the same core activity.

Where did Union Budget 2003 Touch IT? Tax holiday benefits under Sections 10A and 10B of Income Tax Act, available to STP units until March 2009 restored and 100% deduction allowed This tax exemption applicable for an Indian company even if it is transferred to another company via a demerger or amalgamation Software pre-loaded in computers shall not attract any excise duty CD-ROMs containing educational material, journals, periodicals (magazines) or newspapers will attract nil excise duty Custom duty on import of computer systems and peripherals remains unaltered at 33.4%. CD writers however attract custom duty of 16% Custom duty on fiber optic cable reduced from 45% to 39.2%. This will provide an impetus to networking infrastructure Custom duty on import of routers, modems and fixed wireless terminal reduced from 33.4% to 27.6%

What hurt

Despite these positive measures, there’s a lot more Budget 2002-03 could
have done. As Ingram Micro’s Prasad pointed out–"The opportunity to
encourage e-business has been missed again. More draconian is the proposal to
bring cybercafes and training institutes under the service tax purview."

The rate of service tax has been raised from 5% to 8% across the board.
IT-related services that come under the purview of service tax are technical
testing and analysis, technical inspection and certification, maintenance and
repair services like annual maintenance contracts and authorized maintenance and
repair services.

"From first reading, it would appear that IT education and training
would be brought under the purview of 8% service tax.

This would be highly detrimental to the interests of the industry, students
enrolling for an IT training course, and by extension to the IT services
industry," says SSI chairman Kalapathy Suresh.

Kalzoom Technologies’ CEO Uma Ganesh points out that despite talk about
product creation and marketing, e-governance and modernizing higher education
system with IT, no measures have been announced to open up these segments.
"The FM should have seized the chance to focus on both these opportunities
and announced initiatives to augment the country’s capabilities and spend in
this direction," she adds.

The hardware sob story

Even as Jaswant Singh concluded his Budget speech in Parliament, television
studios and trade organization gatherings broke into animated chatter–"You
IT guys have had another good budget" was the refrain amidst backslapping
bonhomie. No doubt, the run-up to the Budget had instilled worries over
termination of tax exemptions under Sections 10 A and 10 B of the Income Tax
Act. Indian IT heaved a sigh of relief when Singh proclaimed that he saw no
reason to "discontinue benefits to a sector that has done the country
proud". Software exporters did have reason to rejoice, and the good times
would continue.

The Union Budget Should Have… Specified measures to reward government departments that show effective computerization and punitive measures in case this does not happen Simplified exports procedures, custom bonding, Softex forms etc. Given retrospective allowance for onsite revenues under Section 10A /10 B Reduced excise duty on computers from 16% to 8% to counter the gray market. With this correction, PC prices could have dropped by about 5% Permitted banks, financial institutions and the services sector to issue C Forms for purchases of IT products at a concession Cut excise burdens for information security products like firewalls or removed duties from the hardware and software used in smart cards Provided incentives to vendors for setting up manufacturing outfits Relaxed issuing of licenses to high technology products like wireless LANs Simplified the duty structure for the hardware sector Exempted duties on capital goods required for setting up infrastructure for providing IT services Reduced custom duty tariffs for any subscriber end equipment/terminals, which would help any IT enabled project being set up reduce costs Rationalized duty and sales tax structures across states to help resellers Brought down the Special Additional Duty (SAD) of 4% reducing the burden on local IT manufacturers. Offered fiscal incentives for software product development Offered fiscal incentives for IT expenditure by companies, educational and research organizations as well as individuals

But on the hardware front was a familiar sense of disappointment–of not
having been heard one more time. MAIT (Manufacturers’ Association for
Information Technology) put out a statement congratulating the FM for a
commendable job, but there was a hint of disappointment–in the form of a
statement that MAIT’s strong recommendation that excise duty on IT products be
brought down had been ignored.

NY Prasad was more forthright in his response. "As far as the hardware
industry is concerned, it is almost as if the Budget did not happen at all.
Almost nothing has changed. By de-linking the software and hardware industries,
we cannot leverage the combined impact on the growth of the IT industry. As long
as the policy makers maintain this dichotomy, domestic growth will remain a
distant dream," he says. Hewlett-Packard India President Balu Doraisamy too
expressed disappointment. ‘‘There could have been a progressive reduction in
customs duty and a drop in excise," he says.

Though the hardware industry has welcomed the simplification of export-import
procedures and reduction of transaction costs and the introduction of value
added tax by April 1, 2003, there are several other issues. The Confederation of
Indian Industry had suggested that annual depreciation on IT products be
increased to 100%. "This would have encouraged the corporate sector to
upgrade technology more frequently. The reduction in excise duty on computers
and increasing the depreciation allowance would have had a greater impact on the
demand of IT products," CII president Ashok Soota says.

"Industry needed an import duty of 0% for components with depreciation
at 100% in Year I. Computer peripherals like printers and UPS’ need to be
given the same treatment as computers themselves, to bring down the overall cost
of ownership," says Invensys Powerware India’s managing director Deepak
Sharma.

Anil Jain, general manager for business development (marketing and
Innovation) at Wipro Infotech, points out the need for reducing customs duty on
key components of computers like motherboards, memory and power supply units
which are taxed at 15%. "Also, certain components like speakers, heat
sinks, Web cameras are taxed at a very high rate of 25%. This needs to be
reduced," says Jain.

As for why is it that software has had it good and hardware continues to be
‘neglected’, Nasscom’s Karnik stresses that this is no "hardware
versus software" battle, and that bringing down the cost of the PC is
crucial for the overall growth of the IT industry. As for why import duties on
PCs do not come down, Karnik points out that it is because of lack of focussed
lobbying. "I can say this in my personal capacity, not as a Nasscom
spokesperson. There are differing interests. A section of the industry doesn’t
want import duties to drop, as these people believe it will affect their own
local manufacturing business.

Even if it means a temporary hit to local manufacturing, import duties on
hardware need to come down. Only then will PC penetration improve and hopes for
a broader market be fulfilled.’’

Karnik explains that the government is lost on what the hardware industry
collectively wants and therefore, is hard-pressed to take any radical steps in
changing duties. ‘‘The two sections need to bury differing interests and
present a focussed case to the government," he adds.

The domestic market

The absence of a unified approach for promoting software and hardware, as
also services, is evident even in the case of the domestic software market. For
India to create a strong IT industry, contribution from the domestic sector has
to be substantially higher than the current 10%. The government also needs to
provide incentives for the use of local language software.

"Software consumption in India is very low. Domestic software packages
still attract taxes. Consumers should be offered incentives to use domestic
software," points out Manoj Kunkalienkar, executive director, ICICI
Infotech. Cisco India president, India and SAARC, Manoj Chugh says,
"Tariffs on high tech products, not manufactured in India, remain the
highest in the APAC region."

Focussed e-governance

Even as the center and state governments across the country trip over each
other to display their readiness to adapt to e-governance ways, few projects
actually make a notable difference. Sops for states to invest in citizen facing
projects as well as incentives for citizens using electronic-enabled facilities
would have helped the cause a great deal. But the Budget did not address these
issues.

"There was a mention of the use of IT in the income tax departments to
ensure tracking of income-tax assesses, but the FM was silent on the use of IT
in other government departments," points out Aptech CEO Pramod Khera.

In the current scenario, governments often do not even spend the prescribed
3% of their budgets on IT. And even if they do, spending is largely on the
purchase of PCs and small servers. There is rarely any long term planning in
terms of back-end infrastructure or organization-wide software applications.

"When governments want to exhaust their IT budgets at the end of the
year, the easiest thing to do is pile up PCs. Planning expenditure on software
and services requires greater clarity and accountability," says Partha
Iyengar, V-P and research director, applications development and IT services,
Gartner India. Iyengar also suggests that the Budget should have spoken about
the streamlining of the procurement process of IT products. Even as proprietary
software companies pitch for a share of the e-governance pie, proponents of free
software have suggested that the FM address the issue of adopting freeware as
the preferred software platform.

What next?

So much for the budget that was. For far too long, industries have pinned
their hopes as well as lobbying efforts on this annual exercise. But what can be
done in the year to come as well as in subsequent budgets to rectify what the
Budget failed to address?

Remedial Measures What can be done in the year to come as well as in subsequent budgets to give Indian IT the boost it deserves Simplification of exports’ procedures like permission for self declaration Avoidance of double taxation impact on employee stock options Tax incentives and boost to small scale units in small towns Specific infrastructure investment to spruce airports and approach roads to software technology parks (STPs) and export processing zones Creation of a fund pool to promote freeware. Provision of IT training from the primary school level Boosting domestic demand by further deregulation and privatization of key IT consuming sectors (such as telecom, financial services, etc) Enhancement of the pace and scope of e-governance initiatives Implementation of e-gov programs to spur domestic demand Development of a robust intellectual property law regime consistent with international standards and enforcement of anti-infringement provisions

"Firstly ensure that there is no discussion and roll-back on something
that is already promised like the 10A/10B factor," says iFlex Solutions CEO
Deepak Ghaisas. Pentasoft CEO D Kannan agrees, saying that major policies should
not be tinkered with every year.

"Currently small scale industry (SSI) units are not growing because once
they touch the turnover of Rs 1 crore, they are subjected to taxes. This tax
burden must be abolished," says B B Somani, MD, , Abee Info-Consumables.
Pramod Saxena, country president, continental India, Motorola expected import
duties/taxes on handsets to be further lowered as there continues to be thriving
gray market due to high rate of duties. "As services penetrate wider and
into the lower segment of the market, the cost of handsets will impact the
overall rate of growth," says Saxena.

Gaurav Taneja, tax partner, Ernst and Young points out that administrative
guidance is urgently required on withholding tax on import and licensing of
computer software. "The Income Tax Department has been taking a view that
all computer software, irrespective of the scale of licensing rights, would be
subject to withholding tax in India. This position appears to be in variance
with internationally accepted principles and could be a disincentive for
software imports, " says Taneja.

Oracle India MD Shekhar Dasgupta believes that the budget should have adopted
the Kelkar Committee recommendations in total (tax rationalization and removal
of current exemptions), rather than just the tax administration reform area.

Infrastructure

Even today, with the exception of Mumbai, Indian cities with the
concentration of IT and IT enabled service companies face severe power cuts.
Fast growing areas like Bangalore, NCR (National capital region including New
Delhi, Noida and Gurgaon) and Pune need to be rid of their power problems soon.
IT parks were essentially set up to overcome infrastructure hurdles like these.
However, restrictions related to the domestic: exports ratio in these zones have
inhibited growth. There is a need to examine whether these restrictions should
be removed.

"The growing ITES industry also needs special attention. It’s
dependency on power and communications infrastructure is well established and
these areas too need more focus," says Adi Cooper, chairman, Tracmail.

Dasgupta suggests that ITeS be treated as an Internet related infrastructure
project. ‘‘Allow 4% debt servicing moratorium, exemption of service tax on
leased circuits and import benefits similar to those offered to ISPs," he
says.

A case for security

Captain Raghu Raman, global practice head, special services group (SSG) of
Mahindra Consulting believes that the budget should have addressed the need for
making special concessions for the basic building blocks in information
security. He says, "The software and hardware in smart cards as well as IT
products like firewalls could have been made duty free."

In the FM’s shoes

The list of issues that "could have been addressed" continues to
grow, long after the Budget speech has concluded, but the ace juggler surely had
his reasons for not meeting these demands. So what was it that held him back?

Perhaps there were political compulsions and he had to swim with his hands
tied firmly behind his back. Maybe he was unwilling to commit to further
investments and expenditure on IT in an already strained financial situation.
Chandrasekaran V, chairman and CEO, Pentamedia believes that the budget largely
stayed away from the education and entertainment segments, perhaps because there
was no lobbying on this front.

"The FM has tried to reduce the burden on the common man. He has also
addressed the revival of other sectors. He has to offset his loss of revenues
due to the sops he has given to various sectors. He has also kept in mind the
prevailing war situation in the gulf and announced measures to insulate our
economy," reasons Uday Birje, Country Manager - India and SAARC, Enterasys
Networks.

Lessons from the globe

Strong domestic IT markets have spurred growth in economies like China and
Taiwan. How can our government replicate this success?

"For any service industry to grow, it is imperative to boost the growth
of products. Even though custom duty on capital goods in IT & Telecom has
come down from 25% to 15%, the import duty on products continues to hover around
40%. It is difficult to offer products at competitive prices, leading to slower
sales and growth cycle for the product segment," says Vineet Nayar, CEO,
HCL Comnet. The overall tax incidence here varies between 25% to 45% as against
17% in China.

"One of the innovative ways to trigger growth for IT products could be
to provide Income Tax based incentives on use of IT products," says Ashok
Soota, adding, "While we have mentioned 100% depreciation for IT products
in business, we would also like to moot the idea of Income Tax rebates on
purchase of IT products by salaried employees."

Alok Shende, Industry Manager (Information Technology Practice), Frost &
Sullivan India, cites the example of the Government of Singapore’s proactive
role in making Singapore a leading base for the cutting edge technologies. But
Zensar global CEO Ganesh Natarajan believes that the Government does not have
the ability to invest on the scale that China has done in Pudong or Zhuhai.
"It can provide simplification and basic infrastructure and leave the rest
to the industry," he says.

Special treatment?

Why not, says most of the IT industry. The IT and ITeS industries generate a
large number of jobs. It is essential that the government boosts this sector. So
what does this encouragement call for? "A vibrant domestic market for IT,
quality infrastructure, low price points and a high quality and quantity of
educational institutes," sums up Birlasoft COO Kamal Mansharamani. Though
it exists as a minority, there is a school of thought that believes that the IT
industry has been pampered enough by the government. Says Hanuman Tripathi, MD,
InfraSoft Technologies, "I feel the government has been quite benevolent to
the IT industry (much to the envy of other sectors) which is why the sector has
seen such exponential growth even in the most sluggish economic conditions.

Alok Shende of Frost & Sullivan India explains that beyond the fiscal
stimulus and Government’s own investments in IT, there’s not much that it
can do. So, the moot question is, "If some one’s doing well, do you just
continue to shower goodies on him, even at the expense of others who actually
need more attention?" The majority says you do. How then, will you
encourage outstanding performance?

Management gurus have endorsed performance-based rewards. Shouldn’t the
country’s CFO too reach for the stars?

Manjiri Kalghatgi