Indian IT to boom, post-Budget

The Indian software industry has been growing at a fast clip over the last few years.

Major reasons for the same include the outsourcing boom, greater competition worldwide, resulting in companies having to cut costs and spend more on technology to become efficient, high quality of services provided by Indian firms, constant diversification into new markets, and movement up the software value chain, resulting in IT companies getting better billing rates for their services.

Budget Measures

	Zero customs duty on items bound under the Information Technology Agreement.
	In order to provide a level playing field to the domestic industry, customs duty on specified capital goods and all inputs required for the manufacture of ITA bound items has been removed.
	Additional countervailing duty (CVD) at 4% has been imposed with immediate effect from 1st March 2005 only on items bound under the Information Technology Agreement, and on specified inputs/raw materials for manufacture of electronics/IT goods. Credit for the CVD will be available against payment of excise duty.
	IT software and documents of title conveying the right to use IT software will not be subject to this levy.

Budget Impact

	The cost of manufacturing items bound under the ITA is expected to fall. With the increase in competition and the abolition of customs duties, the lower costs should be passed on to the end-user, resulting in availability of cheaper hardware, thus giving much-needed encouragement to the hardware industry, which has been a poor cousin of the high-profile software industry in the past.
	No major impact on software companies, which are already operating under a favourable tax regime.

Sector Outlook

Going forward, given the fact that India's software industry is of a miniscule size compared to the global technology industry, there is tremendous scope to grow. In particular, BPO services and higher-end IT services will be the next growth drivers for the industry, and companies which are steadily moving up the value chain will benefit. Companies having a scalable business model, operating in niche areas requiring a higher level of skills, and which are steadily building competencies in providing high-end business solutions to their clients are expected to corner the gains from this growth.

Industry Wish List

Mr. T.V. Mohandas Pai, CFO, Infosys Technologies Provide clarifications on interpretation of the statute provisions of section 10A/10B of the Income Tax Act. Provision of full tax neutralization in India on global income for taxes paid abroad. Take a re-look at India's double taxation treaties with other countries as the withholding tax on royalties and fees for technical services is between 10-20% and this was during an era when India was a net importer of technology and the changed scenario warrants a revision in the withholding tax rates to around 0-5%.
	Mr. Ravi Ramu, CFO, MphasiS-BFL PTax/capital investment incentives for the corporate sector for setting up IT/BPO units in districts and towns and other less urban areas and investing in telecommunications and related infrastructure in semi urban and rural areas. Clarification regarding the uncertainty over the recent interpretation of the Section 10A /10B benefits. E-commerce taxation is an issue that has been left open for a number of years. Specific guidelines on Permanent Establishment and related tax consequences need to be clearly formulated. The cumbersome requirement for IT companies to prepare Softex Forms to be submitted to STPIs surely needs to be done away with since it no longer seems to serve a purpose at all. In keeping with the requirement to bridge the digital divide and to spread the use of IT in a meaningful manner across the country, STPI units should be set up, to begin with, in key district headquarters.
	NASSCOM Wish List Take a fresh look at issues like taxation of non-residents outsourcing IT-enabled services to India. Resolving various issues relating to Sections 10A/10B such as definition of export turnover, realisation of export proceeds, maintenance of separate books of accounts and deductions under Section 10A/10B vis-à-vis under Section 80HHE. Exclude cross-border sale of software from the definition of 'royalty' in order to reduce the cost of software for end-users, unless the buyer gets the underlying copyright(s) in the software, which enable him to replicate the software for commercial use and reaping profits. Indirect Tax issues, such as elimination of all other duplicate levies, even before the introduction of VAT, phasing out Central Sales Tax (CST) upon introduction of VAT, lowering CST on computers and other IT products to 2%, and issuance of Form C for provision of services should be permitted so as to enable STPs to avail the CST refund benefit. Abolition of custom bonding by BPO companies/ITES/software companies operating under the STP/EOU scheme, allow them to import duty-free goods without approval of government agencies, and allow infrastructure sharing to such EOUs/STPs to improve operating efficiency and economies.

Budget over the years

Budget 2002-03	Budget 2003-04	Budget 2004-05

The 100% deduction of export profits allowed to certain units under sections 10A and 10B of the Income-tax Act has been reduced to 90% for FY03. Limit for overseas investments through automatic approval route increased from US$ 50 m to US$ 100 m. The limit for joint venture investments up from 25% of net worth to 50%.	Benefits under Section 10A/10B for IT companies to continue. IT companies will continue to enjoy the benefits of 10A/10B benefits even after a change of management. Pre-loaded software in computers to be exempt from excise duty. Limit on overseas investments for companies increased from 50% of networth to 100%.	Full excise exemption on computers (from 8% earlier). Bill for regulating Special Economic Zones (SEZs) to be introduced. Prepare an Investment Commission to facilitate investments (both domestic and foreign) in the area of telecom and high technology. Telecom FDI limit raised to 74%, from 49%. Service tax has been raised from 8% to 10%. Further, a surcharge of 2% on account of education cess will be imposed on this tax.
		[Read more on Budget 2004-05]

Key Positives

	Huge outsourcing potential With the value proposition of offshore development being well established, corporates in the West are increasingly outsourcing to Indian software companies. Also, the fact that India's share in the global software and services industry is a mere 3% provides Indian IT companies with a huge potential to grow going forward.
	Moving up the value chain Indian software companies are consistently broadening their portfolio of offerings and moving fast up the software value chain. Not only will this help Indian companies garner higher billing rates but it will also give them an opportunity to work far more closely with the top management of client companies.
	Scale benefits of past investments In anticipation of a higher demand for their services going forward, Indian software companies have rapidly ramped up their employee base and opened development centres and sales offices abroad. These initiatives are likely to pay-off over the long-term as these companies are likely to derive benefits of large scale as they grow larger in size.
	Global Delivery Model The Indian offshoring model, or the Global Delivery Model, has been one of the biggest positives for the growth of the Indian software sector. Large companies like Infosys and Wipro have indeed refurbished this model to accommodate to the changing times. What more, the fact that MNC technology majors like IBM, EDS and Accenture have tried to replicate this model, gives it greater authenticity.
	Other positives Among other positive factors for the Indian software industry, the major ones are - large availability of talented manpower, cost advantage and geographical advantages (time-zone advantages).

Hardware and domestic markets While India's software and services exports have witnessed robust growth over the past few years, the growth in the domestic and hardware market has been relatively staid. This is a key cause of concern for the growth of the Indian IT industry.

Key Negatives

	High reliance on the US markets The US market's share in India's software and services exports is in the region of 60 - 65% (FY04). Such a high degree of dependence on a single geographical location spells high risk for the Indian software sector. Over that, backlash in the US against outsourcing of jobs to low-cost countries like India has raised some medium-term concerns for Indian software companies, although by and large, the opposition has died down, and it is now business as usual for the corporates looking to cut costs in an increasingly competitive world.
	Decreasing cost advantage Increasing competition from global technology majors has not only threatened Indian IT industry's cost leadership, Indian software companies have also been made to face intense competition for talent. All these pressures mean lower stagnant billing rates and higher employee costs going forward. This is likely to affect margins and, consequently, the profitability of Indian companies
	High rates of attrition High attrition, especially in the middle and senior positions, continues to damage the performance of Indian software companies to a certain extent. Apart from competition for talent from MNC technology majors, internal factors like job dissatisfaction and higher aspirations (in case of BPO companies) have led to such high attrition in the Indian software sector.

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