The National Association of Software and Service Companies (Nasscom) on Thursday released its pre-budget recommendations for the IT sector and the start-up ecosystem. The industry body suggested that eligible start-ups should be levied taxes on Employee Stock Option Plan (ESOP) only at the time of sale of shares and letting resident investors of start-ups listed under the Department for Promotion of Industry and Internal Trade (DPIIT) pay only 10 per cent tax on sale of share instead of the current 20 per cent to bring them on par with non-resident investors.

The report also seeks clarity on continuation of income tax holiday for IT companies operating out of Special Economic Zones (SEZs) as most are now moving into hybrid work from home (WFH) model.

Also see: IT services industry on track to achieve double-digit growth guidance in FY22: Nasscom

The Finance Act, 2020, had earlier relaxed some of the ESOP tax norms such as deferred tax liability for employees of eligible start-ups till the expiry of 48 months starting from end of assessment year, the date to transfer shares allotted under the plan or the date the employee left the organisation.

It added, “It should also be noted that the above benefit is not a tax exemption, but only deferral of tax payment. Hence, it would be unfair to extend the ESOP relaxation only to eligible start-ups as defined in S.80IAC. Extending this benefit to all DPIIT recognised start-ups would help in boosting start-ups ecosystem in India.”

Taxation bias

Nasscom highlighted the taxation bias on long term capital gain (LTCG) wherein resident investors are paying 20 per cent tax (plus surcharge and cess) on sale of unlisted shares as compared to only 10 per cent (plus surcharge and cess) paid by non-resident investors.

“Considering the risk taken by investors to invest in start-ups and to promote investments (which could act as a strong engine for revival of the economy in the current times), it is important to align tax rate on LTCG for resident and non-resident investors,” the report said.

Adding, “The current tax provisions do not provide a level playing field to domestic investors vis-à-vis foreign investors. Harmonising tax rates for resident investors shall incentivise domestic investors to invest in Indian start-ups.”

It is important to note that countries like Japan, China, USA tax dividends at a rate of around 20 per cent in the hands of certain shareholders (individuals, corporates, etc.). This discrepancy could put resident shareholders in a comparatively disadvantageous position vis-à-vis shareholders of other jurisdictions, Nasscom said.

Income tax holiday for IT Companies

Owing to work from home, the IT -BPM sector in FY20-21 added 138,000 people, many have been joining from Tier 2 cities and rest working from their home towns. Nasscom estimated that industry is growing at around 3.2 per cent in terms of employee addition, the with the total touching about 4.47 billion in FY20-21.

This also bring in a lot of uncertainty around the tax relief enjoyed by IT companies for operating out of SEZs, as most employees are likely to opt for hybrid WFH in the near future.

Also see: Should India push for Customs duty on e-commerce at WTO?

“Currently, S.10AA income tax holiday for operations carried out from the unit in SEZ is under sunset and existing units are availing this for their residual tenure. Emerging from the Covid-19 pandemic, industry is implementing a hybrid working model where, unlike in the past, work will happen both on-site and remotely as a matter of routine. Earlier, this was considered a ‘temporary’ requirement but now it will just be a way of working. Industry is concerned that an aggressive interpretation of S. 10AA could lead to instances where officials may consider that work done remotely by workers of the SEZ Unit is ineligible for the tax holiday,” Nasscom noted.

“Enabling a long-term hybrid work model in the SEZs can greatly facilitate job growth and investments in tier-II cities. The industry will find it attractive to grow there through a hub and spoke model as companies would be able to leverage relatively smaller infrastructure to support larger workforce using a hybrid model. Entities operating out of SEZs will be also able to fully leverage the recent OSP reforms to implement a hybrid work model.”

Along with relevant clarification/changes in the SEZ rules, this reform will help attract new investments in SEZs, which otherwise pose restriction on hybrid model and do not offer any further income tax holiday, suggested Nasscom.

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