IT cos face tax rise despite SEZ shift

IT cos face tax rise despite SEZ shift

Last month, HCL Technologies Ltd, India’s fifth-ranked software services vendor by revenues, inaugurated a new office in a 46-acre campus in Noida, a satellite town in Uttar Pradesh. When fully built, the facility will offer 2 million sq. ft of space—one of the largest in north India—and house 15,000 workers.

Such a mega software development centre is not uncommon in a country that accounts for two-thirds of the tech and back-office support work sent offshore by leading global corporations. What is new is the scramble among India’s large tech and back-office service firms to set up offices in the so- called special economic zones, or SEZs. HCL’s Noida facility is one such.

Reason: a crucial tax exemption on software exports under a so-called Software Technology Parks of India, or STPI, scheme comes to an end in March 2009. With the government showing no signs of extending the tax benefit scheme started in 1999—the industry has been lobbying for a 10-year extension—firms are rapidly moving business into SEZs, which offer a 100% tax exemption on pre-tax profits for the first five years. In the subsequent five years, the exemption shrinks to 50%.

But, as a Mint analysis based on interviews with key Indian software executives has found, the transition to SEZs will not be fast enough and painless, and leading Indian software firms Tata Consultancy Services Ltd (TCS), Infosys Technologies Ltd, Wipro Ltd and HCL are likely to witness a sharp increase in their income-tax of between 5 to 10 percentage points from fiscal 2010. (The additional tax payout will reduce in subsequent five years, but will still be higher than what most firms pay today.)

Under the existing provisions of the Income-Tax Act, importantly, a tech services firm cannot just migrate to an SEZ once the STPI scheme is over. Only new businesses the firm generates can be shifted to an office housed in an SEZ.

Companies operating in facilities not covered by the STPI scheme or not operating in SEZs risk having to pay tax at the corporate tax rate of 33.99%, said Sudhir Kapadia, a partner and national head of tax and regulatory services at KPMG International’s local unit. “Since, at present, tech companies are paying only a minimum alternate tax (of 11.33%), the tax bill of most firms will go up in the near future. And this point will surely hit home in 2009," he said.

Take India’s largest software firm. TCS today has 76 offices under the STPI scheme and just seven in operational SEZs. Eight of its SEZs are being constructed or have received government nod. TCS had paid about 14% of its pre-tax profits as tax—equivalent to Rs683.8 crore—last fiscal. “We estimate that our effective tax rate will rise about 20% after the expiry of the STPI scheme in 2009," a TCS spokesperson said.

India’s third largest software vendor Wipro has a dozen SEZs approved by the commerce ministry, of which nine are operational. The firm currently has more than 20 STPI-bonded units and pays tax at around 14% of its profit before tax (PBT). For the first half of this fiscal, its tax rate was 12%. “We expect an increase in tax rates by around 400 basis points for the fiscal year 2010. In the fiscal after that, it would come down as we increase the proportion of revenues from SEZs," said Suresh Senapaty, Wipro’s chief financial officer. The tax impact, he said, could result in a lower earnings per share growth for that year (fiscal 2010) than growth in revenues or operating margins. Wipro had revenues of Rs11,094 crore in fiscal 2007 and paid Rs334 crore in taxes.

Analysts have already factored in this slowdown. Rishi Maheshwari, senior research analyst at Networth Stock Broking Ltd, said the impact on larger firms was likely to be small compared to smaller peers. “Smaller IT players and (back-office) firms, will be heavily hit with tax issues because of the lack of preparedness," he said.

HCL, which in the year ended 30 June had an income-tax payout of around 10% on the PBT, could see a doubling of taxes as a percentage of pre-tax profits. “In the year ending 30 June 2009, we expect the tax rate to be around 12%. During 2009-10, it could touch 20% of profit before taxes," said the firm’s executive vice-president of finance Anil Chanana.

Infosys, ranked No. 2 by revenues among Indian software firms, already does about 10% of its business from SEZs. The company, which currently pays an income-tax of 14-15% on its revenues, also sees its income-tax peaking in 2010 as it transitions its units from STPI to SEZs. “The tax impact may go up to 21-22% by March 2010," Infosys CEO Kris Gopalakrishnan had told Mint in an interview in late November. The firm had paid Rs352 crore in taxes in fiscal 2007.

Other firms such as Satyam Computer Services Ltd and the New Jersey, US-headed Cognizant Technology Solutions Corp. could not immediately estimate their tax impact after fiscal 2009.