10 October 2014 EY Tax Alert CBDT Circular on threshold limit for transfer of technical manpower to new SEZ unit for availing profit-linked deduction Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent Circular [1] issued by the Central Board of Direct Taxes (CBDT) on the threshold limit for transfer of technical manpower from an existing unit of a taxpayer to its new unit located in a Special Economic Zone (SEZ unit) for availing profit-linked deduction under the Indian Tax laws (ITL). As part of the eligibility conditions, the relevant provisions in the ITL provide that the unit should not have been formed by splitting up of or reconstruction of a business already in existence and that it should not have been formed by the transfer, to a new business, of plant or machinery previously used for any purpose in excess of 20% in value. The CBDT in its earlier circular [2] fixed the threshold of tolerance band for transfer of technical manpower from existing units to a new SEZ unit at 20% of the total technical manpower engaged in the development of software at any point of time in the year of commencement of the business. [1] Circular No. 14 of 2014 dated 8 October 2014 [2] Circular No. 12 of 2014 dated 18 July 2014. See EY Tax Alert dated 29 July 2014
Superseding the previous circular issued on the subject, the CBDT has clarified, in the present Circular, that the condition of splitting up of or reconstruction of an existing business is not violated in the setting up of a new SEZ unit if the total number of technical manpower transferred from an existing unit to a new SEZ unit does not exceed 50% of the total technical manpower actually engaged in the development of software or IT-enabled products in the new SEZ unit as at the end of the financial year, if other conditions of eligibility are satisfied. Alternatively, the said condition is also fulfilled if the total number of new technical manpower recruited across all units of the taxpayer at the enterprise level is equal to at least 50% of all technical manpower of the new SEZ unit. Background Recognizing the potential of the Indian IT industry, several fiscal incentives, including profit-linked tax deductions [3], are being granted to them. These fiscal incentives apply to a unit or an undertaking established under various schemes and deriving profits from export of computer software or IT-enabled services (ITeS), subject to fulfilment of the following, amongst others conditions: The unit is not formed by splitting up of or reconstruction of an existing business. It is not formed by transfer of plant or machinery previously used for any purpose in excess of 20% of the value of the plant and machinery of the new SEZ unit. The issue as to whether transfer or redeployment of technical manpower from existing units of the taxpayer to its new SEZ unit amounts to splitting up of or reconstruction of its existing business has been a contentious issue. A Committee constituted by the Government of India under the chairmanship of Mr. N. Rangachary (Rangachary Committee) examined the issues relating to taxation in the IT industry and submitted its recommendations in September 2012. The CBDT issued clarifications on a number of contentious issues pursuant to this [4]. On the issue of transfer of manpower, the Rangachary Committee had, amongst others, recommended that 50% of the billable employees in a new SEZ unit in the first year should be new employees and this condition is satisfied if the taxpayer is able to demonstrate that the net addition of the new billable employees at the enterprise level is, at least, equal to the number that represents 50% of the total billable employees of the new SEZ unit. In Circular No. 12 of 2014, the CBDT fixed the threshold of tolerance band for transfer of technical manpower from existing units to a new SEZ unit at 20% of the total technical manpower engaged in the development of software at any point of time in the year of commencement of the business. In a case where the threshold is exceeded, the new SEZ unit is considered as formed by splitting up of or reconstruction of an existing business, ineligible for profit-linked deduction. [3] Under Section 10A and 10AA. Though Section 10A expired on 31 March 2012, the clarification would be relevant in litigation [4] Circular No. 1 of 2013 dated 17 January 2013. Refer EY Tax Alert dated 18 January 2013
The IT industry made representations before the CBDT that the limit of 20% was inadequate and restrictive and that such restrictions impact the global competitiveness of the industry in terms of quality of the product and delivery lines. The nature of the industry is such that a talented, skilled and experienced workforce is needed; projects could not be run only with freshers. Accordingly, it was requested to enhance the prescribed technical manpower transfer threshold limit of 20% in the light of recommendations made in the Rangachary Committee Report. Accordingly, the CBDT issued Circular No. 14 of 2014 on 8 October 2014, in supersession of the earlier circular, to provide relief to new SEZ units. CBDT Circular No. 14 of 2014 The setting up of a new unit by the taxpayer in an SEZ will not be considered as splitting up of or reconstruction of its existing business, if it complies with any one of the two conditions below in the year of commencement of business: Transfer or redeployment of technical manpower from existing units does not exceed 50% of the total technical manpower actually engaged in the development of software or IT-enabled products of the new SEZ unit as on the last day of the year ; or The net addition to new technical manpower in all units of the taxpayer at the enterprise level is, at least, equal to the number that represents 50% of the total technical manpower of the new SEZ unit during the year. The Circular is applicable only in the case of taxpayers engaged in the development of software or in providing ITeS in SEZ units that are eligible for profit-linked deductions. The relief provided by the Circular will not apply to completed tax assessments. Where any Appellate Authority has decided the matter in consonance with the Circular, the Tax Authority will not file further appeal against such an order. Illustration explaining effect of the Circular A numerical example illustrating the applicability of the Circular is given below: New New SEZ unit (No. of technical manpower) Transfer from existing Enterprise level (No. of technical manpower including new SEZ unit) Total Existing Net addition of new recruits Total Whether hit by condition of split/reconstruction 100 40 140 500 300 800 No; as each of the conditions is satisfied 100 200 300 500 180 680 No; as condition at the enterprise level is satisfied 100 200 300 500 130 630 Yes; None of the conditions is satisfied
Comments The Circular provides much awaited relief to the IT industry and is welcome. The Circular has largely accepted the recommendations of the Rangachary Committee on threshold limits. The Tax Authority will be bound by the Circular while completing assessments or during pending appeals. The CBDT direction not to file an appeal in case an Appellate Authority order is in consonance with the Circular will reduce litigation.
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