Budget 2011: Will foreign trade policy decide the fate of STP units?

The Foreign Trade Policy (FTP) had introduced the Software Technology Park (STP) scheme with the intention of fostering growth in the IT/ITeS sector by providing the necessary impetus through tax incentives (direct and indirect tax).

Although the direct tax benefits for the STP units may be discontinued on account of sunset clause under Section 10A of Income Tax Act, 1961, the indirect tax benefits would still continue under FTP.

The STP units were primarily setup to avail the tax benefits, especially the direct tax benefit.
Withdrawal of direct tax benefits may result in evaluation of special economic zone (SEZ) option by the industry players.

Section 10AA allows SEZ unit tax holiday for 15 years (100% exemption in first 5 years, 50% in next 5 years and 50% in remaining 5 years subject to transfer of profits to reserve). However, considering the fact that there is no clarity on shifting/migrating of the existing STP units into SEZ, it may not be feasible for everyone to evaluate the option of setting up new SEZ unit.

Further, additional factors such as higher rental cost with a minimum lease commitment of 3 to 5 years in the SEZ's are also forcing the industry to take a cautious approach towards SEZ.

The government may consider extending direct tax benefits to STP units. However, it is very likely that such extension may come with additional riders which may not impress the industry.

There are options available with STP units for claiming the indirect tax benefits after the expiry of income tax benefits (post March 31, 2011). The STP units will face challenges on account of recent amendment in the FTP in relation to services pertaining to IT/ITeS sector.

The FTP provides certain additional export incentive schemes (apart from the STP scheme) wherein the export of services pertaining to the IT/ITeS is eligible for indirect tax benefits, ie served from India scheme (SFIS) and export promotion capital goods (EPCG).

Both the schemes allow the service exporter to avail full/partial exemption from the applicable customs/excise duty on its procurement.

The services eligible for the SFIS and EPCG schemes are defined in the FTP which includes the 'computer and related services'. Typically, the services provided by the STP units include the computer software development, consultancy, implementation services and data processing services.

Such services were included in the list of specified services defined under the FTP on which the benefits under SFIS and EPCG could be availed.

Under the SFIS scheme, the exporter of specified services is eligible for duty credit scrip which is equivalent to 10% of the value of export proceeds received in convertible foreign exchange. This duty credit scrip can be utilised by the service exporter for import/local procurement of duty free capital goods.

Whereas, under EPCG scheme, the service exporter can import capital goods required for providing specified services by paying a concessional rate of 3.09% as customs duty with a condition that it has to fulfill export obligation of 8 times of the duty saved amount in 8 years.

For example, if the duty saved amount (difference between the effective rate of customs duty minus concessional rate of 3.09%) under EPCG is Rs100, the export obligation would be Rs800 which has to be fulfilled in 8 years.

Prior to January 1, 2011, the lists of specified services eligible for the benefits under the SFIS and EPCG scheme were common and were defined in the Appendix 10A of the Handbook of Procedure (HBP).

The government has recently issued a Public Notice No. 25/2010 dated January 18, 2011 (which is effective from January 1, 2011) wherein the list of specified services eligible for SFIS scheme has been defined separately under a new Appendix 41 in the HBP.