Tag Archives: Tax

Tax advantages available to a software company

The Software industry in Karnataka state in India has become one of the main pillars of economy. Karnataka stands first among all the states of India in terms of revenue generated from software exports. If you are planning to set up Software Company, Government of India & State Government provides various Tax advantages to the entrepreneurs to promote Software Companies. Tax Incentives available to Software Companies applies depending upon the location of project like SEZ EOU etc ,  There are different Tax incentives available for a Company having place of business in SEZ than of those not having place of business in SEZ.

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TAX STRUCTURE OF SOFTWARE DEVELOPMENT ENTITIES BASED IN SEZ

SEZs are developed to encourage the companies to engage in export of goods and articles or services. There are various benefits given to the companies having units in SEZ under Direct taxes as well as Indirect taxes.

Tax  Incentives available under Direct Tax:

  • Under Section 10AA of the Income Tax Act, the company will get exemption

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  • Under Section 115JB of the Income Tax Act:

 The profits from SEZ unit which is exempt u/s 10AA will also not be liable for Minimum alternative tax.

If the company declares dividend, then the company has to pay dividend distribution tax @ 16.995%.

 Tax Incentives available under Indirect Taxes:

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 If the SEZ units makes sales within India, then the taxes as applicable to Non SEZ units  will be applicable and other benefits might be withdrawn.

TAX STRUCTURE OF SOFTWARE DEVELOPMENT ENTITIES BASED IN NON-SEZ  

Applicable  Taxes on Software Development Company

Entrepreneurs who wishe to start Software Business, has to pay various taxes such as   direct tax & Indirect Taxes

Implications under Direct Taxes:

  • Income Tax @ 30% on gross total income plus surcharge @ 5%/10% if applicable and education cess at 3%
  • If there is no income tax liability on the income, minimum alternate tax @ 18.5% on the book profits plus surcharge @ 5%/10% if applicable and education cess at 3%.

Implications under Indirect Taxes:

  • Customs duty on imports at applicable rates.
  • Service tax at applicable rates which is presently 12.36%
  • Excise duty at applicable rates.
  • Central sales tax at applicable rates.
  • Value added tax at applicable rates.
  • Applicable taxes on sale of goods and articles or provision of services.
  • Dividend distribution tax @ 16.995%

 However there are few other Tax incentives schemes have been launched by Government under Various heads

TAX INCENTIVES AVAILABLE UNDER ITBT( INFORMATION & BIO TECHNOLOGY ) SCHEME

The Karnataka Government recently announced various fiscal and non-fiscal incentives to give an impetus to Information Technology (IT) and Bio-Technology (BT) industries in the State. In order to enable identification of eligible units so that these incentives can be applied to them, BT and IT units need to obtain a Registration from the designated registering Authorities.

Benefits provided under the IT Policy are as follows:

  1.     Fiscal Incentives:

 a)    Under Millennium IT Policy the companies engaged in IT activities are exempted from the payment of ‘Entry Tax’ on capital goods and purchase tax on computer hardware, computer peripherals and other capital goods including captive power generation sets, during the implementation stage which can be extended up to five years from the date of commencement of implementation.

 b)    IT industries will be offered sales tax exemption for a period of 10 (ten) years or deferment for a period of 12 (twelve) years, subject to a ceiling of 200% (two hundred percent) of the value of fixed assets.

 c)    Captive power generation sets installed by the Information Technology Industry will be eligible for the total exemption from payment of electricity tax without any time limit.

 d)    Power: Software companies will be treated as industrial (and not commercial) and electricity tariff applicable to the industrial consumers will be levied on such companies. These industries would be given priority in sanction and servicing of power and would also be exempt from power-cuts without any time limit.

 B.    Concessions for Creating Employment:

a)    All new IT companies which create employment of more than 250 in Bangalore & 100 in other areas during the first year are eligible for rebate on the stamp duty @15% and rebate on the cost of the land @15% in case companies get land from the state agencies like Karnataka State Small Industries Development Corporation, Karnataka Industrial Areas Development Board, KEONICS etc.

b)    Labour Law: The Labour Department has also initiated procedures to exempt the IT companies from the preview of Industrial Employment (Standing Orders) Act 1946 and other relaxations in maintaining certain registers and filing returns under other laws.

Section 11 of the Shops and Commercial Establishments Act 1951 restricts the opening and closing times of any establishment and Section 12 requires closure of the establishment on one day of the week. Section 25 of the Act prohibits employment of women at night. IT industry will be outside the scope of section 11 and 12 of the Act. An amendment to Section 25 is also approved enabling the IT sector to employ women at night.

C.    For IT Parks Concession is as follows:

a)    Exemption from sales tax/works contract tax arising in the construction of the infrastructure facility for a period of three years or till the date of completion of the project, whichever is earlier.

b)    50% exemption from payment of stamp duty and registration charges on the first sales of land in the case of IT Parks.

c)    Exemption from payment of entry tax on machines, equipment, capital goods and construction material procured for implementation of infrastructure projects, for a period of three years or till the date of completion of the project, whichever is earlier, subject to the condition that each invoice should be for not less than Rs.25 lakhs (Rs.1 lakh for construction materials).

TAX INCENTIVES AVAILABLE UNDER STPI(SOFTWARE TECHNOLOGY PARK OF INDIA)

Software Technology Parks of India (STPI), an autonomous society under Ministry of Communication and Information Technology, Dept. of Electronics and Information Technology, Govt. of India has been set up with distinct focus to boost up Software export from the country. The government’s STPI scheme, introduced in 1991 to encourage software exports, helped make India one of the world’s leading hubs for software and business process outsourcing. Following are Tax Benefits available to Software Company under STPI:*

  • If the unit is registered under STPI, Company can import of capital goods without payment of duty.
  • If the goods are procured from domestic manufacturer, no excise duty is payable provide certain procedures are followed.
  • If activity is undertaken in the form of services and not in the form of development of software on their own, in such situation, Company will have to pay the full Central Sales Tax.
  • If any capital goods are procured from outside the State. In case of procurement of capital goods, there is no concession rate of VAT and Company will have to pay the full VAT & the same is not refundable.
  • If Company is engaged in own software development, in that case they can procure the capital goods from outside the State and Central Sales Tax paid can be claimed as refund from the Development commissioner. In respect of VAT paid on local purchase (only in respect of eligible goods and on stationary or furniture etc), they can claim the refund.

*However STPI scheme has been withdrawn in 2011 as far as benefits under Direct Taxes are concerned. .

Author – Anu Kapoor, Associate with NovoJuris.

Disclaimer: There are many details that the Act prescribes, please speak with your attorney for advice. This is not a legal opinion and should not be construed as one.

TAX TREATMENT OF ESOP DISCOUNT – BIOCON CASE

Income Tax Appellate Tribunal in a recent order (Dy. Commissioner of Income-tax (LTU), Bangalore Vs M/s. Biocon Limited) (“Case”) held that “discounts under the ESOP are an employee cost and should be allowed as a deduction over the vesting period, in the hands of the issuing company.” The above order of ITAT will clear certain ambiguities surrounding the accounting treatment of “discount” provided by the Companies.

In an ESOP, the shares are issued to the employees at a future date (after vesting period) at price lower than fair market value (FMV) of the share.

Hence ESOP discount, is nothing but the reward for services, is a taxable perquisite to the employee at the time of exercise of option, and its valuation is to be done by considering the fair market value of the shares on the date on which the option is exercised.

Please read the Order here.  It is about 50 pages only and must admit it is one of the really well drafted order and you’ll enjoy reading it as much as we did.

Brief Facts of the Case:  

  • Assessee Company (Biocon) had set up ESOP Plan for its employees, where exercise price of options granted was Rs. 10 against the FMV of Rs. 919, thereby giving an upside per option at Rs. 909.
  • Assessee granted certain options to its employees at the above exercise price and total of 6.52 crore was claimed as compensation (difference between Exercise and FMV) to the employees to be spread over the vesting period of four years.
    • Assessee claimed discount under ESOP as employee compensation cost under section 37(1) of the Income tax Act, and claimed a deduction of 3.38 crore in conformity with SEBI Guidelines
    • Assessing Officer disallowed deduction of the same, on the ground that there being no provision to claim deduction under said section.

Issues Involved

Whether the ESOP compensation is an allowable deduction in the computation of income under the head “Profits and gains of business or profession”? Three questions emanating from the statement are as follows:

a)    Whether any deduction of such discount is allowable?

b)    If yes, then when and how much?

c)    Subsequent adjustment to discount

Held:

One of the contentions of the Department was that since there has been no cash outflow from the books of the Assessee, there is no question of expense incurred, hence no deduction can be allowed, as the company has issued options (which will become shares at time of exercise) at a discounted rate to incentivize their employees.

However, it was held that u/s 37(1), which states “Any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.

And, reliance was made on certain Supreme Court cases, which held the expression “expenditure” as used in section 37covers an amount which is really a “loss” even though the said amount has not gone out from the pocket of the assessee.

Hence, even though the Assesee, didn’t make any cash outflow at the time of exercise of options, however it suffered a notional loss, while issuing shares at a discounted rate to its employees. Hence such an expense/expenditure is allowed as a deduction as they are employee cost to the company/assessee.

Contingent Liability:

Tribunal also held that such an event is not a contingent liability: “If we consider it at micro level qua each individual employee, it may sound contingent, but if view it at macro level qua the group of employees as a whole, it loses the tag of `contingent’ because any lapsing options (because of termination of the employee during vesting period) are up for grabs to the other eligible employees. In any case, if some of the options remain unvested or are not exercised, the discount hitherto claimed as deduction is required to be reversed and offered for taxation in such later year. We, therefore, hold that the discount in relation to options vesting during the year cannot be held as a contingent liability”

When and How Much Discount:

It was further debated, on when is the deduction to be allowed and to what extent such deduction is allowed. It was held that no liability on the Company arises at the time of grant of options or at the time of exercise or thereafter.

The actual liability arises during the vesting period and hence held that “the liability to pay the discounted premium is incurred during the vesting period and the amount of such deduction is to be found out as per the terms of the ESOP scheme by considering the period and percentage of vesting during such period”.

Reliance was made on one Re. SSI Limited, case law where deduction was allowed of the discounted premium during the years of vesting on a straight line basis.

Subsequent adjustment to cost

A very important point that emanates from this case is regarding to the variation of FMV of the share at time of exercise.

Now, since the expenditure is allowed as a deduction during vesting period, and as expenditure is difference between the exercise price and FMV, there might be a situation, where the FMV calculated by the company for granting options differs from the actual FMV at the time of exercise.

The accounting of such variations were also dicussed and it was held that

  • “The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvesting/lapsing options at the appropriate time”. Like in case the options lapsed or are unvested the deduction claimed on such options shall be reversed back in the books of the Company.
  • An adjustment to the income is called for at the time of exercise of option by the amount of difference in the amount of discount calculated with reference the market price at the time of grant of option and the market price at the time of exercise of option.”

In case there is increase in the FMV at the time of exercise to what Company has claimed deduction for, the Company is still eligible to claim the difference in the valuation in relevant assessment years.

Similarly, if the FMV drops from the valuation at which company has made reliance on, than the Company shall be obligated to reverse the over expensed amount.

Conclusion:

This order of ITAT will help in substantially reducing the ambiguities around the accounting treatment of the discount/expenditure incurred by the Company. Hence it was summed up as follows:

“That the discount under ESOP is in the nature of employees cost and is hence deductible during the vesting period. No accounting principle can be determinative in the matter of computation of total income under the Act. The question before the special bench is thus answered in affirmative by holding that discount on issue of Employee Stock Options is allowable as deduction in computing the income under the head `Profits and gains of business or profession’.”

Disclaimer:  This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

Dheeraj Khanna, Senior Associate, specializes in structuring businesses and IP.