Tuesday, March 01, 2011

Budget and the Indian IT sector


The Indian IT sector is not very impressed with the budget finance minister presented in the parliament on 28th Feb. IT companies, mainly small and medium ones, are disappointed as the tax incentives under Software Technology Parks of India (STPI) scheme have been withdrawn after 11 years. The tax sops under STPI were intended originally for 10 years. But last year the government had extended it for one more year. It will end in March, 2011. There are 51 STPIs. IT companies’ effective tax rates currently depend on the portion of their units which are under STPI scheme. Discontinuance of the scheme would increase their effective tax rate, unless they move their businesses to Special Economic Zones (SEZs).

Another blow was the slight hike of the Minimum Alternate Tax (MAT) rate from 18% of book profit to 18.5% of book profit. MAT is applicable to even those companies operating from SEZs. It will be applicable to developers of the Special Economic Zones as well. Let’s see what is MAT.

Generally, companies are liable to pay tax calculated as per Income Tax Act. But the P&L is prepared following the Companies Act (1956). There were many instances, where the companies had substantial Book Profits (described below) in the P&L but they were not paying tax as the taxable income computed following the provisions of Income Tax Act was insignificant or nil. These companies are popularly known as Zero Tax companies.

To bring such companies under tax net, the Government of India had introduced section 115JA with effect from the assessment year 1997-98. The Finance Act 2000 inserted section 115JB with effect from assessment year 2001-02 providing for levy of Minimum Alternate Tax on companies. The new provision of Section 115JB provided that if tax payable on total income is less than 7.5% (which is now made 18.5% for assessment year 2011-12) of the book profit, the tax payable will be 7.5% (now 18.5%) of the book profit.

Book profit means the net profit for the relevant previous year plus and minus certain amounts. Amounts which are added to the net profit are the amount of income tax paid or payable, amount carried to any reserves, amounts set aside for provisions made for meeting liabilities and for losses of subsidiary companies, the amount of dividend paid or proposed etc. Amounts which are deducted from the net profit are the amount withdrawn from any reserves or provisions credited to the profit and loss account, the amount of loss brought forward or unabsorbed depreciation, whichever is less as per books of account etc. [for the exhaustive list of items refer to the income tax of India website]. The Book Profit is arrived at by adding and subtracting the above amounts to the net profit. An example below will show the MAT calculation. Let’s assume that for a company the income calculated using the provision of the Income Tax act is 10 million Rupees and the Book Profit arrived at following the above method is 40 million rupees.

Total Income (Income Tax Act)
10,000,000.00
Income Tax @ 32.5% (30% corporate tax + 5% surcharge + 3% cess)
3,250,000.00
Book Profit
40,000,000.00
MAT @ 20% (18.5% MAT +  5% surcharge + 3% cess)
8,000,000.00
As Minimum Alternate Tax payable on the Book Profit is greater than the Income Tax, the amount of tax payable will be 8 million (maximum of the two).

Only relief for the IT companies in the budget is the lowering of the surcharge on corporate tax from 7.5% to 5%. If the companies are to believe, they have to take a hit due to the increase in effective tax rate. The SMEs would be in greater trouble. Hence, even if the revenues soar in the next fiscal, the bottom lines are expected to be subdued for the Indian IT companies.

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