January 06 2004
India is rapidly developing into the location of choice for the outsourcing of software and IT-enabled services. The Indian government has projected total software production of $87 billion and software exports of $50 billion by the year 2008. India has the second largest English-speaking manpower resources in the world and offers various advantages including a friendly government policy, a differential time zone, skilled manpower and low costs.
The development of the Indian IT sector has been (and continues to be) given the highest priority by the government. The dependence of the Indian economy on the domestic IT sector has rendered irreversible several of the incentives provided to this sector.
As part of its policy, the government has granted various benefits to Indian exports. As regards the IT sector, which is presently on the high priority list, the government has created a scheme for software developers and IT service providers in India (the Software Technology Park (STP) scheme). The scheme is administered by the Ministry of Information Technology and Communications, which is currently headed by Minister Arun Shourie.
Under the scheme, STP units can develop computer software, and carry out call centre and data entry, conversion, processing, analysis, control and management services. An STP unit may be located anywhere in India, although units that are located specifically in an STP enjoy certain additional infrastructural and administrative benefits.
Under the STP scheme, IT companies with STP units are eligible for certain incentives and benefits. However, the STP unit must first meet certain obligations (eg, regarding exports). Some of the benefits are discussed below.
Indian STP units are entitled to tax holidays on profits from exports. Under Section 10A of the Income Tax Act 1961 all profits and gains derived by STP units from exports are exempt from corporate income tax until March 31 2009.
Until recently, Indian tax law provided that the tax exemption would be reduced to 90% of the export profits with effect from the financial year beginning April 1 2004. However, the government withdrew this provision after significant resistance from the Indian IT sector and the tax exemption has been restored to 100% of export profits.
In order to claim this exemption, the STP unit must export at least 50% of its total production. Profits derived from local sales are not eligible for the exemption.
Duty-free import of equipment
All STP units are permitted to import their inputs and capital equipment without the need to pay customs duty. Capital equipment may also be imported on loan from clients for a specific period. However, this STP unit must meet an export obligation of $250,000 or three times the cost, insurance and freight value of imported capital goods, whichever is higher. The STP unit must achieve a positive export performance and a minimum 10% net foreign exchange earning as a percentage of exports.
No restriction on change of ownership
Until recently, domestic tax law stated that a change in control of an STP unit would result in loss of the tax exemption. This restriction has been discontinued with effect from April 1 2003, creating several opportunities for the Indian IT sector which were not previously available (eg, venture capital funding, issuing of convertible debt and restructuring), thereby encouraging mergers and acquisitions therein.
STP units are also exempt from the payment of local customs and duties (eg, central excise duty, which is a manufacturing tax) on inputs and capital goods purchased by STP units from Indian manufacturers.
All STP units are entitled to a refund of the central sales tax (equivalent to value added tax) paid on purchases.
Exports of professional and consultancy services are permitted, and any foreign exchange payments that are received will be considered as exports.
STP units may retain 100% of their export earnings in foreign exchange-denominated exchange earners' foreign currency (EEFC) accounts established with banks in India. Overseas remittances may be made from EEFC accounts with minimal regulatory restrictions.
STP units also enjoy special relaxations in the norms for overseas investments and external commercial borrowings.
Currently, 100% foreign ownership of an Indian exporter does not result in the absence of tax advantages. Complete foreign investment is permitted in Indian exporting companies.
India is fast emerging as the world's main outsourcing hub. IT outsourcing to India provides global companies with many significant benefits and, while advantages can be maximized through a well-structured entry, it is vital to take time to understand the issues involved in investing in India and to take the necessary steps to address them at the very inception of any project.
For further information on this topic please contact Bijesh Thakker at Thakker & Thakker by telephone (+91 22 5630 8000) or by fax (+91 22 5630 8100) or by email (email@example.com).
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