Twice a day, software engineers working at the technology hub on the outskirts of Bangalore, undertake a journey that keeps getting longer. The boom in outsourcing, which has led to a stunning expansion of the software industry, has also exacerbated commuters’ woes. During peak periods, it now takes two-three hours to travel just 19km to the city centre.
An expressway link has been urgently required for the past five years. And yet, it’s only now that work has begun on constructing one. The software industry, like all of India’s new economy, is coping with shortages of everything—from roads and power to airport capacity and skilled workers. That’s true, in different degrees, in all of the country’s big cities.
A bigger question, which emerged from the government’s annual Budget on Wednesday, is whether the profitable software companies have a right to ask for improvements when they pay almost nothing in tax. On Wednesday, finance minister Palaniappan Chidambaram imposed a minimum alternate tax on software exporters.
The top four Indian software companies pay 11-15% of their pre-tax earnings as levies, mostly to foreign governments. They are immune to their home country’s corporate- tax rate, which stands at about 34%.
That’s because they enjoy a tax holiday in India on profits of units located in designated export zones. According to the new rule, as long as the exporting unit has a book profit, it can’t escape its liability entirely. It must pay 11% to the government. The software industry sees the move as a promise reneged: The tax holiday was supposed to last until 2009.
When the government granted the liberal tax breaks, it chose to forgo revenue for the sake of employment and hard-currency exports. Now it wants money for its spending programme. Infosys Technologies Ltd, India’s No. 2 exporter of software services, said its tax burden will rise by a full five percentage points. The stock fell 5% on the Bombay Stock Exchange on Wednesday. Shares of Tata Consultancy Services Ltd, Infosys’s bigger rival, slumped 6%.
Chakri Lokapriya, a fund manager at BNP Paribas Asset Management in London, wonders if the move sends a wrong message to global investors on the country’s most high-profile industry.
Twisting the knife still further, Chidambaram also said he would impose a “fringe-benefit” levy on employee stock options. The government takes away a third of people’s salaries. However, if employees sell their shares within one year, they pay just a 10% capital-gains tax. After a year, the gains are tax-free. Now, with the fringe-benefit levy, it’s going to cost employers to pay people in funny money. Software companies, where employee stock options are popular, will be hurt.
Computer software and back-office services have been at the forefront of India’s economic revival. They have created jobs, unleashed entrepreneurial talent, spawned best practices in corporate governance and put cities such as Bangalore and Hyderabad on the world map.
The success of the industry has prompted many Indian technology professionals from the US and Europe to return home; it has prevented many more from leaving the country.
“Not only has the wealth generated by Indian information technology been widely distributed, it has also generated over a million highly paid skilled jobs and helped build the nation’s physical and human infrastructure,” says S. Mahalingam, chief financial officer at Tata Consultancy Services.
With this stellar contribution, the software industry has a legitimate claim to preferential treatment from the taxman. But then who will provide the revenue for the missing expressways, power stations and airports?
The government is promising scholarships to children who would otherwise be unable to complete high school and join the formal workforce. It wants to provide old-age security to landless rural labourers and give financial incentives to companies to hire the disabled. Where will the resources come from to fulfil the social agenda if the new economy remains outside the pale of taxation?
Besides, is it fair for the middle class to bear the burden of personal income taxes while the best-paid employees in India take their pay in stock options? There’s no doubt that the government should improve the efficiency of its spending by retreating from commitments that aren’t pure public goods. That will allow it to spend more where it needs to without increasing tax rates.
This year’s Budget threw open polytechnic education to private investors. India, home to some of the world’s most elite engineering institutes, now needs to produce millions of technicians to ramp up manufacturing. The state doesn’t have the technical or financial capacity to do this.
Similarly, after 15 years of botched efforts, the government is tasting success in enticing non-state investors to put money into electricity generation at affordable prices and without outlandish sovereign guarantees.
The software industry in India can’t forever remain an island of excellence. Yes, the government has broken its promise to the industry. But it’s making a larger pledge in education, health and infrastructure. The Indian state has to rediscover its ability to do good. If the choked Bangalore traffic can begin to move again, the tax on software companies would be forgotten and forgiven.