Government cleans up rules on taxing IT companies

New Delhi/Mumbai/BANGALORE: After the controversial general anti-avoidance rules ( GAAR), the finance ministry on Thursday sought to clear the air on taxation of software companies through a set of clarifications, including allowing Indian companies to claim tax breaks on software development at clients' offices overseas.

The clarifications would come as a huge relief for several Indian IT giants - such as Infosys and Wipro - as in the past, tax authorities had denied benefits for software development done by staff deputed to work abroad, even if all conditions, including receipt of foreign exchange, were met. The income tax department turned down the benefit on the ground that these were "body shopping transactions", as the work was not undertaken in India, and refused to treat it as software exports. But a series of recommendations by an expert committee headed by former CBDT chairman N Rangachary has now prompted the finance ministry to classify them as deemed exports and clearly say that "tax benefits would not be denied". While tax holiday benefits under sections 10A (for eligible units in software technology parks) and 10B (for export-oriented units) expired on March 31, 2012, this clarification will help software companies that are fighting legal battles. The statement comes days before finance minister P Chidambaram begins road shows in Asia and Europe while his cabinet colleagues meet international investors in Davos. The announcement resulted in all round cheer although industry lobby group Nasscom sounded a word of caution. "(We) hope the assessments and past denials are suitably resolved taking into cognizance the clarifications issued. While this is a positive step, it is important that the implementation is carried on efficiently. We urge that benefits denied in the past be reviewed in light of this move, and there be swift closure of cases for the Industry to benefit from this," it said in a statement. "This is a good move for the software industry. Many disputes had arisen on account of lack of clarity, leading to endless litigation. The circular will put all this to rest. The definition clarifies that manpower services with regards to the IT industry are eligible for deductions. It also clarifies that research and development centres engaged in engineering and design are eligible for deductions," added K R Sekar, leader, international tax, at consulting firm Deloitte India.Operational difficulties being faced by the software industry have also been resolved. It has been clarified that tax holiday benefits will not be denied merely because a separate and specific Master Service Agreement (MSA) does not exist for each deal with a client for provision of services. Typically a MSA states the broad terms of the agreement, such as the fees and details of services to be provided. Later, individual contracts are undertaken with the client under a SOW (service agreement) within the framework of the MSA. Tax authorities were denying tax holiday benefits on various grounds, such as the MSA was entered into before the SEZ unit came into existence. The circular clarifies that the SOW would normally prevail over the MSA. TNN