Are IT firms using SEZs to maintain tax holiday?

Over 90 information technology special economic zones, SEZs, have been cleared and atleast 40 more are going to come up. In fact IT SEZS make up for almost half of the total number of SEZS approved as yet. So, why are Indian IT companies so enthused by the SEZ concept? Is it because it offers them a chance to perpetuate a tax holiday that otherwise ends in 2009? Debating this issue are Director of Human Resources of Infosys, Mohandas Pai, CEO of i-Flex, Deepak Ghaisas and Partner at BMR & Associates, Mukesh Butani.

Excerpts from an interview given to CNBC-TV18:

Q: You said that you were convinced that if tax benefits on software exports was extended, then e so many IT companies would not clamour to set up SEZs?

Ghaisas: I think the major attraction clearly is the tax concessions that IT companies have got and if they are going to get extended by or through the mechanism of SEZs, then I think most IT companies would be interested in doing that. But there are a lot of difficulties and variations between STPI and SEZ schemes.

Q: But you said if tax concessions were extended beyond 2009, then so many IT companies would not be jumping into the SEZ bandwagon?

Ghaisas: Absolutely right.

Q: Today you have Infosys, Satyam ,Wipro and TCS - all clamouring to set up SEZs and all have got approvals to some extent. So, what do you think of this big rush to try and perpetuate a tax holiday that otherwise ends in 2009?

Pai: There are two aspects. Firstly, large companies need large infrastructure requirements for expansion. They are not finding it in the existing places except in SEZs and so they have to go to the SEZ to expand. For example, we want to set up a 25,000-person campus in Chennai and the only place you can do it is the Mahindra SEZ.

Secondly, when a policy framework has been made about an SEZ - all of us in the corporate sector have to take advantage of the policy framework so that our shareholders will not point a finger at us. Yes, Narayan Murthy has made the statement - it is a larger policy issue but while running the corporation, we have to do what is available and is required.

But one must remember that, at the national level, the tax holiday is worth about Rs 125,000 crore in terms of market value for the whole industry. The industry today has market value of Rs 500,000 crore, which works out to 25% liquid stock, 5% of revenues and around 20%-25% of profits are tax exempt - this if calculated is worth Rs 125,000 crore and we can't throw it away.

Q: So you are saying that it is all right for IT companies to try and perpetuate that tax holiday even if it doesn’t exist beyond 2009 via the SEZ route? You spoke of infrastructure, we understand that the minimum area required for an IT SEZ is 25 acres and whereas the minimum area required for a multi-product SEZ is 2,500 acres, 25 acres is the minimum but that cannot clearly be an infrastructure play, it has to be a tax play?

Pai: It is a tax play but it is not a good policy for smaller companies. For eg a smaller companies with 100 people want to set up shop and we need many more small innovative companies in this country who are into a product area. For them, an SEZ restricts their choice, they need an STPI scheme. I think from a policy point of view, it is best to extend STPI schemeS like the commerce secretary has said and also give software companies a choice of the STPI scheme. But once you have a policy, naturally all companies will take advantage of the policy to do what is best for them.

Q: Do you think it is fair that IT companies be given another chance to extend what is now becoming a 2-3 decade long tax-free period for them via the SEZ policy? And is it going to be operationally possible for them to migrate existing business contracts or the renewed ones to these zones and treat them as new businesses and avail of the benefits?

Butani: There are two aspects - one is from the policy standpoint - the expiry of tax holiday in 2009 is something that the government thought about. Several successive tax reform committees suggested that we should get rid of all tax holidays.

The second is the policy - something that the government is trying to think since the late 1990s that we should have SEZs designed on the basis of what you have in China. But it is a different story about how the policy has evolved and there is a 25 acre limit for IT SEZs and also there is a limit of one million sq.ft for developed areas. I don’t think we should confuse the tax holiday with the policy part of it. The government from a policy standpoint is saying that this policy is going to encourage greater level of investment at large, in the country.

Q: What about the fact that this investment may not be new investment, it may be existing business contracts that are renewed in a zone and thereby allowing IT companies to use this to perpetuate the holiday?

Butani: How can you say that you can renew the contract? After all, at the end of the day I don’t have to set up an SEZ just because I have to expand. I have to set up an SEZ because I may want to have multiple locations. I may have significant expansions. After all, any entrepreneur who is thinking of developing one million square feet has to demonstrate significant investment, has to demonstrate he's hiring new people and has to demonstrate he's got new contracts.

Q: So are you saying that the Department of Revenue is going to lay out very strict guidelines that doesn’t allow IT companies to actually renew existing business contracts and insist that all business in SEZs is new business?

Butani: If you look at the law today, there is no provision in the law which talks about migration. So, if today I move from an STPI into SEZ with my people and with a contract, nothing prevents me from claiming a tax holiday. The only difference here is that as a part of the amendment in the special economic zone rules, they have put a prohibition on transfer of plant and machinery.

So, if I am using a plant and machinery in an STPI I can't move it into a SEZ. However, having said that and given the larger intent and substance of the law, I won't be surprised if the Department of Revenue comes out with suitable checks and balances to prevent migration from occurring.

Q: If they come up with that list of preventions, do you think that many IT companies will actually clamour to set-up SEZs?

Ghaisas: Let us look at this arithmetic what we talked about. We are talking about 25 acres, we are talking about million square feet of built-up area within three years time and this means 10,000 people and therefore you require 10,000 new people and everybody knows that any new project that comes up, you can't just stock it with new people. You need to have the old people also working with the new people. So, I am not sure exactly how the tax benefit is going to work.

More than that, the Ministry of Finance's real intention is not to give the tax benefits left right and centre as it was before, and therefore my worry is that the laws are going to be so stringent. And therefore, there will be a lot of disputes with the income tax department going forward - that people are not going to get benefits like they used to under the STPI.

Q: Are you in favour or do you think the industry would be in favour of very strict guidelines that ensure that only new business is set up in special economic zones?

Pai: The industry would be in favour of good guidelines. One that there is incremental large-scale investment and two, large-scale incremental employment is created and three large-scale incremental works. I don’t think the industry expects the existing work to shift to the SEZ. They would expect to play by the rules and the rules are very clear - ie. incremental investment, incremental employment and incremental business.

Earlier, the Software Technology Parks Of India (STPI) policy was existing and continuing possibly to grow. Now the existing STPIs will not grow and all new investment, new development and new employment will be in the SEZs - that is the interpretation the industry is making

Q: Do you think we are going about this entire SEZ policy in the right fashion? Should we be following the China example or do you think that is not applicable to India?

Pai: I think the vision should be much larger. Our vision is very myopic. We should make large-scale investment. We should ensure that manufacturing gets priority, followed by services but the division has to be much larger. The way it is today, the division is very myopic and too small and I am afraid that we may not get the benefits that China did.

Q: What do you think of the SEZ policy?

Ghaisas: The SEZ policy in-principle is fine. We require big townships to balance growth in the country. The areas which are underdeveloped need to get developed through SEZ schemes and that is how the SEZ policy should be implemented - with very simple and straightforward rules, which don’t give any interpretation disputes later on.

Q: Do you approve of this - about not leaving any space open for interpretation?

Butani: I entirely echo Deepak's view and I would rather make one suggestion - that if there is a single window clearance by the Minister of Commerce and Board of Approvals, then why can't they actually guarantee tax exemption at that stage itself. That will prevent all kinds of controversy and litigations that could come up in the future.