IT Sector in India Shocked by US$1.55 Billion in Tax Notices

By Dezan Shira & Associates

India’s information technology (IT) sector received yet another blow as the federal tax body has sent tax notices to about 200 companies. Media reports state the number of affected companies is larger.

The notices reportedly make a service tax demand that collectively amounts to US$1.55 billion (Rs 100 billion). This includes returns on export benefits claimed in the last five years from 2012 to 2016, an additional 15 percent service tax, and fines.

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IT and IT-enabled service (ITeS) companies believe they are exempt from paying this service tax as they export software services, and can therefore claim export benefits. This is challenged by the tax department, which states that instructions provided to IT/ITeS firms by their foreign clients via email regarding software specifications is to be treated as ‘supply of goods’ for taxation purposes.

This contention will now be judged in the appellate tax tribunals; however, exporters appealing the case will still need to deposit 10 percent of the tax demand.

The sudden tax notices has sent shock waves in the IT sector, which is already reeling from global headwinds, especially tightening immigration norms in the U.S. and automation, aside from the increase in tax liability under GST (18 percent). In fact, the current unpredictability of the government’s reform environment has pushed some small and medium sized firms (SMEs) to shift the base of their operations outside India to remain competitive in the international market. Further, SMEs form the backbone of India’s IT sector, and may not be able to afford prolonged tax litigation.

The overall sector is also in the midst of a technological transition as India adapts to the disruptions caused by automation and allied technologies, popularly referred to as ‘SMAC’ or social media, mobility, data analytics, and cloud computing. This has altogether resulted in restructuring efforts by the sector’s leading IT firms, leading to the layoff of competent, technically trained, and experienced technology professionals.

Industry observers and foreign investors will keenly watch how the retrospective tax liability gets resolved; key promises of the Modi government hang in the balance – job creation and ease of doing business. 

Update: The federal government announced mid-December that it would set aside the US$1.55 billion tax demand. However, tax experts remain uneasy as the matter can be only resolved through adjudication – till then the tax department is capable of raising similar demands again.

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