A balanced budget for the IT sector

In his Budget speech, Finance Minster Jaswant Singh acknowledged that the IT industry is India’s success story and expressed the need to not just maintain its momentum of growth but continuously encourage it. Mani Bharadwaj of Deloitte Touche Tohmatsu delves into the provisions behind this sentiment, and analyses what they all really mean for the industry. While the overall impact is positive, the widening of the service tax net and the increase in the quantum of service tax could prove to be a bit of a dampener

The Budget can be perceived as an honest attempt to boost the information technology industry, says Mani Bharadwaj

The last year witnessed the Information Technology industry slowing down compared to the strong growth witnessed in the dot-com boom period. Economic recovery around its key markets, especially the US, is slowly picking up though the business environment continues to be uncertain. The US being the largest market for Indian software exports, capital investment on equipment and technology by Indian majors continues to be subdued. Outsourcing is becoming a preferred way of service offering and India is trying the cash in on this next wave.

According to the National Association of Software and Service Companies (Nasscom), the software industry will log a 34 percent annual growth in the years ahead to touch $80 billion in turnover by 2008. The industry has been clocking growth rates of nearly 75 percent in the IT-Enabled Services (ITES) space last year. The software exports industry has also been clocking a decent better-than-20-percent growth in the last year despite a worldwide slowdown in IT spending.

The Union Budget 2003-2004 presented by Finance Minister Jaswant Singh has many provisions that should spur the IT industry. The Finance Minister has in his speech recognised that the IT industry is India’s showpiece success story and has therefore expressed the need not just to maintain its momentum of growth but continuously encourage it. The high potential of IT to generate wealth, foreign exchange and employment has already caught the imagination of India’s businessmen, citizens, economists, bureaucracy and politicians. As part of the current year’s Budget, the commitment of the government to continue the strong support extended over the years is clearly visible.

Let us analyse the impact of the Budget on some significant areas of Information Technology.

The hardware industry
In the last few years, the IT hardware industry in the country is being overshadowed by the strong performance in the software and services segment. The hardware industry has received some sops in the past with cutbacks in the Customs and excise duty rates in previous Budgets. The industry expected further rationalisation again in the current Budget.

Customs duty: Electronics and the IT hardware sector requires a conducive manufacturing environment. Considering the key role of information-based industries, in March 1997 India joined the Information Technology Agreement (ITA), which is a multilateral agreement within the WTO, which aims to expand world trade in information technology products. According to the agreement, customs tariff on IT items was to be brought down in stages to zero. As per plan, India had committed to bring down tariffs on 217 bound items, out of which 95 lines are to be reduced to zero percent customs duty by the year 2000, four lines in 2003, two lines in 2004 and the balance 116 lines in 2005.

In the current Budget, customs duty on twelve electronic components has been reduced in conformity with the commitment made to the WTO. Further, customs duty on specified telecom equipment for manufacture of components used by the telecom and the IT industry will be reduced from 25 percent to 15 percent. Customs duty on optical fibre used widely for networking and providing bandwidth for the IT community will be reduced from 25 percent to 20 percent. At the same time, to provide a more level playing field, customs duty on specified raw material for manufacture of E-glass roving has been reduced from 30 percent to 15 percent. Also, customs duty on routers, modems and fixed wireless terminals has been reduced from 15 percent to 10 percent. Otherwise, excise duties for IT and IT related products have been left untouched. This reduction in excise duty should help reduction in hardware prices to the end-customer.

Excise duty on preloaded software: In the current Budget, the Finance Minister removed an anomaly wherein pre-loaded software (like the operating system and Office tools) was subject to excise duty when software is already exempt from excise duty. Post-Budget, the value of loaded software in case of computers would be excluded for the purposes of charge of excise duty on computers. This should bring down the total price of the hardware to the end customer, but only marginally.

Tax holiday: The tax holiday available for telecom and domestic satellite service companies’ network of trunking, broadband network and Internet services has been continued till the end of March 2004. This should help new companies that have got into these segments and help their profitability in these early years.

The software industry
The Indian software industry juggernaut continues to roll along in spite of a slowdown in its key markets. The industry continues to move up the value chain and the mind share of the industry continues to grow in the key markets. But small and medium players without deep pockets are under lots of pressure in the current context. Key industry players have expressed that the next few years would be the time for consolidation in the industry.

Tax incentives: The Finance Minister has rightly pointed out that the industry’s success is India’s showpiece success story and has repeated the government’s commitment to help sustain this growth. The Kelkar Committee task force had recommended that the tax incentive under section 10A and 10B for companies engaged in manufacturing computer software be provided only till the ‘totalisation’ agreements are signed with trading partners like the US. The minister has rejected this recommendation and the concessions extended under these sections will continue as originally envisaged.

Continuing tax incentives on transfer of ownership: Further, in an important amendment in the Finance Bill 2003, the Finance Minister has proposed the deletion of section 10A(9) and (9A) and section 10B(9) and (9A), thereby ensuring that tax incentives in relation to the tax holiday are not lost on change in the ownership of the companies or change in shareholding. This will encourage the industry through its period of consolidation by encouraging mergers and acquisitions. The tax holiday will be available to the amalgamated company or the resulting company in the case of an amalgamation or de-merger. This should help software companies consolidate their operations in association with other appropriate companies, resulting in better quality, standardisation and efficiency.

Indian companies going global: Further, corporates with a proven track record have been permitted under the Budget to make overseas investments in areas other than their core areas under the automatic route. The current limitation, limiting overseas investment to 50 percent of the net worth of the Indian company, is being raised to 100 percent. Industry experts expect Indian companies to announce big-ticket acquisitions during the coming months as an outcome of the proposed changes. The proposals are widely expected to benefit information technology companies, which are scouting for growth opportunities abroad. This is especially considering that most acquisitions by Indian companies overseas have been all-cash deals.

Service tax concessions: Service tax has been another area where certain concessions have been available to the industry. The previous Budget provided for exemption from service tax on services of ‘consulting engineer’ in relation to computer software and also exempting the levy of excise and Customs duty on IT software.

To encourage the ITES sector, the current budget has provided for service tax exemption for the ITES segments of data processing, networking, back-office processing and computer facility management.

Service tax inclusions: However, in the current Budget, revenue streams like training, coaching and annual maintenance services have been brought under the ambit of service tax. All the services of the computer training industry will come in the service tax ambit. The fledging Internet café industry has also been brought in its ambit. Further, the rates of service tax have been increased from 5 percent to 8 percent, which will have an impact on services of ‘online information, database access or retrieval’ already in the ambit of service tax.

Besides the above, the other new services brought under the service tax net include business auxiliary services, franchise services, commissioning or installation, maintenance or repair, technical testing and analysis, technical inspection and certification.

Simplifying procedures
Filing returns electronically: In the next assessment year, assessees will be granted option to file returns of income in electronic form in accordance with a scheme to be notified. Corporate assessees will have to file returns for TDS in electronic form.

Self-assessment of customs duty: In case of customs duty, a procedure of self-assessment has been introduced for both importers and exporters. Physical inspection of imported goods will be done using risk assessment and management technique based systems. The existing system of concurrent audit is to be replaced by a system of post-clearance audit.

Tax clearance certificates: The provisions for obtaining tax clearance certificates by persons not domiciled in India have been simplified. Such persons will only be required to furnish an undertaking to the prescribed authority to the effect that tax payable by such person shall be paid by the payer of income. These proposed amendments will take effect from June 1, 2003.

Conclusions
In summary, the hardware industry has got more concessions in this Budget in the form of reduced customs duty on many hardware components, elimination of excise duty on pre-loaded software and the continuation of the tax holiday till March 2004 for specific industries. These measures should help bring down the cost of the hardware and thereby serve the objective of supporting the software industry where significant growth is expected. As far as the software industry is concerned, there are many incentives, starting from the extension of the tax exemptions, making the tax exemptions applicable on the transfer of ownership of software companies and exemption of service tax for ITES—these measures should be welcomed by the software companies. However, the single negative fallout has been the inclusion of some more activities—including training, maintenance and business auxiliary services—into the ambit of service tax, and further, the increase in the service tax from 5 percent to 8 percent. This would increase the cost of some software services, and to that extent may be considered as a dampener by the software industry. But, on the balance, the Budget can be perceived as an honest attempt to boost the information technology industry.

Mani Bharadwaj is director, Deloitte Touche Tohmatsu India. He can be contacted at mani.bharadwaj@dttin.com