The budget is presented! Lots of expectations and pre-conceived economic calculations are dashed against. Crowds of unexpected rewards are awarded. The IT industry, like its other cousins, also has been busy in searching for its share of the pie inside the complex economic web. As rumblings and whispers, joys and silence and angers, and objections greet the “gives and takes” of the annual economic extravaganza, VARIndia attempts to make you overhear the responses from the corridors of the country’s torch-bearing industry.
Poster Boys to feel the Heat: The Mat Impact
The software companies, which have consistently enjoyed and exalted tax-free status, appear to have finally run out of luck. The markets that had been gearing up for an extension of the tax exemption beyond 2009–10 under Section 10A/10B were jolted by the introduction of the Minimum Alternate Tax (MAT) of 11.33 per cent on adjusted book profits. Outlining this measure, the Budget states, “Every corporate taxpayer participating in the economy must contribute to the exchequer.”
NASSCOM is dismayed at the proposal to extend MAT on export incomes which are exempt under Sections 10A and 10B. Commenting on the budget, NASSCOM spokesperson says, “This is a regressive step that withdraws government’s commitment to provide tax incentives till 2009, on the basis of which companies have made their business plans and investment decisions. This could affect investor’s confidence and growth in this sector which is not only India’s biggest exporter (US$31.6 billion in 2006–07), but is the biggest employer in the organized private sector. It is our expectation that the introduction of MAT will be accompanied by an extension of the STPI scheme (and Sections 10A, 10B benefits) by 10 years, as suggested unanimously by the IT industry.
A quick calculation of the effective tax rate of large and mid-cap software companies shows that among large cap companies, HCL Technologies, with the lowest effective tax rate, may have to consider a larger tax provision relative to its peers. Infosys Technologies may also have to bear some additional outgo, while this proposal may be neutral for TCS, Wipro and Satyam. Among mid-cap software companies, MphasiS, Aztec Software, 3i Infotech, Subex Azure and Nucleus Software (the last two are product companies) may have to consider a higher tax provision. Small and fledgling IT companies will be the worst hit by the MAT. Companies like Aricent, Infrasoft, Birlasoft and MindTree Consulting will bear the brunt of this move.
Unhelpful FBT
To rub salt into the wound, the fair market value of employee stock options offered by software companies will also be taken into account for computation of fringe benefit tax. The restricted stock options issued by companies at face value or highly discounted price will also come within the purview of this provision. Companies such as Satyam Computers, Wipro or iGate have issued RSUs to their employees.
MAT will have an impact to the tune of 1.5 per cent to 2 per cent on the bottom lines of these companies. Companies housed in STPI, free trade zones, export processing zones, electronic hardware technology parks enjoyed this benefit which was previously available till 2009–10. Under Section 10B, tax breaks are available to companies located in EOUs. Earlier, they could claim full deduction on their export profits till 2010.
“It was agreed that there would not be any tax till 2009 under Section 10B. The government is going back on its commitment. Many companies base their investment decisions on the commitments that are given, this sends a wrong signal,” says Ashank Desai, Co-Founder, Mastek.
One of the options that STP units are exploring is shifting/migrating to the SEZ regime after March 31, 2009. Under the current provisions of Section 10A dealing with tax holiday for SEZ units, there are no splitting up/ reconstruction provisions. Budget 2007 proposes to insert splitting up/ reconstruction provisions in Section 10AA which are similar to those existing in Section 10A and 10B. If the proposals were accepted, existing STP units will not be able to migrate to the SEZ regime. This may create different playing fields for STP units vis-à-vis SEZ units.
The rate of Dividend Distribution Tax is proposed for increase from 14.025 per cent to 16.995 per cent. This will impact the amount of distributable dividends to shareholders and more so for foreign companies operating in India under wholly-owned subsidiaries, as in most cases this is not creditable.
Move to tax ESOPs a Regressive Step
Currently, ESOP expense in the case of an approved plan is not subjected to FBT. Further, the same is not taxable in the hands of employees at the time of vesting/exercise of the options. It is taxable in the hands of the employees as capital gains only at the time of selling the shares allotted under the plan.
The Finance Bill proposes to subject ESOP expenses to FBT. The FBT is proposed for levy on the difference between the fair market value of the options on the date of the exercise and the amount recovered from the employees. Guidelines for determination of the fair market value would be notified. To top it all, IT companies would have to shell out service tax on the lease rentals on commercial property, without the recourse of any set-off. On the move to grant
“pass through” status for venture capital funding in certain industries, the Budget had not evaluated all the needy industries before zeroing in on the selected ones. Sectors such as logistics and infrastructure could have benefited greatly if included under this umbrella.
S. Mahalingam of TCS comments on the provision, “For a sector that is reliant on human talent, bringing ESOPs under the FBT umbrella could also prove a dampener.”
According to Mr. Roopen Roy, Partner, PricewaterhouseCoopers, the proposed FBT on ESOP is a “regressive” measure. “Talent is everything in the IT industry, where one has to devise innovative ways of rewarding and retaining talent. The measure is not going to fetch the Government a lot of money, but it will be the knowledge worker who will be the loser,” he said
The Increase in Dividend Tax
The increase in dividend tax paid by corporations to 15 per cent from the current 12.5 per cent is also a burden as the IT sector has been good at utilizing its profits by investing in physical infrastructure and human resources for the future, rewarding shareholders consistently and act
ing as a magnet for drawing in large FII investments into the Indian market.
The net tax on corporates distributing dividend would go up from 14.025 per cent to 16.995 per cent (inclusive of Surcharge and Education Cess), for dividends declared or distributed after April 1, 2007.
For employee whole-time Directors, it would still make sense to have dividends as a preferred way of compensation, in contrast to salaries, which still attract a higher tax rate under the Income Tax Act.
No Cheers for Telcos
The telecom industry expressed disappointment as none of their major demands found a mention in the Budget proposals. Though the Finance Minister said the Government would consider the industry’s suggestion of replacing the existing multifarious levies and charges by a single levy, the industry was hoping for an initial reduction in their annual licence fee from a maximum of 10 per cent to a uniform 6 per cent of their revenues.
Union Budget fails to impress Channel Partners
Channel partners have reacted sharply to the Union Budget 2007–08, saying the Finance Minister has ignored the IT sector completely.
The only point they could find consolation in is the Central Sales Tax (CST) would be reduced from 4 per cent to 3 per cent has left very little for the partners to cheer about.
“It is just a part of the problem that the Government has cleared, but the main dilemma still persists. Without the removal of Form C from CST, this decision is not of any significance to us as it defeats the purpose of a uniform tax regime that VAT aims to achieve,” said a channel partner.
Keeping its fingers crossed, the channel community was hoping that the government’s financial policy for the new fiscal would help them wriggle out of certain critical problems.
Among other things, the channel wish list included pointers like duty reduction to 10 per cent from the present 12.5 per cent, excise duty reduction on IT products from 16 to 8 per cent. Partners are also anguished as the Finance Minister chose to ignore addressing issues like discrepancy on HSN vis-à-vis VAT in some states.
Also, the Budget is silent on the 8-per cent customs duty on packaged software and also issues like octroi abolition. MAIT welcomed the thrust given in the Union Budget to sustaining the national economic growth and making it inclusive. Further, the industry body expressed satisfaction that the Government has announced several schemes towards promotion of education, especially among the socially and economically backward.
Vinnie Mehta, Executive Director, MAIT, said, “We welcome the government’s decision to maintain the current excise and customs duty levels on IT products. The hardware industry supports long-term stability in policies and duty structures as frequent changes could adversely impact the investment and business plans of the industry. The last fiscal witnessed impressive growth in IT consumption as well as manufacturing investments and we are confident this momentum will continue this financial year. Further, the focus given on education is, indeed, very welcome as developing suitably skilled human resource is critical to sustain the competitiveness of the IT sector as a whole.”
While IT hardware firms in the country feel distanced by the Budget, they are happy that stability in duty structures is maintained.
The consumer electronics major, Samsung, is peeved that “this year’s Budget has virtually left the demands of the consumer electronics sector unouched”. “The only relief that has come to this sector is in the form of the reduction in the peak rate of customs duty from 12.5 per cent to 10 per cent, which gives some marginal relief for products that are imported as CBUs or the components that are imported,” said Mr. R. Zutshi, Deputy Managing Director, Samsung India.
Hardware sector bets on Computerization and e-Governance Initiatives.
In spite of their disappointment, many vendors kept their chins up and pinned hopes on the secondary effects of the e-governance and computerization thrust. The Finance Minister also announced an increase in the funds into e-governance to Rs.719 crore in 2007–08. The Central Government also increased support for state-level e-governance action plans from Rs.300 crore in 2006–07 to Rs.500 crore in 2007–08.
The reduction in duty on plastics from 12.5 per cent to 7.5 per cent will also offer some small relief.–“But the overall impact of this Budget on prices of consumer electronics products, there is no sign of relief coming to consumers,” said Mr. Zutshi. PC vendor HCL agreed, “Our expectations have not been met. From the end-consumer perspective, there is nothing to look forward to in the Budget.” The Budget has exempted USB flash memory, DVD drive and DVD writer from excise duty. It has also proposed to extend the retail sales price (RSP)-based assessment on personal computers, printers, monitors, computer keyboards, modems and Set-Top Boxes, among other products. The RSP extension date is to be notified later. Computers, printers and set-top boxes may become costlier with the Budget proposing to impose excise duty on retail sale price as against the factory-gate price at present.
Most of the hardware vendors welcomed the Budget’s thrust on e-governance and the stress put upon education.
Cisco’s reaction in this regard is worth mentioning. It expressed in a press release that the overall focus of the Union Budget 2007 on faster and more inclusive growth with a spotlight on rural development augurs well for the long-term economic development of the country. And, that it is a progressive and balanced budget from the economic perspective
Conclusion
As an adage goes, he who tries to please all pleases none. In the similar way, it is obviously difficult to wave the annual financial wand to ward off the ills in all sectors. While the hardware sector expressed its guarded delight over major announcements on e-governance and computerizations of the PDS and the status quo on the tax front, the software sector has received a jolt by the imposition of MAT, the heat on the ESOPs and the double dividend tax. While it has very less to offer to the channel partners, the telecom sector
seems not to be happy either. However, one thing is crystal clear that all these proposals really mean that the IT sector, which has been the flagship of India on the global map, rather than getting kudos, has been at the receiving end.
