The Government
of India, through its Ministry of Finance/ Department of Revenue/
Central Board of Direct Taxes, has issued a clarificatory Circular
No. 01/2013, F. No. 178/84/2012-ITA.I, dated 17th January 2013
pertaining to issues relating to export of computer software and
corresponding direct tax benefits.
Perry4Law
and Perry4Law’s
Techno Legal Base (PTLB) are hereby discussing the Direct Tax
Benefits Issues Relating to Export of Computer Software for our
readers. We hope all the stakeholders would find this discussion
useful.
The Indian Software Industry has been the
beneficiary of direct tax incentives under the provisions like
Sections 10A, 10AA & 10B of the Income -tax Act, 1961 in respect
of their profits derived from the export of computer software. These
provisions prescribe incentives to “units” or “undertakings”,
established under different schemes, which are/were deriving profits
from export of computer software subject to fulfilling the prescribed
conditions.
It has been represented by the software companies
that several issues arising from the above mentioned provisions are
giving rise to disputes between them and the Income-tax authorities
leading to denial of tax benefits and consequent litigation and,
therefore, require clarification. Various issues highlighted by the
Software Industry have been examined by the Board and the following
clarifications are hereby issued -
(i) (a) 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; and
(b) Whether receipts from deputation of technical
manpower for such “on-site” software development abroad at the
client’s place are eligible for deduction under sections 10A, 10AA
and 10B.
(a) CBDT had earlier issued a Circular (Circular No.
694 dated 23.11.1994) which 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. However, certain doubts
appear to have arisen following the insertion of Explanation 3 to
sections 10A and 10B (vide Finance Act, 2001) and Explanation 2 to
section 10AA (vide Special Economic Zones Act, 2005) providing that
“the profits and gains derived from on site development of computer
software (including services for development of software) outside
India shall be deemed to be the profits and gains derived from the
export of computer software outside India”, and a clarification has
been sought on the impact of the Explanation on the tax-benefits as
compared to the situation that existed prior to the amendments.
The matter has been examined. In view of the
position of law as it stands now, it is clarified that the software
developed abroad at a client’s place would be eligible for benefits
under the respective provisions, because these would amount to
‘deemed export’ and tax benefits would not be denied merely on
this ground. However, since the benefits under these provisions can
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. To this extent, Circular No. 694 dated
23.11.1994 stands further clarified.
(b) It has also been brought to notice that it is a
common practice in the software industry to depute Technical Manpower
abroad (at the client’s place) for software development activities
(like upgradation, testing, maintenance, modification,
trouble-shooting etc.), which often require frequent interaction with
the clients located outside India. Due to the peculiar nature of
software development work, it has been suggested that such deputation
of Technical Manpower abroad should not be considered detrimental to
the benefits of the exemption under sections 10A, 10AA and 10B merely
because such activities are rendered outside the eligible units
/undertakings.
The matter has been examined. Explanation 3 to
sections 10A and 10B and Explanation 2 to section 10AA clearly
declare that profits and gains derived from ‘services for
development of software’ outside India would also be deemed as
profits derived from export. It is therefore clarified that 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.
(ii) 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 practice prevalent in the software
development industry, generally two types of agreement are entered
into between the Indian software developer and the foreign client.
Master Services Agreement (MSA) 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)
are formed. These 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. Clarification has
been sought whether more than one SOW can be executed under the ambit
of a particular MSA and whether SOW should be given precedence over
MSA.
The matter has been examined. It is 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 non-fulfilment of any other
prescribed condition.
(iii) 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.
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….”. The CBDT had already
issued Notification No. 890(E) dated 26.09.2000 specifying such
items. The notification includes Engineering and Design but does not
specifically include Research and Development activities related to
software development in respect of which clarification has been
sought.
After examining the matter, it is clarified that the
services covered by the aforesaid Notification, in particular, the
‘Engineering and Design’ do have the inbuilt elements of Research
and Development. However, for the sake of clarity, it is reiterated
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.
(iv) Whether tax benefits under sections 10A, 10AA
and 10B would continue to remain available in case of a slump-sale of
a unit/undertaking.
The vital factor in determining the above issue
would be facts such as how a slump-sale is made and what is its
nature. It will also be important to ensure that the slump sale would
not result into any splitting or reconstruction of existing business.
These are factual issues requiring verification of facts. It is,
however, 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 fulfilment of prescribed conditions.
(v) 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.
Since there is no requirement in law to maintain
separate books of account, the same cannot be insisted upon. However,
since the deductions under these sections 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.
(vi) Whether tax benefits under section 10AA can be
enjoyed by an eligible SEZ unit consequent to its transfer to another
SEZ.
This issue relates to cases where an eligible SEZ
unit is shifted from one SEZ to another SEZ on account of commercial
exigencies. This 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. 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. The matter has been examined and it is 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. It is 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.
(vii) 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.
Whether setting up of new unit/undertaking in a
location (covered by sections 10A, 10AA or 10B), where an eligible
unit is already existing, would amount to expansion of such already
existing unit is a matter of fact requiring examination and
verification. However, it is 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 setup after obtaining necessary
approvals from the competent authorities; has not been formed by
splitting or reconstruction of an existing business; and fulfils all
other conditions prescribed in the relevant provisions of law.
