Pranab Mukherjee?s Budget 2009-10 might have been largely branded as a conservative affair, but not for the $50 billion Indian software exports industry. Not only did the industry heave a sigh of relief as most of its demands had been addressed, it was elated that concrete steps are being taken to get the industry back on the growth path. Be it the one-year extension of the fiscal benefits under Section 10A/10B to mitigate impact of the recession and protectionist measures being adopted globally, or the removal of excise duty on packaged software, and also of the fringe benefit tax (FBT), all the relief measures brought an across the board cheer.
At the same time, a major dampener was the increase in minimum alternate tax (MAT) from 10-15%, which could increase the tax liability of IT companies.
And when one reads the fineprint, the tax maze could get even more puzzling for the uninitiated. As the euphoria settles down, we spoke to the chief financial officers and top honchos of some Indian IT and BPO companies to understand how the announcements will affect the topline and bottomline of the IT firms, especially when the global economic crisis has severely impacted the growth and profitability of the industry.
Extension of tax holiday for software technology parks of India (STPI) units has obviously brought cheer to the industry, but gains vary depending on how old the unit is.
If one were to read the fine print, the budget has only increased the sunset clause of the 10-year tax holiday for STPI units. What this means is that units which have been operating for 10 years now will get another year before they come out of the STPI. Demystifying the muted benefit, Infosys Technologies CFO S Balakrishnan says that some STP units of the company will go out of the tax holiday this year, while certain others will expire in the next year. Market analysts are also of the view that tax savings from the extension are not enough to make up for the loss in business due to reduced IT spend globally, but the move is beneficial for IT companies. Nevertheless, the extension of the fiscal benefits under Section 10A/10B is particularly important for small and medium businesses (SMBs) to facilitate their continued growth, provide parity with incentives under the special economic zone (SEZ) scheme and encourage the IT industry to move into Tier 2/3 cities.
The IT industry which has been severely impacted by the global economic crisis and has seen its growth rate half over the past fiscal (from over 30% to 16-17%) has been demanding the extension of the STPI by 3-5 years. Interestingly, this is the second consecutive one year extension for the STPI scheme under Section 10A of the Income Tax Act.
In addition, the budget has brought some clarity on the multiplicity of taxes on packaged software. So far, companies had to pay a service tax of 10%, an excise duty of 8% and a VAT of 4% on packaged software.
However, there will now be a distinction between software as a product or a service and will levy the respective tax accordingly.
Without any doubt, the global downturn has changed the business environment and has had a consequential impact on the Indian IT-BPO sector. Growth for the industry has slowed down to single digits in FY 2009-10 impacting new employment creation. At the same time, direct and indirect protectionist measures by major countries are threatening to impede the industry?s business models. Competitive pressures from other countries like China, Philippines, Vietnam, Brazil, Egypt etc, which offer substantial incentives such as taxation, training subsidy and rent free accommodation to attract global businesses, will continue to increase pressures.
Hence, this year?s fiscal exercise was a much-awaited event and keenly watched by the Indian IT industry. Impact of MAT is arguably the most complicated. For one, though the MAT rate has been increased by 50%, tax analysts reckon that the three year extension (from seven years to 10 years now) for availing the tax credit will set off the impact in many ways. Moreover, if the tax-holiday under the STPI does not get extended beyond 2011, companies will have additional three years to avail the tax credit accumulated over the years, which would have lapsed otherwise.
In simple words, MAT is the tax that companies pay when they are under some tax-holidays and are not eligible to be taxed under the standard bracket. However, companies get the tax credit for the MAT they have paid, which means that the MAT paid over the years gets accumulated and can be deducted from the tax liability of the company in stipulated time frame. ?If the tax credit cannot be completely utilised in one year, it is carried forward to the next year?s tax liability,? says Sudhir Kapadia, partner and tax head, Ernst & Young. ?Now, with the three year extension for availing tax credit, companies can get the full benefit of the accumulated MAT,? he adds. Take the case of India?s second largest software firm, Infosys Technologies. The company expects its effective tax rate to be 20% this year, up from 17% in the last year. According to Balakrishnan, there will be no impact of the MAT going up on the company?s balance sheet as ?the actual tax could be higher than the MAT. Even next year, our tax payout is expected to be higher than the MAT,? he says. As far as the tax credit is concerned, the company is looking at utilising it this year.
While companies were earlier paying 11.33% tax, which includes 10% MAT rate plus surcharge, the rate will now go up to 16.99%. Anand Vora, CFO of HTMT Global Solutions says that though the increase will impact the cash of the company, as the BPO firm will have to shell out more tax this year, in actuality it will not be much of an impact as the money will flow back into the company when it decides to avail the tax credit.
Vora says, ?If the STPI doesn?t get extended beyond 2011, our tax rate will become 34% like all other companies. In that case, we can deduct the MAT credit from our tax liability, which will increase significantly. The three year extension for tax credit will definitely help us avail full benefits.?
KTS Anand, CFO, NIIT Technologies agrees and says that the company will assetise the tax credit when the tax liability is huge. ?Increase in MAT has been balanced by expanding the time-frame for setting-off from seven years to 10 years which appears fair,? reveals Suresh Senapaty, executive-director and CFO, Wipro.
Despite the fact that the increase in MAT rate will be balanced by the extension in the timeframe of availing tax credit, in the short term, the impact will be felt by the companies as their tax liability will go up at least this year, wherever applicable. ?These are troubled times, when companies are looking at saving every single penny they possibly can,? notes an industry analyst.
At the same time, there is an industry consensus that the elimination of the FBT will remove a major administrative overhead of the industry. According to estimates, the IT industry was one of the biggest contributors to the Rs 8,000 crore collected as FBT last year due to its high expenditure on travel, hospitality and employee stock options. Senapaty says that the FBT removal will put more cash in the hands of a salaried employee in today?s times when salary increases are hard to come by.
Though the FBT component of the tax liability of IT companies was within the 2% range and even lower than 1% in some cases, IT companies are of the view that it will save a lot of procedure. At the same time, the removal will not impact the way in which companies structured the incentives paid out to their employees. While technically, companies had to pay tax on the perquisites dolled out to the workforce, it was the employees who had to bear the brunt. In most companies, incentives such as leased cars, club services were offered after the FBT component was deducted from them. It was only in the case of travel or hotel stays which were marked to the company?s account that invited FBT to be paid directly from the firm’s books. ?It will save a lot of procedure and earlier, every deduction had to be taken care of,? says Vora of HTMT. He adds that FBT component of the last fiscal?s tax liability was around 2-2.5%. However, Anand of NIIT says that the company was not deducting the FBT component from the salaries and the amount would go from the company?s books. ?But, the move will ease some pressure from the salaries,? he adds. The current financial year has seen very few companies giving out salary hikes with some even laying off employees. Given the circumstances, the removal of FBT has brought joy to both employers and employees.As we look ahead, while uncertainties of the global economic recession impact the industry growth, there are few who doubt the long-term potential of the IT industry.
The industry has the potential to achieve revenues of $225 billion and create employment for over 30 million people by the year 2020, says a Nasscom-McKinsey report. In order to realise these objectives, we need sustained efforts by all stakeholders, with the government chipping in with its own fiscal dollops for the industry.