IT Companies in India have been getting Direct Tax benefits on the profits derived from export of computer software, under Sections 10A, 10AA & 10B of the Income -tax Act, 1961, subject to fulfillment of the prescribed conditions. However, due to different interpretations of law and lack of clarity on issues such as, whether “On-Site” Development of Computer Software qualifies as an Export Activity for Tax Benefits, Income from deputation of manpower for such on-site work would be allowed for tax benefits etc. at times lead to denial of Tax Benefits and consequently Tax Disputes were raised.
In order to resolve the aforesaid issues, the Government of India, had constituted a Committee known as the Rangachary Committee. The Rangachary Committee submitted its report on “Taxation of Development Centers and IT Sector” on 14th September, 2012, making recommendations on the following issues:
- Parameters to identify contract R&D services provider with insignificant risk;
- Application of profit split method;
- Conditions for eligibility to claim deduction under section 10A, 10AA & 10B of Income Tax Act 1961.
The Central Board of Direct Taxes (CBDT) after reviewing the report submitted by the Rangachary Committee and considering the various representations made by the Software Industry issued a clarification, vide Circular No. 1/2013 dated 17th January, 2013, on issues which were being raised by the software industry at the time of availing Tax benefits:
The following clarifications were issued by the CBDT –
- Whether “On-Site” Development of Computer Software Qualifies as an Export activity for Tax benefits under sections 10A, 10AA and 10B of The Income Tax Act, 1961 CBDT pointed out that, the earlier Circular No. 694 dated 23.11.1994 issued by it provided that a unit should not be denied tax-holiday under sections 10A or 10B on the ground that the computer software was prepared ‘on-site’, as long as it was a product of the unit, i.e., it is produced by the unit. CBDT clarified that the software developed abroad at a client’s place would be eligible for benefits under the respective provisions, because it would amount to ‘deemed export’ and tax benefits would not be denied merely on this ground. However, since the benefits under these provisions could be availed of, only by the units or undertakings set up under specified schemes in India, it is necessary that there must exist a direct and intimate nexus or connection of development of software done abroad with the eligible units set up in India and such development of software should be pursuant to a contract between the client and the eligible unit.
- Whether receipts from deputation of Technical Manpower for such “On-Site” Software Development Abroad (Like Upgradation, Testing, Maintenance, Modification, Trouble- Shooting Etc.), at the Client’s Place are Eligible for Deduction under sections 10A, 10AA and 10B of the Income Tax Act, 1961. CBDT clarified that Explanation 3 to sections 10A and 10B and Explanation 2 to section 10AA clearly declares that profits and gains derived from ‘services for development of software’ outside India would also be deemed as profits derived from export. Therefore, profits earned as a result of deployment of technical manpower at the client’s place abroad specifically for software development work pursuant to a contract between the client and the eligible unit should not be denied benefits under sections 10A, 10AA and 10B provided, such deputation of manpower is for the development of such software and all the prescribed conditions are fulfilled.
- Whether it is necessary to have separate Master Service Agreement (MSA) for each Work Contract and to what extent it is relevant. As per the circular the general practice prevalent in the software development industry is that two types of agreement are entered between the Indian software developer and the foreign client. First is the Master Services Agreement (MSA) which is an initial general agreement between a foreign client and the Indian software developer setting out the broad and general terms and conditions of business under the umbrella of which specific and individual Statement of Works (SOW) (the second Agreement) are formed. The SOWs, in fact, enumerate the specific scope and nature of the particular task or project that has to be rendered by a particular unit under the overall ambit of the MSA. CBDT reframed the question as “Whether more than one SOW can be executed under the ambit of a particular MSA and whether SOW should be given precedence over MSA.” CBDT Clarified that the tax benefits under sections 10A, 10AA and 10B would not be denied merely on the ground that a separate and specific MSA does not exist for each SOW. The SOW would normally prevail over the MSA in determining the eligibility for tax benefits unless the Assessing Officer is able to establish that there has been splitting up or reconstruction of an existing business or nonfulfillment of any other prescribed condition.
- Whether Research and Development (R&D) activities pertaining to Software Development would be covered under the definition of “Computer Software” stipulated under Explanation 2 to Sections 10A and 10B. CBDT pointed out that the definition of “Computer Software” stipulated under Explanation 2 to sections 10A and 10B includes “any customized electronic data or any product or service of similar nature, as may be notified by the Board…..”. CBDT further pointed out that it had already issued Notification No. 890(E) dated 26.09.2000 specifying such items and that the notification included Engineering and Design but did not specifically included Research and Development activities related to software development in respect of which clarification has been sought. CBDT clarified that the services covered by the aforesaid Notification, in particular, the ‘Engineering and Design’ did have the in-built elements of Research and Development. However, for the sake of clarity, it was reiterated by CBDT that any Research and Development activity embedded in the ‘Engineering and Design’, would also be covered under the said Notification for the purpose of Explanation 2 to the above provisions.
- Whether Tax Benefits under Sections 10A, 10AA and 10B would continue to remain available in Case of a Slump-Sale of a Unit/Undertaking. CBDT pointed out that the vital factor in determining the above issue would be facts such as how a slump-sale is made and what is its nature. Also it is important to ensure that the slump sale would not result into any splitting or reconstruction of existing business and such factual issues required verification of facts. CBDT clarified that on the sole ground of change in ownership of an undertaking, the claim of exemption cannot be denied to an otherwise eligible undertaking and the tax holiday can be availed of for the unexpired period at the rates as applicable for the remaining years, subject to fulfillment of the prescribed conditions.
- Whether it is necessary to maintain Separate Books of Account for an Assessee in respect of its Eligible Units Claiming Tax Benefits under Sections 10A and 10B CBDT Clarified that since there is no requirement in law to maintain separate books of account, the same cannot be insisted upon. However, since the deductions under Sections 10A and 10B are available only to the eligible units, the Assessing Officer may call for such details or information pertaining to different units to verify the claim and quantum of exemption, if so required
- Whether Tax Benefits Under Section 10AA can be enjoyed by an eligible SEZ Unit consequent to its transfer to another SEZ. CBDT pointed out that the issue relates to cases where an eligible SEZ unit is shifted from one SEZ to another SEZ on account of commercial exigencies and the shifting is permissible under Instruction No.59 (F.No.C-4/2/2010-SEZ) issued by Department of Commerce (SEZ Division), provided approval from the Board of Approvals (BOA) has been obtained. CBDT further pointed out that doubts have been raised whether such shifting of an eligible unit would deprive the unit/undertaking of tax benefits, provided there is no splitting or reconstruction of an existing business. On this CBDT clarified that the tax holiday should not be denied merely on the ground of physical relocation of an eligible SEZ unit from one SEZ to another in accordance with Instruction No. 59 of Department of Commerce (referred to above) and if all the prescribed conditions are satisfied under the Income-tax Act, 1961. CBDT further clarified that the unit so relocated will be eligible to avail of the tax benefit for the unexpired period at the rates applicable to such years.
- Whether New Units/Undertakings set up in the same location where there is an existing eligible unit/undertaking would amount to expansion of the Existing Unit/Undertaking CBDT pointed out that, whether setting up of new unit/undertaking in a location (covered by sections 10A, 10AA or 10B), would amount to expansion of such already existing unit, where an eligible unit is already existing, is a matter of fact which requires examination and verification. CBDT clarified that setting up of such a fresh unit in itself would not make the unit ineligible for tax benefits, as long as the unit is set-up after obtaining necessaryapprovals from the competent authorities; it has not been formed by splitting or reconstruction of an existing business and fulfils all other conditions prescribed in the relevant provisions of law.
The clarifications issued by the CBDT have put to rest many of issues relating to export of Computer Software raised by the Software Industry. Such type of Circular always helps the Tax Authorities as well as the Assessee in deciding the correct amount of Taxable Profit and minimizing the dispute. Although tax benefits under Section 10A and Section 10B expired on 31st March, 2012, the clarification issued by the CBDT will assist in adjudicating the pending Tax disputes of the Software Industry.