Budget 2003: SMEs can win too

Small and medium enterprises (SMEs) in the software sector can be major revenue earners and job creators, provided the government protects them and industry body Nasscom offers financial help to promote SME interests, says Sameer Kochhar in his analysis of Budget 2003-04

Sameer Kochhar suggests that the government should tax IT firms with a turnover of more than Rs 100 crore

Budget 2003-04 had two very clear messages—the middle class matters and small companies can win too. Despite the best efforts, or rather the lack of them, from lobbies and large companies, the benefits under section 10A/10B that allow full income tax exemption for software exports have not only been retained but reverted to a 100 percent exemption level. Last year 10 percent of the income of software exporters was brought under the tax net without as much as a squeak from the lords and leaders of the software industry.

But there was near panic in the SME community when the Kelkar report came down on them like a tonne of bricks, seeking abolition of tax exemptions for software exports. What made things worse was that there wasn’t an outcry for justice from the leaders of the industry. In fact, the beacon of Indian software industry, Infosys, went the extra mile by stating that software exporters should be taxed. Thank God, as an answer to a supplementary they clarified that even they would like to see SMEs exempt.

The software industry needs tax breaks to be internationally competitive in new lines of business like ITES and BPO, which have the potential to contribute 70 percent of the $50 billion export target by 2008. SMEs needed a level playing field vis-à-vis large companies that are of late indulging in predatory pricing practices, having prospered for a lot longer under a very benign tax and policy regime.

SMEs are likely to contribute $14 billion in exports by 2005. 40 percent of the SMEs were expected to go out of business over the next two years, resulting in a direct loss of 100,000 jobs and an indirect loss of 400,000 jobs, had the tax breaks been taken away. Large companies had the option of shifting their billing to tax havens while using India as an internal production base without accruing profits. SMEs had no such options.

An idea for Mr Singh
Here is an idea for the next Budget, which at no cost to the government provides much needed support to the SMEs and also caters to the noble desire of being taxed by some of the large companies. According to Nasscom data total software exports from India in 2001-02 were Rs 36,500 crore, and out of this Indian companies with more than Rs 100 crore in turnover accounted for 67 percent or Rs 24,455 crore, with MNC companies accounting for another 22 percent at Rs 8,030 crore. Even assuming a conservative 10 percent profit, the profit for these companies works out to Rs 3,248.5 crore. If one were to tax only these companies at the proposed rate of 35 percent we could generate over Rs 1,100 crore based on last year’s performance and over Rs 1,300 crore for the current year. The money thus collected can be viewed as a development cess and ploughed right back to promoting the IT industry as a whole and supporting companies that are less than Rs 100 crore in size in particular.

Look at what this money can achieve. 40 percent of it (Rs 520 crore) can foot almost the entire Department of Information Technology budget. Another 40 percent can make all STPI data communication links to SMEs free, set up SME promotion centres in every major market and fund hundreds of them with seed capital. And that still leaves the government richer by Rs 260 crore, which can be used as a fixed pool to adjust the tax refund demands based on totalisation agreements by mostly large companies on taxes they pay in the US and other countries on their fast diminishing onshore services.

Everyone is happy and the proposal is revenue neutral. Large telecom companies have a rural telephony roll out obligation to promote telecom penetration in the country. Similarly, this action will ensure effective penetration of IT and emergence of a strong and widespread SME software exports base as well.

More good news for SMEs
We also need to widen our understanding of real SME issues. The Nasscom demand on self attestation of Softex forms, instead of a qualified department like STPI doing so, if accepted by the government would have been harakiri for SMEs as it exposes them to the Inspector Raj and the vagaries of dealing with departments from Customs to Excise to Income Tax.

The long-standing issue of the adverse impact of the stipulation that software companies whose beneficial ownership changes would lose the benefits under 10A/10B has at long last been removed. This paves the way for fresh equity injections, mergers and acquisitions and a host of other growth options for SMEs. Incidentally, it also paves the way for the impending IPO of TCS, which is not an SME by any yardstick but would have lost its tax breaks had it done an IPO without the removal of this condition.There is also a raging debate on whether ITES has been slapped with a service tax. Let us limit the debate to whether that is the case for domestic ITES as nowhere has export of services been taxed.

Hardware impact
As far as the hardware industry is concerned, no one can really beat them in the self-inflicted injury game. As always they like to approach the Budget with such a long list of demands that someone in the finance ministry is blindfolded and forced to put a finger and pick the demand that is to be granted. This year, the finger pointed toward an excise exemption on pre-loaded software, which at best is an anomaly correction rather than a real benefit. No wonder almost no hardware vendor is proposing to pass on the Rs 500 or so benefit on this account to the consumer as the money was rightfully theirs to start with.

Finally, at the expense of repeating myself on the lines of what I have said when analysing every Budget for the past many years, the hardware industry needs only two things, a 100 percent deprecation that would increase PC penetration manifold, increase government revenues and give a deathblow to the grey market. This year was a golden chance of actually getting this benefit (come on, even the water treatment guys got it); the second significant step would have been the merger of the defunct EHTP scheme with the flourishing STP scheme to encourage hardware exports. By the time these two demands are met, it would be a point of no return for the hardware industry and we have only ourselves to blame.