– By Naveen Aggarwal
India’s technology sector continues to demonstrate resilience amidst weaker global contracts, subdued hiring activities and clampdown on discretionary spend. With AI / GenAI taking center stage, there is increasing emphasis on areas such as semiconductors, data processing, cybersecurity, blockchain, amongst others. The sector expects this year’s budget to bring the much-needed reforms that will help unleash the next phase of exponential growth.
More legroom on Safe Harbors
Safe harbor provisions provide certainty and relief from rigorous tax scrutiny to taxpayers complying with specified conditions. The margin rate currently prescribed for IT and routine software development services is 17-18% for international transactions up to INR 200 crores. This is higher than the comparable benchmark and commercially unviable for taxpayers to adopt, thus the need to revisit the current margin rates and align it with global trends.
Additionally, the present threshold of INR 200 crores eliminates several medium sized companies and almost all the large companies from purview of safe harbour provisions, as the international transactions undertaken will likely surpass the limit. To augment a more comprehensive regime, the government should consider abolishing the threshold or increasing it to at least INR 1,000 crore, and also bringing in routine engineering design transactions also within the ambit, which will help attract fresh investments in the sector.
Fast tracking Advance Pricing Agreements (APAs)
The average timeline to conclude APAs’ in India is 4-5 years and, in many cases, get concluded post expiry of the period sought to be covered under the APA. During the period when APA is under negotiation, taxpayers are subjected to regular transfer pricing audits. There is a need to prescribe a timeline for concluding the same, including introducing a mechanism to fast-track processing of renewal applications as well as APAs’ for standard transactions, simplifying the compliances and holding regular audit proceedings in abeyance till APA process is ongoing. This will make the APA route more attractive and provide a predictable tax regime for technology companies with growing India interest.
Driving certainty on Significant Economic Presence (SEP) and Equalization Levy (EL)
Despite being a frontrunner in introducing these measures to tax the digital economy, ambiguities remain around its scope and compliance remit. Clarity is required around aspects such as its interplay with royalty, fee for technical services (FTS) transactions and attribution of profits in respect of SEP, etc. The expectation is that this year’s budget will likely refine these SEP provisions / guidelines to ensure that digital businesses are taxed fairly.
On EL, a critical ask is that the levy deposited should be allowed to be adjusted against the income tax liability in case of subsequent Permanent Establishment (PE) determination or Royalty/ FTS characterization. With EL here to stay, considering the uncertainty around ratification of BEPS (Base Erosion and Profit Shifting) Pillar One, an appeal mechanism for EL related disputes will help bring stability in the tax ecosystem.
Defined roadmap on implementation of BEPS Pillar Two
The sector, with its international operations and intricate value chains, is expected to get impacted by the global tax deal on BEPS. Several countries such as UK, Switzerland, Japan, South Korea, members of the European Union, amongst others have already adopted or looking to adopt BEPS Pillar Two. Therefore, a clear roadmap towards its implementation, which aims to deter profit shifting by setting a minimum effective tax rate of 15% for large multinationals, will be essential for companies to plan and comply effectively.
Relief from TCS on ESOPs
Pursuant to the recent amendments in overseas investment and Tax Collected at Source (TCS) regulations, remittance in respect of ESOPs issued by foreign entities to Indian subsidiary’s employees are covered within the LRS limit and potentially subject to TCS at 20%. While employees can claim credit in their income-tax returns, such TCS has a significant cash-flow impact. Remittance in respect of stock plans is out of the employees’ tax paid salary and the perquisite component is also tracked under the withholding tax provisions. There is therefore a need to provide relief from applicability of TCS on ESOPs and similar plans to help maintain their attractiveness as an employee retention tool.
Adding thrust to Make in India
One expects the PLI to get extended to newer sectors that involve manufacturing across hi-tech products, consumer and industrial electronics, computers, etc., bolstering domestic production and attracting investments. Growing sectors such as space, drones, in fact the growing tech startups, would greatly benefit from this fillip and keep the momentum going on the ‘Make in India’ sentiment.
No surprises, the tech sector will play the anchor role in India’s $10 Tn journey, given its heft in driving innovation, drawing investments and employment generation. One is hopeful that this budget sets the tone for a transformative growth led agenda for this sector to help build a globally competitive business ecosystem in the time to come.
(Naveen Aggarwal is the Partner, Tax at KPMG in India.)
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