Reality Check India

IT SEZ : Everyone loves a holiday

Posted in Uncategorized by realitycheck on October 13, 2006

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And now for something completely different.

I love Indias IT industry. This is not your usual rant against the low-tech wage arbitration model. I have no problems with moving down the so called value chain if that is what it takes to enable growth. I think lower down the value chain is even desirable in India because it takes 100x more people to produce the same revenue as a product company. This means 100x more jobs. Indian IT industry has provided an escape vent for millions, enabled large scale immigration and resultant forex remittances, replaced snake charmers as the image of India. I admire Narayan Murthy, Azim Premji, Ramadorai for keeping their focus and transforming their companies into multi-billion dollar corporations.

So, what seems to be the problem ?

The problem is the tax holiday enjoyed by these companies. Like other things in India, the exception always seeks to become the rule.  Once benefits are given they cant be taken back or cut down. The existing tax holiday under the STPI scheme is set to expire in 2009. This means all IT companies will have to pay 30+% corporate tax as well as indirect taxes like any other company. While this would result in a major revenue boost to the central and state governments, the IT companies are setting up SEZs or lobbying to extend the 2009 deadline.  Before I dive deep, some background about the existing tax holiday.

STPI Scheme:

STPI (Software Technology Park India) is a scheme that dates back to the early years of the IT industry.  It allowed for a 10-year exemption from Corporate Income Tax (upto 90% of turnover), Sales Tax, Customs Duty, Excise duty. Details here . Back in the day, the infant IT companies could not deal with the astronomical cost of telecommunications, archaic customs duty rules, and a high rate of taxation. So the initial 10-year tax holiday helped an infant industry attain critical mass. Even though companies like Infosys are 20 years old, they are still able to avail of the 10-year tax holiday by setting up new units with fresh 10-year extensions. For companies outside the STPI, the corporate income tax rate alone is 36-37% ( Corporate Income Tax = 35%, Surcharge = 2.5%, Education cess = 2%).  Sales tax exemption is 10-12% for states and 3-4% for Union Territories (UT). This is why you dont find all IT companies in UTs.  The contribution of the STPI tax holiday to the overall success of the IT story cannot be underestimated. I would rate it as one of the best initiatives undertaken by the Indian government. Some more here in Basab Pradhans blog. He is an ex-head of global sales and marketing at Infosys.

The problem is, we have all grown up now. IT is a $30 billion dollar industry. Infosys, TCS, Wipro are all on track to cross $3bn in revenues this year.  They have all built giant campuses, have long term customer contracts, have large cash reserves. Their founders are no longer needy entrepreneurs who need to fight against bureaucracy.  As they are primarily wage-arbitrators (nothing wrong with it) – they do not have to invest in R&D or long term product development. These three are already the top three private sector employers in terms of headcount. TCS at around 75,000, Infosys at 66,000 and Wipro at 65,000, beatTata Steel at 38,000 and Reliance Industries at 40,000.

India needs money, lots of it for its social, education, military, and infrastructure programs. I question the very logic of inviting private sector for every highway project. To keep such a cash-rich and mature industry out of the corporate and excise tax regime is ill advised. The IT industry, atleast the big ones can easily absorb the tax charge. Even the IT bosses admit that readily.

So, anyway the party it set to end in 2009. If all IT companies come out of the scheme – the Indian government will realize between $3-5 billion dollars (15-25000 cr) in direct taxes alone (this figure is based on projected size of the IT industry at a 36% tax rate on a $50bn size).  Some figures for profit before tax : Wipro (2005 profit 2400 Cr), Infosys (2005 profit 3008 cr), TCS (2005 profit 3356 cr). If these companies maintain the current growth I think the $3-5 bn figure is in the right ballpark.  This does not take into account the customs duty, excise duty and sales tax exemption. That could push the figure even higher. I dont want to get further into these statistics. I realize the dangers of voodoo amateur economics. Can some one who is more knowledgeable provide accurate numbers ? Probably someone like Atanu Dey.

Enter the SEZ

The SEZ policy is welcome, very welcome. We need islands of non-interference.  The devil is in the details as usual. The centre has formally approved  212 SEZ units with an inprinciple approval to 152 more. Read more here. I dont buy the usual rhetoric that poor farmers will be affected and the like. First of all, large landowners are not necessarily poor. Everyday, dozens of large landowners are turning into instant millionaires by turning in their lands to real estate / IT giants.  The government must assure prevailing rates to them and/or issue bonds tied to the future development of the area.  It must also take into account small and marginal landowners interests and device a new scheme for them which ties them monetarily into future development in that area. The issue must stop there. 

Now back to the IT companies. Since the SEZ policy has been announced the IT companies are wondering if they can use it to extend their tax holidays.

Infosys, Wipro, Satyam, TCS – the big boys of Indian IT are each setting up a Special Economic Zone. Why just them, over 100 IT SEZs are in the offing. That’s more than half the total number of SEZ applications cleared by the government. The big attraction – tax benefits! After all the industry has not yet got an extension to the tax holiday on software exports upto 2009.

Source : Moneycontrol

The SEZs provide a 15 year tax holiday to the IT companies after 2009. The details : 100% exempti0n for the first 5, 50% for the next 5, and variable for another 5 based on reinvestment in SEZs.

Why the government should withdraw or minimize tax holidays to IT companies ?

The government should seriously consider the forward and backward linkages of IT companies to the local economy before granting tax benefits.

Yes, IT companies employ a lot of people who pay taxes.  That is not a valid argument because even if the tax holiday is withdrawn the employees will still pay taxes. So, it is not a “either-or” question. Employees pay individual income tax and companies pay excise and corporate income tax. If this is to be used as an argument in favor of the tax holiday – then you have to establish that imposing taxes reduces employment opportunites and retards growth.

The tax holiday is a precious tool. If used right, it will help such as the case with the STPI. If abused, it will spoil the already powerful corporates and will stifle new competition.

Tax holidays for strategic companies such as Nokia, BMW are worthwhile – they bring technology into Indian soil that does not exist.  We must consider tax holidays to LCD panel manufacturers, semi conductor fabs, memory makers, and contract manufacturers for electronic and white goods. We dont have the capabilities in these areas yet.

Tax holidays for software product companies are needed. The services and products companies are totally different. While there is some overlap in terms of engineers, the processes and business models, and the technical depth required are different. This industry is still in its infancy, and needs to be encouraged. Tax incentives provided to these units will be reinvested by them in research and development activities.

The most important reason is : The IT companies cannot function as castles isolated from the society around it. Today you see IT companies running their own trasport buses side by side with dilapidated city buses which have hapless folks hanging on for dear life. The right way is to pay taxes, make the governments richer, so every citizens standard of life improves.  In the face of such disparity between the haves/have-nots we need more information from the government about why this IT Tax holiday should continue from STPI to the SEZs.

I love money and I think everyone should. I am not in anyway envious of the wealth created by these companies for their founders or employees.  

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22 Responses

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  1. Apollo said, on October 13, 2006 at 10:35 am

    I agree with ur views. The tax sops to established IT companies must stop.period. but if u leave a loophole saying that product companies or product startups will be exempt then surely these established companies will take advantage of that too. i think the whole benefit package should be ended on 2009. The IT biggies will threaten to take their business elsewhere since their business model is like u said based on cost arbitration. But if we fall for that line it will be like rewarding them for not moving up the value chain in this tax free period. Whichever way we see it, i feel the Tax holiday should end.

  2. Barbarindian said, on October 13, 2006 at 11:32 am

    I was planning to post on this issue on my blog as well.

    Perhaps you have read Raghuram Rajan’s talked about article about this issue:
    http://www.imf.org/external/pubs/ft/fandd/2006/09/straight.htm

    Blogger Nilu of Recursive Hypocrisy also had quite a few interesting takes on the SEZ issue.

    I think the biggest issue with the SEZ is the very idea that the Government can run the economy. Rememeber, they tried it with the giant steel companies?

    Secondly, we have to ask, are SEZs making new type of industries and/or new players viable in significant numbers? The answer is a resounding NO! We would have expected nimble players making cool manufacturing units a la Taiwan. Instead, we see the biggest guys including Reliance and the Tatas lining up for a share of this largest land grab in history. No new industries are forthcoming. In other words, SEZ will just contain those industries that would have happened anyway – except they will enjoy huge benefits. Of course, the tax break will probably increase their equilibrium size. Rememeber that giving a set of companies an unfair advantage over international competitors may actually stifle competition.

    Third, no one is talking about the possible implications on international trade. If you are subsidizing these folks so much, can you possibly open up export markets? I haven’t read anything on this issue yet but my guess is that it will create problems.

    The SEZs will create another set of us vs. them segmentation and huge political opportunities. Even PC was not in favor of tax breaks initially, recently read in TOI that he said he was 100% behind Alok Nath on this. I guess they were able to resolve differences on how to share the loot. And talking of the loot, we are talking megabucks here – remember that SEZs have a myriad set of rules and the more rules there are, the more are the bucks for our beloved leaders.

  3. realitycheck said, on October 13, 2006 at 11:45 am

    Apollo, you are correct about the loophole. There is some heavy duty lobbying going on by Nasscomm to extend the holiday.

    The government should act now because if the SEZ act comes into affect, IT companies will find a way out of full taxes until the year 2024 !

    2009 + 15 years (5 full+5 half +5 variable)

    The cumulative lost benefits to the government is huge. We can never hope to bridge the divide between the haves/have nots if such a huge gift is handed to the people who need it the least.

    The IT companies must contribute to the country, state, and city they operate in. Not by baby steps like planting trees, or adopting schools, or renovating toilets or busstops. They need to pay their dues and make the central and local governments $RICHER$.

    The media maintains a stunning silence on this issue. The Indian news media is the king of the trivial. Yesterday, the burning issue on CNN_IBN was the police questioning H.Gibbs about a long forgotten match fixing incident.

  4. realitycheck said, on October 13, 2006 at 12:01 pm

    Barb,

    Thanks for the link. I will read it soon.

    The land grab issue is serious.

    Take Bangalore for example, the common man has to scrounge all this life savings, get indebted for life, hunt like crazy, take a leap of faith about land titles, to purchase a 30×40 or 30×20 plot. This costs anywhere from 1000 – 2000 / sqft even in outlying areas.

    Now Infosys steps in and announces that 845 acres (1 acre = 36 30×40 plots) has been acquired

    845 acres ! This is the size of entire Manhattans central park. Why does an IT company need that much land ? The only explanation is they want to create a zone for themselves. A shiny piece of India – they can call their own. This is not very different from a Biodome.

    Perhaps, another post is in order.

  5. Barbarindian said, on October 17, 2006 at 4:00 pm

    It looks like practically every investable region is being converted into SEZs. Why not just open up the economy altogether? Let the investors decide where and how they want to invest. If we have so much and so many SEZs, no investor will go to say a tribal area in Jharkhand which might have potential.

  6. realitycheck said, on October 17, 2006 at 5:36 pm

    There was an article online (I cant remember where). It contrasted our foolish SEZ policy with that of Chinas. Instead of hundreds of SEZs, each comprising a handful of buildings – the article recommended to establish one or two SEZ’s like Shenzen of 100+ square miles.

  7. Barbarindian said, on October 17, 2006 at 6:47 pm

    Found the article (pasting a part of it simply to prevent the comment from going into spam):

    http://www.moneycontrol.com/india/news/business/infosystvmohandaspai/whatsdifferencebetweenindiachinassezpolicy/market/stocks/article/243900

    Each of the five SEZs in China is the size of a mega city. Even the 25,000-acre Reliance SEZ in Navi Mumbai pales in comparison.

    Unlike India, where 200-odd SEZs will spread over the length and breadth of India, China’s five SEZs are strategically located in the southeast, three of them in Guandong province.

    Tax Head, KPMG India, Sudhir Kapadia says, “They are close to ports and trade nations like Hong Kong, Macau and Taiwan. A lot of thought has gone into the location of these SEZs. ”

    China’s SEZ initiative is government driven. But in India the private sector will develop most of them. There is no minimum area requirement to set up an SEZ in China, unlike as in India. And China does not offer tax incentives across the board to all companies, as India does.

  8. Barbarindian said, on October 19, 2006 at 3:29 am

    “And the way it (the SEZs in India) is being managed, you know the politicians are getting their hands on it and ultimately you have to take land. There is nothing wrong with it as long as people pay for it. And if you get politicians to assign it, then you can be sure there is a rent, and clearly when you have something like that, you are offering a temptation to the politicians or bureaucrats or whoever. That is also when you build resentment, when peoples’ lands are taken. But we are a democratic system.

    “Similar things are happening in China, which is experiencing land grab. There they have no recourse at all. They don’t have any NGOs to go to, they don’t have a free press, no independent judiciary, and no opposition parties. So, what do they do? At least here it’s being discussed. But as I said, we don’t need the damn thing.”

    http://timesofindia.indiatimes.com/articleshow/2201326.cms

    Jagadish Bhagwati, Columbia University
    Economics Nobel Prize nominee

  9. realitycheck said, on October 19, 2006 at 5:10 am

    Thanks for the link,

    There is an urgent requirement for a reality check on China Vs India. I dont think there is any such thing, the fate of the two countries are not intertwined in anyway. Anyone who has been to China can tell you that. Apart from the dramatic difference in basic infrastructure – there seems to be a national purpose in the air in China. Forget about Communism / Democracy for a minute – the people there just seem to be happier and impatient to see better days in their lifetime.

    Once I was chit chatting with a Chinese taxi driver in Hongkong about how this century was going to be Chinas and Indias. His reply was, “No la, this century is going to be Chinas – maybe next century will be Indias”.

    That was the last time I talked about India and China like that – it was my dose of reality check.

  10. Barbarindian said, on October 28, 2006 at 10:37 pm

    This thing is turning into a joke now:

    For NRI children, visiting India may no longer be an annual event any more. Now, they can look forward to longer stays as the first PIO university is finally taking shape.

    The ministry of overseas Indian affairs (MOIA) is finalising a policy to set up a PIO varsity, spread over 100 hectares, in a special economy zone (SEZ) in the country.

    While, the status of the deemed university, fully funded by the NRIs/PIOs, will be governed by the provisions of the Sec 3 of the UGC Act, the investors will be exempted from IT, customs duty, excise duty, sales tax etc, since it will be in the SEZ.

    http://timesofindia.indiatimes.com/articleshow/208893.cms

    On the other hand, they will not allow private universities to offer education. Obviously there is a huge demand. They are just creating another layer of have and have nots. I can easily see where this is going, in a few years their will be demand for SC/ST and OBC SEZs.

  11. realitycheck said, on October 29, 2006 at 4:41 am

    This is ridiculous. Yesterday Manipal agreed to increasing OBC quota if the government agreed to increase their NRI quota. This kind of wheeling dealing is everywhere.

    Have you heard Narayan Murthy complaining about the government lately ? Have the potholes in Bangalore disappeared all of a sudden ? Recently, a whole bunch of Infosys employees including the HR Director had to spend the night in the office because Hosur road was blocked. Strangely they are silent.

    As long as all IT services companies are taken out of the tax holiday scheme – I have no problems with this behavior. After all in an open competition environment is pays to be selfish – nothing wrong with that.

  12. Barbarindian said, on October 29, 2006 at 8:44 pm

    RC,

    One of the prime reasons for downfall of nations is that they don’t allow domestic competition. If you look at the early Japanese auto industry, while they were closed to the world, they allowed fierce competition in the domestic market.

    In India, typically we have big industry lobbies getting cozy with politicians and creating barriers to entry through the political process. We will be big losers to China if we don’t wake up.

  13. 2006 November 08 « Reality Check India said, on November 8, 2006 at 6:32 am

    […] IT SEZ : Everyone loves a holiday […]

  14. […] About the never ending holiday : […]

  15. bjvish said, on January 3, 2007 at 2:16 am

    I agree to a lot of points made by you regarding IT SEZs. Particularly, it should be used as a carrot to push Infy & folks more to research and development rather than allowing them to just stay as slave drivers. And, there is a possibility of a real revenue loss. Also, the principle of fairness will be violated if we just allow the companies in SEZs alone to enjoy all the benefits, and those who do core work languishing with heavy tax bills.

    But, not all SEZs are bad. For eg. Chennai is bringing some very good SEZs that could totally revolutionize the City as well as India. Instead of the conventional IT, Chennai is bringing a lot of core telecom/electronics companies besides becoming the India’s biggest auto component center. And the massive projects from Reliance with its own power supply and fully-contained infrastrurcture would help to move people from the crowded cities. Indian cities with their high real estate prices need a correction, and if more and more rural areas compete with cities for development by creating their own SEZ, we could have a more balanced development.

    Thus, India’s quest for SEZ is different from those of China. We want development to be spread across, be it moving IT from Tier-I cities or starting new industries like electronics & auto in Chennai or bring more technology to poor states like Orissa, Jharkhand & Uttaranchal. Also, more money with Private sector can bring more benefit to the people in a lot of indirect ways. After all, companies like Reliance & Tata invest most of their revenues in sectors like Infrastructure and this will do good to India in the long run, rather than having billions with our finance ministers.

  16. rc said, on January 3, 2007 at 8:54 am

    >> Particularly, it should be used as a carrot to push Infy & folks more to research and development rather than allowing them to just stay as slave drivers >>

    Why ? I would rather have them do what is best for their shareholders. If “slave driving” is what gets them maximum returns, then so be it.

    My only gripe is they cannot avail of tax holidays any more. We desparately need that money for primary education and infrastructure.

    >> For eg. Chennai is bringing some very good SEZs that could totally revolutionize the City as well as India. >>

    The ones you are talking about are not SEZs. They are SIPCOT industrial estates. This goes to prove the point that SEZs are not essential for industrial development.

    I believe all SEZ licenses should be cancelled. Only 3-4 huge SEZs must be created by the government (not private players). These SEZs must be located in coastal areas. Private players are free to construct this-or-that parks (apparel, tech) within these SEZs. They should not control the SEZs itself.

  17. 5ac511cda4079beed6746e9723028c9d said, on January 27, 2007 at 10:54 am

    5ac511cda4079beed674

    5ac511cda4079beed6746e9723028c9d5ac511cda407

  18. […] SEZs ( Everyone loves a tax holiday […]

  19. GulabiWorld said, on April 30, 2007 at 6:08 am

    Removing the Tax Sops for IT industry will hurt the growth story in the short term and long term may jeoparadise the whole IT industry.

    Government making lossed on account of extending Tax sops is ill thought about. Its better govt look at ways to manage the existing funds they get, which go unaccounted down the drain.

    At this juncture in Indian growth story, one trigger of hefty tax outflow of 40% on all IT biggies will tumble the stock market…….. the only indicator of Indian Economy… what kind of implications does the elite think tank forsee, who are lobbying for ending the Tax sops.

    How can we related competition in the industry to extending Tax sops, the domestic IT industry is very competitive and dont forget our IT companies predominantly survive on forerign markets. The analogy with Japanese auto companies in 50’s doesnt suit the bill.

    There is no harm in IT companies setting up SEZ, remember these lands are acquired at market rates unlike lands allotted to them 10 years ago when the industry was nascent.

    Politicians who hardly know anything about the Industry will be the key players in deciding the future of Indian IT industry.

  20. […] scam :Nilekani Imagining India,  SEZs need to go in Goa,  SEZ Chat, PIO University in an SEZ ? , IT SEZ – Everyone wants a holiday, Minimum Alternate Tax issue, Everything is wrong with us (maximum size cap on SEZ), Panel extends […]

  21. […] This post was mentioned on Twitter by K V Sarma J, Reality Check India. Reality Check India said: @KVSarmaJ try this ? https://realitycheck.wordpress.com/2006/10/13/it-sez-we-will-be-right-back-after-this-break/ […]

  22. […] new start-up, Gridstone Research (headquartered in San Mateo, Calif., India offices in Mumbai), by following links in a discussion of the role played by generous tax “holidays” in nurturing the Indian […]


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