India is a favoured offshore destination for outsourcing information technology (IT) and information technology-enabled services (ITeS), thanks to, among other things, a conducive tax environment—in the form of tax holiday under section 10A of the Income-tax (I-T) Act, 1961, available to undertakings registered under software technology park of India (STPI) scheme.
With this tax holiday being slated to expire on 31 March, the industry seems to be exploring alternative options. After 31 March, the only comparable option is a holiday under section 10AA of the I-T Act available for special economic zone (SEZ) units. This holiday is available for a period of 15 years (on a graded basis) from commencement of operations in SEZ.
From a comparison stand point, the SEZ tax holiday requires operations to be physically located in designated SEZs only, while for section 10A, one could have operations set up anywhere in the country after registration with STPI. For new companies setting up operations, this condition may not look daunting. However, for existing companies moving to a designated area simply to avail a tax holiday, this poses major challenges. Nonetheless, this is somewhat mitigated by the proliferation of SEZs across India.
Assuming that existing companies can overcome this operational hurdle, they are still not assured a tax holiday because of strict anti-abuse provisions embedded in section 10AA, which among other thingsrequire that SEZ unit should not be formed by:
•Splitting up or reconstruction of a business already in existence; or
•Transfer to a new business, of machinery or plant previously used for any purpose.
The first condition is complex, given the connotation of the terms “business”, “splitting up” and “reconstruction”, which are not expressly defined under the Act.
Historically, courts have tried to interpret these terms across various cases. In principle, “splitting up” involves breaking up an existing business and shifting a part to SEZ; “reconstruction” involves changing some characteristics (activities and other identifying features remaining the same) and then moving the business to SEZ. Simplistically, if a business is migrated, anti-abuse provisions would start and a tax holiday would be denied!
While the second condition has its own costs and implications, at least it is simple to understand and implement by ensuring investment in new assets only. A special carve-out provision allows transfer of 20% old plant and machinery to the new SEZ unit. A common misconception is that the 20% carve-out rule applies to even employees; whereas the rule specifies only plant and machinery—not even other assets!
Expansion of business, contrary to migration, stands on a different footing. Generally anti-abuse provisions do not get triggered if the expanded business is set up in an SEZ while the old business continues outside the zone. Nonetheless, planning becomes extremely critical, especially where there is some interaction between the two businesses. For example, there could be a challenge for a company having a single master services agreement and working on different projects through independent statements of works (SoW) to prove that a new SoW (for SEZ business) is an independent business activity. The problem can get compounded if an SoW is linked to people who may be common.
While a move from STPI to SEZ looks appealing, multiple hurdles and issues require adequate planning and analysis before a decision is taken. In the years to come, this issue will remain one of the topmost concerns for existing companies having STPI operations, unless the section 10A tax holiday is extended beyond 31 March.
Vikram Doshi is an executive director with KPMG. The views expressed here are personal. Comment at firstname.lastname@example.org