Tax benefits for export of software – CBDT’s latest clarifications

softwareTax benefits for export of software – CBDT’s latest clarifications

In this article the author has examined the contents of the CBDT’s circular giving clarifications on various issues which relate to sections 10A, 10AA & 10B of the I.T. Act, 1961. According to the author, the circular has clarity, on the issue of tax benefits for the export of software.

Introduction

1. Fast developments in the field of information technologies, including in the field of softwares, have made their impact, inter alia, on taxation aspects. There had been a growing realization that the Indian businesses should get tuned to the new culture of working of I.T. Softwares, which has by now assumed the status of an Industry.

Software development (also known as application development, software design, designing software, software application development, enterprise application development or platform development) is the development of a software product. The term ‘software development’ may be used to refer to the activity of computer programming, which is the process of writing and maintaining the source code, but in a broader sense of the term it includes all that is involved between the conception of the desired software through to the final manifestation of the software, ideally in a planned and structured manner. Therefore, software development may include research, new development, prototyping, modification, re-use, re-engineering, maintenance or other activities that result in software products [http://en.wikipedia.org].

2. Software in the context of the Income-tax Act, 1961 (the Act)

2.1 Under section 10A – Section 10A provides for exemption of income, inter alia, for the export of computer software, which has been defined in the Explanation 2 to section 10A as under:-

“(i)

‘computer software’ means –

 

(a)

any computer programme recorded on any disc, tape, perforated media or other information storage device; or

(b)

any customized electronic data or any product or service of similar nature, as may be notified by the Board,

 

which is transmitted or exported from India to any place outside India by any means”.
Explanation 2 to section 10A, clarifying the position regarding onsite services reads as under:-
“For the removal of doubts, it is hereby declared that the profits and gains derived from onsite development of computer software (including services for development of software) outside India shall be deemed to be the profits and gains derived from the export of computer software outside India”.

2.2 Under section 10AA – It is a special provision in respect of newly established units in Special Economic Zones (SEZs) conferring tax benefits on such undertakings, including on export of computer software. Explanation 2 to this section clarifies the position regarding export of such software in regard to on the spot services as follows:-

Explanation 2 – For the removal of doubts, it is hereby clarified that the profits and gains derived from onsite development of computer software (including services for development of software) outside India shall be deemed to be the profits and gains derived from the export of computer software outside India.

This Explanation clearly says that onsite development outside India would constitute export and profits therefrom will be entitled to the benefit of section 10AA.

2.3 Under section 10B – This section of the Act is titled ‘Special provision in respect of newly established 100 per cent EOU. The definition of computer software in this section is the same as in section 10A (supra) and the Explanation 3 to this section likewise clarifies the position in regard to on the spot development of computer software thus:-

Explanation 3 – For the removal of doubts, it is hereby declared that the profits and gains derived from onsite development of computer software (including services for development of software) outside India shall be deemed to be the profits and gains derived from the export of computer software outside India.

CBDT’s Circular No. 01/2013, dated 17th January, 2013

3. The circular clarifies the position regarding export of computer software in the context of sections 10A, 10AA & 10B.

The relevant aspects from this circular are discussed in the later paragraphs.

The foregoing discussion shows that there was no confusion regarding grant of tax benefits under sections 10A, 10AA & 10B concerning receipts relating to onsite development of computer software outside India. However, to put the matter beyond doubt, the position has been clarified in replies to queries 4(a) & (b) in following few paras :-

4. Queries

4. (a) Whether onsite development of computer software qualifies as an export activity for tax benefits under sections 10A, 10AA & 10B of the I.T. Act, 1961?

4. (b) Whether receipts from deputation of technical manpower for such onsite software development abroad at the client’s place are eligible for deduction under sections 10A, 10AA & 10B?

5. Detailed replies to above two queries

Reply to query at Sl. No. 4.(a) – CBDT had earlier issued a circular (Circular No. 694, dated 23-11-94), which provided that a unit should not be denied tax holiday under section 10A or 10B on the ground that the computer software was prepared onsite, as long as it was a product of the unit, i.e., it was produced by the unit. However, certain doubts appear to have arisen following the insertion of theExplanation 3 to sections 10A & 10B (vide Finance Act, 2001) and Explanation 2 to section 10AA (vide Special Economic Zones Act, 2005) providing that ‘the profits and gains derived from onsite development of computer software (including services for development of software) outside India shall be deemed to be the profits and gains derived from the export of computer software outside India, and a clarification has been sought on the impact of the Explanation on the tax benefits as compared to the situation that existed prior to the amendments.

The matter has been examined in details. In view of the position of law, as it stands now, it is clarified that the software developed abroad at a client’s place would be eligible for benefits under the respective provisions, because it would amount to deemed export and tax benefits would not be denied merely on this ground. However, since the benefits under these provisions can be availed of only by the units or undertakings set-up under specified schemes in India, it is necessary that there must exist a direct and intimate nexus or connection of development of software done abroad with the eligible units set-up in India and such development of software should be pursuant to a contract between the client and the eligible unit. To this extent, Circular No. 694, dated 23-11-1994 stands further clarified.

Reply to Query at Sl. No. 4.(b) – The clarification given reads as follows:-

It has also been brought to notice that it is a common practice in the software industry to depute technical manpower abroad (at the client’s place) for software development activities (like upgradation, testing, maintenance, modification, trouble shooting, etc.), which often require frequent interaction with the clients located outside India. Due to the peculiar nature of the software development work, it has been suggested that such deputation of technical manpower abroad should not be considered as detrimental to the benefits of the exemption under sections 10A, 10AA & 10B merely because such activities are rendered outside the eligible units/undertakings.

The matter has been examined in details. Explanation 3 to sections 10A & 10B and Explanation 2 to section 10AA clearly declare that profits and gains derived from services for development of software outside India would also be deemed as profits derived from export. It is, therefore, clarified that profits earned as a result of deployment of technical manpower at the client’s place abroad, specifically for the software development work pursuant to a contract between the client and the eligible unit should not be denied benefits under sections 10A, 10AA and 10B, provided such deputation of manpower is for the development of such software and all the prescribed conditions are fulfilled.

6. Queries on other related issues :

6.1 Query – Whether it is necessary to have separate master service agreement (MSA) for each work contract and to what extent it is relevant?

6.1-1 Reply to Query at Sl. No. 6.1 – As per the practice prevalent in the software development industry, generally two types of agreements are entered into between the Indian software developer and the foreign client. Master Services Agreement (MSA) is an initial general agreement between a foreign client and the Indian software developer, setting out the broad and general terms and conditions of business under the umbrella of which specific and individual Statement of Works (SOW) are formed. These SOWs, in fact, enumerate the specific scope and nature of the particular task or project that has to be rendered by a particular unit under the overall ambit of the MSA. Clarification has been sought whether more than one SOW can be executed under the ambit of a particular MSA and whether SOW should be given precedence over MSA?

The matter has been examined. It is clarified that the tax benefits under sections 10A, 10AA and 10B would not be denied merely on the ground that a separate and specific MSA does not exist for each SOW. The SOW would normally prevail over the MSA in determining the eligibility for tax benefits, unless the Assessing Officer is able to establish that there has been splitting up or reconstruction of an existing business or non-fulfilment of any other prescribed condition.

6.2 Query – Whether Research & Development (R&D) activities pertaining to software development would be covered under the definition of computer software stipulated under Explanation 2 to sections 10A and 10B?

6.2-1 Reply to query at Sl. No. 6.2 – The definition of computer software stipulated under Explanation 2 to sections 10A & 10B includes ‘any customized electronic data or any product or service of similar nature, as may be notified by the Board..’. The CBDT had already issued Notification No. 890(E), dated 26-9-2000 specifying such items. The notification includes engineering and design but does not specifically include R&D activities related to software development in respect of which clarification has been sought.

After examining the matter, it is clarified that the services covered by the aforesaid notification, in particular the engineering and design do have the inbuilt elements of R&D. However, for the sake of clarity, it is reiterated that any R&D activity embedded in the engineering and design would also be covered under the said notification for the purpose of Explanation 2 to the above provisions.

6.3 Query – Whether tax benefits under sections 10A, 10AA & 10B would continue to remain available in case of a slump sale of a unit/undertaking?

6.3-1 Reply to query at Sl. No. 6.3 – The vital factors in determining the above issue would be the facts such as how a slump sale is made and what is its nature? It will also be important to ensure that the slump sale would not result into any splitting-up or reconstruction of existing business. These are factual issues requiring verification of facts. It is, however, clarified that on the sole ground of change in ownership of an undertaking, the claim of exemption cannot be denied to an otherwise eligible undertaking and the tax holiday can be availed of for the unexpired period at the applicable rates for the remaining years, subject to fulfilment of prescribed conditions.

6.4 Query – Whether it is necessary to maintain separate books of account by an assessee in respect of its eligible units claiming tax benefits under sections 10A & 10B?

6.4-1 Reply to query at Sl. No. 6.4 – Since there is no requirement, in law, to maintain separate books of account, the same cannot be insisted upon. However, since the deductions under these sections are available only to the eligible units, the Assessing Officer may call for such details or information pertaining to different units to verify the claim and quantum of exemption, if so required.

6.5 Query – Whether tax benefits under section 10AA can be enjoyed by an eligible SEZ unit consequent to its transfer to another SEZ?

6.5-1 Reply to query at Sl. No. 6.5 – This issue relates to cases where an eligible SEZ unit is shifted from one SEZ to another SEZ on account of commercial exigencies. This shifting is permissible under Instruction No. 59 (F.No. C-4/2/2010-SEZ) issued by the Deptt. of Commerce (SEZ Division), provided approval from the Board of Approvals (BoA) has been obtained. Doubts have been raised whether such shifting of an eligible unit would deprive the unit/undertaking of tax benefits, provided there is no splitting-up or reconstruction of an existing business?

The matter has been examined and it is clarified that the tax holiday should not be denied merely on the ground of physical relocation of an eligible SEZ unit from one SEZ to another in accordance with Instruction No. 59 of the Deptt. of Commerce (referred to above), if all the prescribed conditions are satisfied under the I.T. Act, 1961. It is further clarified that the unit so relocated will be eligible to avail of the tax benefit for the unexpired period at the rates applicable to such years.

6.6 Query – Whether new units/undertakings set up in the same location where there is an existing eligible undertaking would amount to expansion of the existing unit/undertaking.

6.6-1 Reply to query at Sl. No. 6.6 – Whether setting-up of a new unit/undertaking in a location (covered by section 10A, 10AA or 10B), where an eligible unit is already existing, would amount to expansion of already existing unit is a matter of fact requiring examination and verification. However, it is clarified that setting-up of such a fresh unit in itself would not make the unit ineligible for tax benefits, as long as the unit is set-up after obtaining necessary approvals from the competent authorities, provided it has not been formed by splitting-up or reconstruction of an existing business and it fulfils all other conditions prescribed in the relevant provisions of the law.

Concluding comments

7. The circular clarifies a number of queries concerning computer softwares. As far as onsite development out of India is concerned, the position was quite clear even before the issue of circular. However, the circular brings clarity and certainty in the matter.

The clarifications given on other aspects too are welcome to give us a clear-cut position of the relevant law.

 

Source : www.taxmann.com

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