IT SEZ : Everyone loves a holiday
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 (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.