Gimme a break – a tax break

Are there industries in India more profitable than the IT industry? If there is one, it must have an awesome business model. Companies like Infosys make 25% net margins after taxes. At $20B in revenues, the industry is no longer a small industry needing encouragement.

So why does the IT industry not pay corporate income tax? Not just that, under the SEZ act, that tax holiday will now be extended, indefinitely.

In the late 80s, early 90s, the STPI Act was used to incentivize the then fledgling IT industry. It was needed. The Software Technology Parks were needed. The cost of a telecom link to the US was high. Many small companies in the STP could share a telecom link. Custom duties were very high on computer hardware, software and networking equipment which could make IT company uncompetitive. So there was the duty-drawback. Last but not least, there was a 10 year tax holiday on export revenue out of the STP. For all this the companies within the STP had to be 100% export oriented.

So far so good. I might have an issue with the tax holiday, but the incentives were timely and well directed. The industry, led by a few major companies like Infosys, TCS and Wipro grabbed the opportunity. Later their ranks swelled with many other smaller companies. Soon the BPO industry (also called ITES or IT enabled services, I think to justify their need for special treatment) also swung into action.

Fast forward to 2006. We now have a large and still rapidly growing IT and BPO industry entirely focused on offshore services to developed markets. Most of the larger firms are very profitable. The custom duties are way down. Telecom bandwidth is dirt cheap. So why in the world would the industry need more tax breaks?

That it doesn’t is very clear. Not just because of the reasons I give. But because industry leaders like Nandan Nilekani say that they don’t. However, if the SEZ provision is available, it would be irresponsible for them to not secure the best tax status for their shareholders.

The income tax lost to the IT industry, by my calculations came to $1.3 B last year. That would be a pretty significant % of the Indian govt. budget. Why would the Indian govt. run a deficit budget, skimp on investment in infrastructure yet spare the wealthy shareholders in Indian IT companies? One could argue that since deficit financing causes inflation, the government is taking from the common man and giving to the wealthy shareholders of IT companies. It is no wonder that the Finance ministry does not support this loss of revenue.

You could also argue that a tax holiday has no impact in the IT industry. If you make profits, you get the benefit of the tax break. But if you make profits, why do you need the tax break? The IT industry is not a capital intensive industry like say the steel industry, where a certain RoI must be met, beyond just being profitable.

The SEZ Act might make sense for many, especially manufacturing industries. For the IT industry it does not. But, profitable industries have wealthy industrialists. Some of them know how to lobby the government. Then there are the real estate developers, who too stand to gain by getting the right to develop the SEZ parks. They too have deep pockets and political connections.

In 10 years when we need to take a relook at the SEZ act, the IT industry will be even bigger. The industrialists will be wealthier. If I were a betting man, I’d say, this ain’t going away.

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9 Responses to Gimme a break – a tax break

  1. Tax holidays for IT, as you’ve rightly pointed out, are no longer necessary. However, it is surprising to know that IT companies lobby for tax breaks even in these “best of times”.

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  2. Siddharth says:

    Basab, As you have observed earlier, “Fear and Greed – that’s what makes people move.” Same holds true for many firms unless you spiritualize the business.

    Tax breaks do not break our Tax system. Lack of simplicity in processes does. It gives opportunity for lobbying, manipulating etc. As long as we continue on the e-governance curve, and use the same yardstick for all, will get in shape sooner or later.

    In any case, employees of the IT majors make up. E.g. 2000 people joined Infosys on June 26th – translate that into as many Tax ID numbers…!

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  3. Arvind says:

    Basab, Perfectly said…IT companies also get excise duty,sales tax,and customs duty breaks on all items that they buy. This is also revenue loss to the govt.
    Instead of taxing these cash rich companies, the govt decides to levy about 50% tax on petrol and diesel which affects the common man in a big way.

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  4. Nirav says:

    I agree in principle on not having tax breaks.

    My impression, The tax breaks or now SEZs are motivated by politicians to get advantage on their favourable area.

    But i had read somewhere that taxes are too high in india. Is that the case still? A case from ICFAI in 2003 or so that showes that one could import cheaper than produce.

    Isn’t there a need to have no tax breaks and Low taxes system that allows everyone a fair game with an open inivitation to be in india?

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  5. Vinayak says:

    The hidden agenda is to encourage people to invest more of public money into the IT industry as it is anyway more than attractive. This also attracts new entrants venturing into new startups. Since it is not capital intensive and all the special treatment that it receives makes it the most irresistable industry to overlook and not invest and not to talk of all those financial institutions with all the mutal funds and hedge funds also the FDI etc., every single one would bet their money on , and this inturn creates more jobs. So the pvt sector, more so the IT industry is polarised in creating more jobs because of this. Also the guys sitting in the think tanks foresee it to be one of the fastest growing industry, has the ability to absorb all the educated youth force into these newly created job. The govt should encourage and keep the extension of tax holiday as such.

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  6. ila says:

    As someone running an sme in the countrys largest employment generating sector , my nationalistic pride in the success of the IT industry soon turned to envy and now downright resentment. I struggle to cope with the myriad laws my non polluting unit is subject to, the excise and sales tax inspectors i have to deal with and the oily ITO who will disallow legit bills simply because he “cannot pass a corporate assessment without disallowing expenses” .
    I resent having to pay an FBT on my travel trips to 2nd tier indian cities by train or on horrible roads and then see that the IT guys jetting across continents gets a waiver for their business trips.

    The time is not far away when some businessman is going to file a PIL against this govt. for discriminating between citizens.

    But the biggest irony of all – not a “choo” from Karat and co. on this SEZ Act which has forfeited tax money that could have helped build a few thousand schools for the aam aadmi ! This act is a state sanctioned land grabbing exercise !

    Incidentally, Jerry Rao wrote a brilliant article on this act in the Indian Express a few months ago.

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  7. One defense of the STP act is that the increase in employment results in employees paying tax. Yes, their employees do – but that goes to the centre.

    If you think that’s a lot of money consider this: if 5 lakh people (in the IT/BT/BPO industries in Bangalore) pay an average tax of Rs. 25,000 per year, the total tax collected is only Rs. 1,250 crore. A person earning Rs. 20,000 to Rs. 25,000 per month will pay approx. Rs. 25,000 per year in taxes.

    That means the whole “new” industry in Bangalore pays less tax than HALF of Infosys’ annual net profit (2800 crores).

    Read that carefully. One company’s net profits are more than double the tax paid by all the IT denizens of Bangalore. If Infosys was taxed at corporate rate (35%) that means Bangalore would get Rs. 980 crores as tax, which can be used for infrastructure. ONE company’s tax can pay for 100 flyovers. For 200 km of roads.

    If we tax all IT companies at 35% the govt. will have more than Rs. 10,000 crores extra. This is about 20% of India’s defence budget!

    There is such a poor response to BMP’s infrastructure project requrests for private participation – private companies don’t even want to do seven footpaths! Why should only the builders – Prestige, Purvankara etc. – do this sort of work? Can’t a company like Wipro, or Infosys or Biocon do it? Or any of the tens of hundreds of MNCs?

    Take out the SEZ act.

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  8. giridhar says:

    “Companies like Infosys make 25% net margins after taxes. At $20B in revenues, the industry is no longer a small industry needing encouragement.”

    On a tangent, is this fairly critical account — see the section “The IT Sector” at http://www.rupe-india.org/41/reality.html

    The authors do not question the sector’s current profitability. They take issue with any conclusions that one might draw about India as a “knowledge economy”. Wonder what you make of this gloomy prognosis, Basab?

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  9. hiten says:

    basab.. ur blogs cover very good contemporary articles and are thought provoking…

    just a suggestion to improve the UI.. the font is too small, it can be increased by couple of points..

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