The Software Technology Park scheme under the Foreign Trade Policy (FTP) was introduced by the Government to boost the growing IT/ITES sector. The purpose of the scheme was to foster growth of the sector by providing the necessary impetus through tax incentives (i.e. direct and indirect tax).

Direct and indirect tax benefits stipulated under the STP scheme are mutually exclusive, which means even if the direct tax benefit is withdrawn by the Government (which is likely from April 1, 2011), the indirect tax benefits would still continue under the FTP. It is a known fact that the driving factor for setting up of the STP units was to avail the tax benefits, especially the direct tax benefit stipulated under section 10A of the Income Tax Act, 1961 (I-T Act).

Withdrawal of direct tax benefits may force industry players to evaluate the Special Economic Zone (SEZ) option wherein they may set up new units in the SEZ to avail the direct tax benefits. Section 10AA of IT Act allows the SEZ unit tax holiday for 15 years i.e. 100 per cent exemption in first 5 years, 50 per cent in next 5 years and 50 per cent in remaining 5 years subject to reinvestment. However, considering the fact that there is no clarity on the shifting/migrating of the existing STP units into SEZ, it may not be feasible for everyone to evaluate the option of setting up new SEZ units. Further, factors such as higher rental cost with a minimum lease commitment of 3-5 years in the SEZs are also forcing the industry to evaluate the SEZ option with more caution.

In the Budget 2011, the industry will be anxiously looking at the Finance Minister speech for the extension of the direct tax benefit to the STP units. Such extension would buy additional time for the STP units to evaluate future options as it is known fact that there is a sunset clause attached to the Income tax benefits which would expire sooner or later. However, it is likely that such extension (if any) may come with additional riders, which may not impress the sector as a whole.

This article discusses the options available to STP units for claiming indirect tax benefits after the expiry of income tax benefits (i.e. post March 31, 2011), and the challenges on account of recent amendment in the FTP in relation to services pertaining to IT/ITES sector.

Apart from the STP scheme, the FTP provides certain additional export incentive schemes wherein the export of services pertaining to the IT/ITES is eligible for indirect tax benefits i.e. Served From India Scheme (SFIS) and Export Promotion Capital Goods (EPCG). Both the schemes allow the service exporter to avail the full/partial exemption from the applicable customs/excise duty on its procurement.

The services eligible for the SFIS and EPCG schemes are defined in the FTP which includes the ‘Computer and Related Services'. Typically the services provided by the STP units include the computer software development, consultancy, implementation and data processing etc. Such services were included in the list of specified services defined under the FTP on which the benefits under SFIS and EPCG could be availed.

Under the SFIS scheme, the exporter of specified services is eligible for duty credit scrip which is equivalent to the 10 per cent of the value of the export proceeds received in convertible foreign exchange. This duty credit scrip can be utilised by the service exporter for import/local procurement of duty-free capital goods. Under the EPCG scheme, the service exporter can import the capital goods required for providing the specified services by paying a concessional rate of 3.09 per cent as customs duty with a condition that it has to fulfill an export obligation of 8 times the duty saved amount in 8 years. For example if the duty saved amount (i.e. difference between the effective rate of customs duty minus concessional rate of 3.09 per cent) is Rs 100, the export obligation would be Rs 800 which has to be fulfilled in 8 years.

Prior to January 1, 2011, the lists of specified services eligible for the benefits under the SFIS and EPCG scheme were common and were defined in the Appendix 10A of the Handbook of Procedure (HBP). The Government has recently issued a Public Notice No. 25/2010 dated 18 January 2011 (which is effective from 1 January 2011) wherein the list of specified services eligible for SFIS scheme has been defined separately under a new Appendix 41 in the HBP.

Interestingly the list of services specified under Appendix 41 does not include the services in relation to IT/ITES sector such as computer and related services. Effectively it means that the Government intent to limit the benefits of SFIS to service sector other than the IT/ITES sector.

Unlike earlier wherein the list of services eligible for availing benefit under SFIS and EPCG where common, now the service exporter has to look into two separate list of specified services for determining the eligibility under the respective export incentive schemes. It seems that Government has decided to prune the incentives granted to the IT/ITES sector by withdrawing the SFIS benefits. This has a far reaching impact on the sector as this amendment is announced in the year in which the direct tax benefit is also likely to be withdrawn. With this the IT/ITES sector is left with EPCG scheme (apart from the STP scheme) for claiming the indirect tax benefits.

It is crucial for the IT/ITES sector to represent the Government for amendment in the Appendix 41 of the HBP to include the services related to IT/ITES sector eligible for SFIS scheme. The SFIS is friendlier scheme as compared to the EPCG scheme for service exporters as it allows the service exporter to import/ procure the required capital goods without payment of any customs/excise duty with minimum compliance requirement as compared to the EPCG scheme wherein the service exporter has to pay a concessional customs duty of 3.09 per cent.

Although the intention of the Government is clear in terms of restricting the indirect tax benefits for the IT/ITES sector to EPCG scheme, it may be prudent for the sector to evaluate the EPCG scheme for availing the indirect tax benefits post withdrawals of the income-tax benefits.

It should be wait and watch strategy for the existing STP units and they may look forward to the Budget 2011.

(The author is Executive Director, Indirect Tax, KPMG.)

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