The Indian IT industry has looked forward to the Union Budget in recent times. That’s the time when taxes and duties are slashed and sops are handed out to fatten India’s golden egg-laying goose. But this time around, industry is worried. The reason—the Kelkar Task Force Recommendations, which, if adopted, will impose a huge tax burden on the industry.

Kelkar checks in...
So what does the Kelkar recommendations bode for Indian IT and its players?

"If the only tool you have is a hammer, you tend to see every problem as a nail. Keep relationships, emotions and finances simple" Abraham Maslow

The task force has recommended the elimination of tax incentives under Sections 10 A and 10B of the Income ATax Act—"for all tax payers other than those engaged in manufacturing computer software". This is the Kelkar Catch...These two Sections (10 A and 10B) deal with tax incentives available for exports by companies operating out of special trade zones as well as 100-per cent EOUs (export-oriented units), especially software companies. These exemptions would no longer hold if the finance minister adopts the recommendations of the Kelkar Task Force. The worst affected by such a change would be upcoming BPO and ITeS companies.

It has come as no surprise that Nasscom is hotly opposed to a revocation of the tax benefits. Says Nasscom president Kiran Karnik, "The outstanding success of the IT software and services sector is an example of what government support and government-industry partnership can do. To build on this, the government should honor the commitment of full exemption from taxes on export profits till 2010, since investments and business plans have been made on the basis of that commitment."

That is something that the industry is unanimous about.

"It will be really good if the government does not take away any incentives already committed—like income tax benefits under 10 A and 10B. Taking away promised incentive like tax benefits would have negative effect, as companies are now signing multi-year outsourcing contracts," says Pawan Kumar, president and CEO of Vmoksha.

Moreover, revoking the tax holiday would affect high-growth segments like ITeS and business process outsourcing adversely.

"The need of the hour is to create an ecosystem that will help the BPO segment grow in India. For this, both fiscal and non-fiscal measures need to be adopted by the government. Adopting the recommendations of the Kelkar Task Force, especially with respect to the provisions in the 10 A and B of the Income Tax Act, might be detrimental," says Raman Roy, president & CEO of Wipro Spectramind.

The wishlist
Industry bodies like Nasscom and MAIT have rolled out their own recommendations for the Union budget. (see boxes). Some of these recommendations have been longstanding demands of the industry. Take, for one, the Nasscom recommendation to the government to pursue vigorously the ‘Totalization Agreement’ with the US. Though there’s been some talk about such an agreement between India and the US for nearly a year-and-a-half, nothing concrete has come out so far.

Totalization agreements provide that an individual be covered under the social security system of only one country, usually the home country (in this case India). Since employees of Indian companies are already covered in India under various schemes like the Employees’ Provident Fund, employees of these companies who may work on onsite projects need not be again brought under the US Social Security. Presently, 18 countries have totalization agreements with the United States.

"A totalization agreement with the US will save about 17% paid by Indian companies for onsite employees as social benefits, which would come to these employees only if they live in the US for 40 quarters (10 years)," says vMokhsha’s Kumar. In fact, even the Kelkar Task Force report has recommended that " the Government of India take immediate steps to negotiate with foreign governments to enter into a comprehensive totalization agreement…" The report has also observed that the annual loss to India because of absence of totalization agreement was "$500 million, and such losses were increasing rapidly".

A longstanding demand of the Indian hardware industry has been "rectification of the inverted tariff structure". As per the WTO agreement, India is committed to enter into zero-duty regime for all IT and telecom products by 2005. Domestic manufacturers will continue to import raw materials, components and sub-assemblies as inputs. If these imports are not at zero-customs duty, there’s likely to be a situation where finished goods will be zero-duty, whereas raw materials would be charged duties. This is called an "inverted tariff".

Says Venkat Kedlaya, MAIT chairman (southern region), "Normally, we expect tariffs to be lowest for raw materials, rising as value addition increases in the imported product. So, if imported finished products are at zero duty, so should all inputs that go into manufacturing. We also believe that all capital goods that go into manufacturing should also be at zero duty to offer a level playing field vis a vis international manufacturers."

"Most international manufacturers based in East Asia are in free trade zones and pay no duty on capital goods. We also expect that all dual-use components and raw materials also have zero duty—for example, certain electrical components could be used by IT as well as non-IT industry players. When such inputs are used by IT, there should be no duty. We also expect that these changes will be made now so that domestic manufacturers have time to adjust to the zero-duty regime in 2005," he adds.

The hardware industry has, in the past, accused governments of giving them a step motherly treatment. But this time around, it hopes that things would be different.

As MAIT executive director Vinnie Mehta says, "IT manufacturing in India is faced with several disability factors that add up to almost 16-20%—a significant proportion—of the manufacturing cost. These can only be overcome by a progressive policy that can help reduce the transaction costs through simplified procedures." As for emerging sectors like the semiconductor business, a proactive approach will help India Inc grab a piece of the global market, which is projected to grow at a rate of 22%, to $173.1 billion in 2003.

"Currently, most of the semiconductor business is with companies in the United States. However, there is a substantial opportunity for business with Japanese semiconductor companies. A large of this trade currently goes to China due to the difference in the withholding tax (WHT) rates. The WHT between India and Japan is 20%, whereas between China and Japan, it is nil. The government needs to set up a financial task force to set this anomaly right quickly," says Shyam Kodavarthi, general manager (business development) at Sasken’s semiconductor business unit.

Ask him about his wish from the Budget, and he says—"The Indian semiconductor design companies invest a lot on EDA tools to service customers. There is a difference of up to 40-50% in EDA tool costs, compared to the US and other countries, which reduces the cost competitiveness of Indian IC design houses. A tax incentive to EDA tool companies would offer a level playing field to Indian IC design houses."

Ganesh Natarajan, the global CEO of Zensar Technologies is also strong in his view of the situation. "An alarming statistic recently revealed by the Confederation of Indian Industry is that to achieve the 8% growth rate that is the target for the country, it will have to be industrial growth that moves from the current level of 6.5% to 13% in the short term—and stabilize at double-digit growth levels in the medium term—clearly, a tall order for Indian manufacturing. No wonder then, that even some of our policy planners and the new breed of young politicians have begun to consider manufacturing a lost cause and are looking at services to achieve the miracle that India needs for true transformation."

In conclusion...
Like most other Budgets, this one too will be discussed, debated and dissected across homes and corporate boardrooms through the country. But with the clock ticking away on the WTO deadline and Indian IT limping back to recovery, all eyes in the Indian IT world will be focussed on Union finance minister Jaswant Singh as he rises to present the annual Union budget for FY 2003-04.

TV Mahalingam With inputs from Sarita Rani