UNION BUDGET 2008-09: IMPLICATIONS FOR THE INFORMATION TECHNOLOGY COMPANIES

BUDGET 2008-2009 IMPACT ON BPO/ITES

HIGHLIGHTS OF THE BUDGET VIS-A-VIS INFORMATION TECHNOLOGY SECTOR

DIRECTLY IMPACTING IT SECTOR

   1. No confirmation on the extension of the income tax exemption available to Companies /units registered as Software Technology Park Units ('STPs') beyond Financial Year 2008-09.

   2. Imposition of service tax on the software and related services and changes in the CENVAT Rules.

   3. Increase in the excise duty applicable on branded / packaged software from 8% to 12%.

   4. Changes in FBT related provisions.

   5. Issues related to income tax, service tax, etc.

 

INDIRECTLY IMPACTING THE IT SECTOR

   6. Significant increase in the personal income tax rates and slabs, which will benefit employees of IT corporates.

 

OUR DETAILED ANALYSIS

   1. LIKELY WITHDRAWAL OF SECTION 10B WITH EFFECT FROM APRIL 1, 2009:

• Belying expectations from the IT industry, the Budget does not talk about the extension of the tax exemption available to IT corporates operating as export oriented units registered under the Software Technology Parks of India. The tax exemption covering the export profits of STP units as laid down by Section 10B of the Income tax Act, 1961, is all set to expire on March 31, 2009. The tax holiday withdrawal would mean that the STP units/companies would be required to pay tax in respect of Financial Year 2009-10 and onwards.

• Under the current scheme of things in the Income tax law, there is no tax exemption for software exporters who do not operate as STP units or SEZ units and consequently, the withdrawal of the tax holiday would not impact the non-STP/SEZ IT exporters, including software exporters.

• With effect from April 1, 2007, i.e. the current financial year, Minimum Alternate Tax ('MAT') has already been imposed on STP Units. MAT is payable on a company's Book Profits @ 10% plus Surcharge plus Education Cess of 3%. At the highest level, the MAT would work out to 11.33%. All STP Units are required to pay MAT on their book profits and this will continue into the next year and subsequent years. Fortunately, there has been no change in the MAT rate. Of course, the MAT payment made by the STP units is adjustable against their' future years' normal tax payments and this adjustment is available for a period of seven years.

STP UNITS VIS-A-VIS SEZ UNITS :

• The tax exemption given to the IT exporting units located in Special Economic Zones, under Section 10AA of the Income tax Act, continues. Very briefly, tax exemption is available for a period of 15 years from the year in which the SEZ unit is set up, without any sunset clause. Thus, if an exporting unit is set up in an SEZ area in 2015, it would still be entitled to tax exemption for 15 years starting from 2015-2016. Apart from the tax exemption under Section 10AA, SEZ units are not liable to pay MAT. This apart, there are several other fiscal incentives including non-imposition of service tax, etc.

Moving to an SEZ area would be essential for IT corporates, to be able to avail of the tax exemption beyond 2008-2009. We could thus see a scramble for space in the SEZs, as we go into 2008-09. However, we must caution that IT STPs which are planning to move into SEZ units would need to ensure that they do not get caught by the restrictive conditions laid down in Section 10AA related to 'reconstruction of business' etc. in which case, tax exemptions under Section 10AA would be denied, despite having moved into an SEZ.

Many IT STPs have been set up in specific industrial or software or technology parks, which are not recognized as SEZs. All of these STPs would lose the tax holiday with effect from April 1, 2009.

 

2. IMPOSITION OF SERVICE TAX ON SOFTWARE SERVICES

Till now, software services were exempted from the payment of service tax. However, IT Enabled Services, BPO services, KPO services, etc. are already being subjected to service tax. The Budget 2008-09 has brought in software services within the service tax net. The following services falling under a new service called 'Information Technology Software Service' will come under the service tax net from the time the Finance Bill 2008 is notified.

      'Information Technology (IT) software service' includes

• Development (study, analysis, design and programming) of software.
• Adaptation, up-gradation, enhancement, implementation and other similar services in relation to IT software.
• Provision of advice and assistance on matters related to IT software, including:

•  Conducting feasibility studies on the implementation of a system,
• Providing specifications for a database design,
• Providing guidance and assistance during the start-up phase of a new system,
• Providing specifications to secure a database,
• Providing advice on proprietary IT software.
• Acquiring the right to use,-
• IT software for commercial exploitation including right to reproduce, distribute and sell,
• software components for the creation of and inclusion in other IT software products,
• IT software supplied electronically.

Software consists of carrier medium such as CD, Floppy and coded data. Softwares are categorized as "normal software" and "specific software". Normalised software is mass market product generally available in packaged form off the shelf in retail outlets. Specific software is tailored to the specific requirement of the customer and is known as customized software. Packaged software sold off the shelf, being treated as goods.

 

IT IS CLEAR THAT ALMOST ALL ACTIVITIES CONNECTED TO THE SOFTWARE SERVICES SECTOR INVOLVING DEVELOPMENT OF CUTSOMIZED SOFTWARE WOULD COME INTO THE SERVICE TAX NET.

• For exporters of software services / customized software, the imposition of service tax might afterall be a 'blessing in disguise', as they would be entitled to claim a refund of the service tax paid by them on their input services like rentals, etc., which they are not able to utilize against their output service tax liability. In the earlier scenario, since software services were considered 'exempted services', no service tax refund was possible.
• For IT STPs in the software space, the imposition of service tax would not make any difference vis-à-vis service tax payment to the Department, as export of any services is anyway exempted from payment of service tax under the Export of Services Rules, so long as the sale consideration is received in convertible foreign exchange and subject to fulfilment of certain other conditions.
• For exporters of IT Enabled Services etc. the imposition of service tax on software services will make no difference, as IT Enabled Services are already under the service tax net and there is no levy of service tax on exports, as aforesaid.
• There are significant changes in the Cenvat Credit Rules, 2004, which govern the availability of cenvat credit for service providers. The existing Rule 6(3) dealing with service providers who provide taxable and exempt services is proposed to be replaced with a new rule which talks about reversal of proportionate credit or payment of 8% service tax on the exempt services.
• In our opinion, with software services becoming taxable, we feel that almost the whole of the IT industry has now come into the service tax net. Of course, the levy of service tax will indeed affect players catering to the domestic market.

3. INCREASE IN THE EXCISE DUTY RATE ON PACKAGED/ BRANDED SOFTWARE

• The excise duty on branded / packaged software has been increased from 8% to 12%, with effect from March 1, 2008, vide Notification No. 12/2008 All 'off –the-shelf' software packages like TALLY are considered as 'packaged software' which is considered to be 'goods' for purposes of levy of excise duty and Value Added Tax. In addition to the excise duty @ 12%, VAT would be applicable @ 4% on sale of branded / packaged software.
• No service tax is applicable in respect of sale of branded/ packaged software. Similarly, no VAT or sales tax is applicable in the case of customized software services.

4. CHANGES RELATED TO FRINGE BENEFIT TAX

• In a major development which would hit most employees of IT corporates, the FBT exemption on 'paid vouchers' will henceforth be restricted only to expenditure on or payment thro' non-transferable pre-paid electronic meal cards usable only at eating joints or outlets, subject to fulfilment of conditions to be prescribed by the Central Board of Direct Taxes. Many IT Corporates follow the practice of paying a part of the remuneration of their employees thro' SODEXHO or similar transferable pre paid vouchers, which can be used by these employees for a variety of purposes at various joints and departmental stores. This practice is being plugged by the Department and henceforth, it would be only pre-paid electronic meal cards which would be exempted from FBT. The CBDT will specify the upper limits for these cards which cannot be transferred. Private sector banks like AXIS Bank are issuing these cards which will now have to be re-issued to fit into the new logic. Most IT corporates can expect this to impact the take home salaries of their employees as the amounts till now, paid thro' SODEXHO or similar vouchers, would henceforth have to suffer FBT.

• THE FBT related provisions are being amended to provide that the following payments shall not be considered for FBT levy, viz.

1.      Payment which fulfils any statutory obligation

2.      Payment which mitigates occupational hazards

3.      Providing first aid facilities

4.      Providing crèche facility for the children of employees

5.      Sponsoring a sportsman, being an employee

6.      Organizing sports events for employees

Given the wide reach of FBT, we would strongly advise our clients to take care of whatever exemptions that have been specified. For instance, it's a common practice for IT companies to take their employees out, for picnics / get-togethers. They are advised to have some sports event (including tug-of-war games, in a lighter vein) based on which they can avail of the aforesaid exemption.

• The FBT rate on Festival Celebrations has been reduced from 50% to 20%.
• It has been clarified that maintenance of any accommodation in the nature of a guest house other than accommodation used for training purposes, would be exempted from FBT.
• Levy of FBT on ESOPs, introduced in the 2007-08 Budget, continues. FBT on other items also continues.

 

5. ISSUES RELATED TO INCOME TAX ETC

• The Income tax returns and Fringe Benefit tax returns would now have to be filed on or before September 30, 2008 in respect of 2007-08, INSTEAD of on or before October 31, 2008. A similar procedure would have to be followed for the coming years, as well.
• All IT corporates would now need to plan their closure of accounts, audit and the filing of the Income tax returns in a more effective manner.
• There are no changes in the corporate income tax rates, surcharge rates, education cess rates and TDS rates.
• Weighted deduction of 125% is now available to payments made to companies engaged in research and development.
• Banking Cash Transaction Tax (BCTT) is withdrawn.
• A Parent company is now allowed to set off dividend received from its subsidiary company against the dividend distributed by the parent company, for purposes of payment of Dividend Distribution tax. This is a good move which will eliminate double taxation of the same element of dividends. There is no change in the position that dividends are exempt in the hands of the shareholders.
• Section 40A(3) disallowance for cash payments is now being modified to cover all transactions within a day to the same party, upto an amount of Rs 20,000/- .
• Amount of deferred tax and the provision thereof and interest charged under the Income-tax Act will now be added to the net profit to find out the 'book profit' for levy of Minimum Alternate Tax, with retrospective effect from the assessment year 2001-02.
• TDS certificates in the physical format will continue till March 31, 2010.
• The initial / threshold exemption limit for service tax payers has been increased from Rs 8 lakhs to Rs 10 lakhs. Consequently, it becomes compulsory for a service provider to obtain registration, if the value of taxable services provided by him exceeds Rs 9 lakhs.

 

6. CHANGES IN THE PERSONAL INCOME TAX FRONT

Contrary to the dismal outlook for IT corporates vis-à-vis this Budget, there is a lot of good news for employees on the personal taxation front. These are briefly summarized below:

• The threshold limit of exemption raised. In the case of all assessees, from Rs. 110,000 to Rs. 150,000. In the case of women assessees, from Rs.145,000 to Rs. 180,000 and in the case of senior citizen, from Rs. 195,000 to Rs. 225,000; The four slabs and rates will be as follows : Up to Rs. 150,000 Nil; Rs.150,001 to Rs. 300,000 10 per cent; Rs. 300,001 to Rs. 500,000 20 per cent; Rs. 500,001and above 30 per cent.
• The Senior Citizens Savings Scheme, 2004 andthe Post Office Time Deposit Account added to the basket of saving instruments under Section 80-C.
• Additional deduction of Rs. 15,000 under section 80D to a individual who pays medical insurance premium for his/her parent or parents.
• The rate of tax on short term capital gains under Section 111A and Section 115AD raised to 15% from 10%.
• For the sake of easier understanding, we have compiled a table showing the pre and post Budget income tax liability for individuals.