The Hindu Business Line : A `taxing' interpretation

A supportive fiscal policy has been one of the driving factors for the Indian Information Technology (IT) and IT-enabled Services (ITES) industry. Sections 10A and 10B of the Income-tax Act, 1961 (`the Act') reflect one such incentive to this industry. Though the tax holiday under sections 10A/10B expires after March 31, 2009, of late, there has been a new controversy relating to the computation of the deduction available under the scheme.

The controversy

The Act provides that the deduction would be computed by applying the following formula: Profits of the business of the eligible undertaking X Export Turnover (ET)/ Total Turnover (TT). The controversy relates to the computation of ET and TT, which are very relevant for quantifying the deduction.

TT has not been defined in section 10A/10B. However, ET has been defined as: `export turnover' means the consideration in respect of export by the undertaking of articles or things or computer software received in, or brought into, India by the assessee in convertible foreign exchange in accordance with sub-section (3), but does not include freight, telecommunication charges or insurance attributable to the delivery of the articles or things or computer software outside India... "

While interpreting and applying the above provisions, the tax department has taken a stand that:

a) The lease line (connectivity/communication) expenses incurred by the IT/ITES companies are in the nature of telecommunication charges attributable to the delivery of computer software outside India, and should accordingly be reduced from ET; and

b) No such corresponding adjustment should be made to TT In the absence of its definition in sections 10A/10B.

The tax authorities have already completed two rounds of assessments and raised significant tax demands on this basis. There are also instances where closed assessments for earlier years have been re-opened to modify the computation of the deduction.

The other side

The taxpayers naturally have a reason to be unhappy with the above interpretation, which seemingly goes against the very intention of section 10A/10B to provide for a complete tax holiday for 100 per cent export-oriented units. Some of the arguments of the taxpayers are as below:

The exclusion of any amount from ET towards freight, telecommunication charges and insurance ought to be made only if such amount is included in the invoice as an outlay to be reimbursed for the delivery of the product, over and above the sale price of the product concerned. If the taxpayer is not recovering from the customers in respect of such outlay (being reimbursements), and hence not including it in the export consideration, the question of reducing such expense from ET ought not to arise;

The method of computation of the deduction under section 10A/10B is similar to the method of computation of the deduction under sections 80HHC and 80HHE of the Act. Therefore, in the absence of the definition of TT in sections 10A/10B, the definition/clarifications should be borrowed from sections 80HHC/80HHE, which provide for a similar adjustment to TT;

Even to a layman, TT would mean ET plus domestic turnover. Accordingly, where the entire turnover of the Company consists of ET, TT should be equal to ET;

In a formula, there should be parity of basis between the numerator and the denominator to give a correct yield. As such, in the event of any change to ET, a corresponding change would also have to be made to TT;

The lease line charges are generally used for various purposes, including regular e-mails, calls, etc. As such, it is not practically possible to determine the expenses incurred only for the actual delivery of software outside India; and

If at all any adjustment is to be made, it ought to only be of a portion of the lease line expenses, and the total expenditure cannot be considered to be attributable to actual delivery of software.

Case for Clarification

Leaving aside the technical arguments, there appears to be less force in the above position of the tax authorities, as their interpretation leads to a conclusion that even in the case of a company that has 100 per cent export sales, the entire profits would not be eligible for deduction under section 10A/10B! Surely, this was not the intent with which the tax holiday under sections 10A/10B was introduced.

The aggressive position being taken by the tax authorities on this matter is one of the many issues the IT/ITES industry is currently struggling with.

A suitable clarification on this matter in the forthcoming Union Budget, 2007, can save the IT/ITES industry from avoidable litigation before the tax tribunal and the courts.

(The authors are Bangalore-based chartered accountants.)