A Chinese proverb goes “Count not what is lost but what is left”. Initial impressions appear to be that the Income-Tax Department is following this maxim to collect what is left from the freebies granted under Sections 10 and 10A of the Act and the inexact world of international taxation in general, and transfer pricing in particular. A Rs 400-crore demand on Infosys has raised a hornests' nest, with the industry pooh-poohing the stance of the Department that the cost of employees sent abroad cannot be included as a part of export turnover. Other software and Section 10A companies are being identified and notices being sent. The industry claims that the Department has not comprehended a basic necessity of any professional these days — knowledge of the business - while the Department labels this practice “body-shopping” in disguise for which no specific exemption is available under existent tax laws.

Section 10A

Section 10A of the Income-Tax Act grants a deduction for units located in free trade zones from the total income of profits and gains as are derived by an undertaking from the export of articles or things or computer software for a period of ten consecutive assessment years. They key words are profits and gains and export of articles or things or computer software . The other clauses in the Section are mathematical and administrative in nature as they restrict the deduction to 90 per cent of profits from April 1, 2003, provide a sunset date of April 1,2012 for the deduction, ration the deduction to 100:50 for the first five and next three years respectively, force the creation of a Special Economic Zone Reinvestment Allowance Reserve Account and direct how this account is to be utilised, mandate that the deduction can be granted only of the proceeds are received in convertible foreign exchange and illustrate the manner in which the total income shall be computed.

Section 10AA contains almost similar provisions for SEZ units. The Explanations to the Section define computer software to mean software that is transmitted or exported from India to any place outside by any means while the definition of export turnover is defined as the consideration in respect of export turnover that is brought into India in convertible foreign exchange, but excludes freight, telecommunication charges and insurance attributable to the delivery of the articles outside India or expenses incurred outside India in providing technical services. The Department is gung-ho about the inclusion of the last point in the Section and opines that most foreign trips of software engineers would fall under expenses incurred outside India. Software companies would argue that their revenue model is invariably on a time-and-material basis and there is a nexus between both on-shore and off-shore work done for clients, all of which should be covered under the umbrella of export of software.

Charging Clause/Explanation?

While this issue is to be litigated at every level possible, the solution to the conundrum could lie between the superiority of a charging clause in a section over an Explanation to the Section. The Charging Section of 10A talks about the grant of a deduction on profits or gains from the export of computer software while the Explanation Section clarifies four categories expenses that would clearly not form a part of export turnover. The charging clause in the Section would appear to hold sway. The Explanation to the Section could be interpreted in myriad ways — it could be stated that the expenditure incurred abroad was not for technical services, but for administrative purposesit could not strictly be called expenses incurred abroad since they are being charged to the client and are being reimbursed by them.

Direct Taxes Code

Software companies could also draw reference to the refurbished Direct Taxes Code (DTC) to prove that the intent of the Section is not to disallow expenses incurred abroad. Though exempt incomes have the same Section number under the DTC, the section is a fraction of the present one in terms of length with all the nitty-gritty having been moved to Schedules. The Twelfth Schedule develops a formula to compute the net income of a SEZ by including incomes and deducting expenses including capital expenditure incurred wholly and exclusively for the purposes of business. The expenses in dispute now could never be disputed as a deduction under the DTC. Units in SEZs spend tons of money on capital expenditure and the formula above could result in a negative number. The Minimum Alternative Tax would ensure that there is a minimum payment of tax by such units.

It is normal for every Budget to insert a clause to nip in the bud litigious issues between Revenue Departments and tax-payers. This year's Budget could see an insertion in Sections 10A and its alphabetical variants till the DTC takes over.

(The author is a Bangalore-based chartered accountant.)

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