In the drive towards
cutting down on litigation and with the objective of creating a stable and
certain tax environment for industry, including specifically for sectors like
the IT / ITES sector which has been the torchbearer of India’s growth story, the
issuance of the CBDT circular on several aspects related to the tax holidays
under section 10A, 10AA and 10B of the Income-tax Act, 1961 (“the IT Act”) is a
welcome move, particularly in an environment where the tax holidays have been
constantly denied by the Revenue Authorities (“RA”) on some ground or the other
leading to litigation.
The Government had
constituted a committee on August 3, 2012 under the chairmanship of Mr. N.
Rangachary, former Chairman Central Board of Direct Taxes (“CBDT”) and The
Insurance Regulatory and Development Authority (“the Committee”) to look into
issues impacting the IT sector. The Committee submitted its first report on
September 14, 2012 (referred to as ‘Taxation of Development Centre and IT
Sector’ providing various recommendations on direct tax issues pertaining to the
computer software industry) to the Finance Minister, to resolve the points of
controversy in relation to the interpretation of the statute as well as
recognizing the business practices followed by the industry.
The CBDT has now
issued Circular No. 1/2013 addressing many of the pending issues, which appears
to have taken into consideration the representations of the industry, as well as
the recommendations of the Committee. A summary of the clarifications and the
context in which they have been issued has been captured in the following
paragraphs.
1.
Onsite software
development and manpower deputation
CBDT
clarification:
(a)
CBDT has clarified
that tax holidays shall not be denied merely on the ground that the “software
was developed onsite” so long as the same is developed pursuant to a contract
between the client and the eligible Unit/Undertaking, depicting the direct and
intimate nexus or connection of the development of software abroad with the
Unit/Undertaking in India.
(b)
CBDT has also
recognized that it is a common practice followed in the software industry to
depute technical manpower at the client’s place abroad to facilitate software
development activities such as up-gradation, testing, trouble-shooting,
modification, etc which requires constant interaction with the client.
Considering this, CBDT
has clarified that the deputation of technical manpower abroad shall not in
itself be considered detrimental to claiming tax exemption, provided that such
deputation is for development of software and linked to onsite projects carried
out by offshore Units in India claiming the holiday.
BMR
Comments:
Most software
companies work on a mix of onsite and offshore model and the deputation of
employees on long term onsite projects is a common practice. In recent years,
the RA had started denying tax holiday on such onsite development on the grounds
that no software was developed by the Units India and deputation of employees
amounts to only “manpower supply” or “body shopping”. The circular recognizes
the business realities and /or contractual obligations that may warrant onsite
development of software and deployment of manpower by Indian Units claiming tax
holidays. .
2.
Statement of Work vs
Master Service Agreement
CBDT
clarification:
The CBDT has clarified
that typically a Statement of Work (“SOW”) outlining project specific obligation
between taxpayer and the client would prevail over the Master Service Agreement
(“MSA”) which specify the broader and general contracting terms between parties.
The exception however, would be in a situation where the Assessing Officer is
able to establish that there has been splitting up or reconstruction of existing
business or non-fulfilment of any prescribed condition and the MSA is drawn up
separately to couch such reality. It also clarified that it is not essential to
enter into a separate and specific MSA for each
SOW.
BMR
Comments:
It has been a growing
practice of RA seeking to deny tax holiday on the ground of reconstruction or
splitting up of existing business on the basis that a single MSA covers multiple
Units, which ignores the fact there could be multiple SOWs for projects carried
out by more than one Unit. By reiterating the supremacy of the SOW over an MSA,
in a situation where there are no Unit wise MSAs, and instead placing onus on
the RA to establish that there is non-compliance of any condition to constitute
splitting or reconstruction of business, the clarification would greatly ease
the practical difficulties at tax assessment stages and the consequent
litigation that follows. This would benefit companies undertaking business
through multiple tax holiday units under the ambit of single MSA but different
SOW.
3.
Migration or change of
ownership of eligible unit/undertaking
CBDT
clarification:
(a)
Change in the
ownership of an Unit/Undertaking in case of a slump sale of its business, shall
not hinder the entitlement of the purchaser to claim tax holiday for the
unexpired period, at the rates as applicable for the residual tax holiday
period.
(b)
Physical relocation of
an eligible Special Economic Zone (“SEZ”) unit from one SEZ to another[1] with the approval of Board of
Approvals shall not disentitle such unit from claiming tax holiday for the
unexpired period.
(c)
Setting up and
co-existence of a new Unit/Undertaking alongside an eligible Unit in the same
location after obtaining necessary approvals from the competent authorities,
would not in itself amount to expansion of existing Unit/Undertaking, unless
other specific and determining tests for splitting up and reconstruction fail.
BMR
Comments:
These again are
important clarifications in the context of companies seeking to realign and
reorganize business operations which may also involve Units claiming tax
holiday. Clearly, the intention of the CBDT seems to suggest that so long as
the substance of the restructuring or realignment of business is not driven by
tax holiday needs, but arises more from commercial exigencies, such changes in
the location, ownership or transfer of business undertakings cannot be used by
the RA to deny tax benefits.
In the past, RA have
taken a view of not allowing tax holiday on slump sale of business on the ground
that there is a change in ownership and tax holiday sections covers only
reconstruction on account of amalgamation or demerger and not slump sale. This
view was struck down by the Bombay High Court decision in the case of Sonata
Software Ltd[2]. Seen in this
backdrop, CBDT’s clarification is again welcome.
4.
Separate books of
account
CBDT
clarification
Maintenance of
separate books of accounts is not a requirement prescribed under the IT Act for
claiming tax benefits (under sections 10A and 10B of the IT Act), although an
Assessing Officer may seek details pertaining to different Units claiming a tax
holiday, to enable him to verify the claim and quantum of exemption.
BMR
Comments:
While neither the IT
Act nor the Software Technology Parks of India Scheme warrants maintenance of
“separate books of accounts”, RA continue to insist that tax payers are required
to maintain and furnish Unit wise books of accounts, in the traditional manner
of book keeping and generation of Unit wise financial statements . By
recognizing that there is no requirement in law to maintain separate books of
accounts, the clarification enables tax payers to have the flexibility to
demonstrate a true and accurate tax holiday claim on the basis of modern
accounting and book keeping records which can generate the required information
to verify the claim. Seeking “necessary” information would however still leave
a window open for the RA to call for voluminous amount of data with the pretext
of verifying claims and unless this power is exercised judiciously, the reality
faced during scrutiny of tax claims may not change significantly. This
clarification is also in line with the Karnataka High Court decision in the case
of Fusion Software [3].
SEZ Units would
continue to be governed by the SEZ Regulations which do require maintenance of
separate books of accounts and hence, to that extent the clarification does not
impact the statutory obligation for SEZ Units.
It would have also
been useful if the CBDT had clarified as to under what circumstances can
information be sought for, considering that the Units/Undertakings claiming a
tax holiday are required to not only get their financial statements audited, but
also have their tax holiday claims certified in the prescribed forms by a
Chartered Accountant.
5.
Research and
development activities
CBDT
clarification
The CBDT has clarified
that the research and development activities embedded in the “Engineering
and Design” pertaining to software development shall be covered under the
definition of “Computer Software” stipulated under Explanation 2 to section 10A
and 10B of the Act read with Notification No 890(E) dated September 26, 2000.
Taxbymanish
Comments:
A large number of
Indian software companies are engaged in rendering contract research and
development activities to their clients. The industry understanding has always
been very clear that research and development activity fits into the larger
umbrella of software development services that qualify for tax holidays under
the IT Act.
Recently however, the
RA have been taking a view that research and development services (albeit in the
sphere of software development) would not be covered by the notification[1] providing
the list of IT services that are eligible for tax holiday under section 10A
and 10B, since no specific mention of research and development has been made in
the notification recognising eligible services.
By recognising that
research and development activity embedded in the ‘Engineering and Design’ would
also be eligible for the tax holiday, the CBDT has reassured the industry on
what was always the understanding. This is line with the Bangalore Tribunal
decision in the case of GE India Technology Centre (P.) Ltd[2]. There
could however be challenges the RA at the ground level recognising the fact that
such activities are indeed “embedded” in the Engineering and design services,
recognised in the notification.
1 comment:
Where can I find the Rangachary Committee's Report?
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