Q (ii):         Whether it is necessary to have a separate Master Service Agreement (‘MSA’) for each work contract? To what extent is the MSA relevant?

The CBDT has explained that a 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.

The CBDT has now clarified that the tax benefits under section 10A, 10AA and 10B will not be denied merely on account of the fact that a separate and specific MSA does not exist for each SOW.  Also, the SOW would prevail over the MSA unless the Tax Authorities are able to establish that there has been splitting up or reconstruction of an existing business.

SKP’s Comments:

This is a welcome clarification provided by the CBDT. It appears that the CBDT has taken into account the business realities and acknowledged that it may not be possible to draft the MSA to cover all the aspects to be included in the individual SOW and hence the tax benefit should not be denied on technical grounds where the SOW provide for additional items not covered in the MSA.

Q(iii):        Whether Research and Development activities pertaining to software development would be covered under the definition of ‘computer software’?

The CBDT, through an earlier Notification [No. 890(E) dated 26.09.2000], had clarified that certain IT enabled services inter alia, including engineering and design activities, are covered under the definition of “computer software” and are hence eligible for tax benefits. Research and development activity (R&D) was not specifically included in the extended definition of “computer software” and hence it has led to considerable litigation as regards eligibility of R&D for the tax incentives. 

The CBDT has now clarified that ‘Engineering and Design’ has in-built elements of Research and Development. Hence, any Research and Development activity embedded in ‘Engineering and Design’ would be covered under the definition of “Computer Software”

SKP’s Comments:

This is again a welcome clarification and would provide relief to a large number of tax payers who are engaged in R&D using Information Technology.

Q(iv):         Whether the tax benefits under section 10A, 10AA and 10B will continue to be remain available in case of a Slump Sale of a Unit / Undertaking?

The CBDT has clarified that the mere fact of change in ownership will not result in denial of tax benefits under the respective sections to an otherwise eligible undertaking.  However, the factual aspects such as how the slump sale is made, what is its nature and whether it results in splitting up or reconstruction of an existing business need to be considered.

SKP’s Comments:

The CBDT Circular reinforces the prevailing legal position that the tax holidays based on nature of activities are attached to the unit and not to the owner and hence even if the unit is transferred on slump sale basis the benefit of the tax incentive would be available to the buyer for the unexpired tax holiday period.

Q(v):          Whether it is necessary to maintain separate books of account for a unit claiming tax benefits under section 10A, 10AA and 10B?

The CBDT has clarified that the law does not provide for any requirement of maintaining separate books of account. The tax authorities may call for details and information regarding different units to verify the claim and quantum of exemption.

SKP’s Comments:

The CBDT Circular confirms that the tax payer may maintain combined books of account for its eligible and non-eligible units. However, the accounting records should be such that they will enable identification of costs and revenues relating to the eligible business so as to quantify the amount of tax benefit.

Q(vi):         Whether tax benefits under section 10AA can be enjoyed by an eligible SEZ unit consequent to its transfer to another SEZ?

The CBDT has explained that this issue relates to cases where a unit is shifted from one SEZ to another SEZ on account of commercial exigencies and has clarified that the tax holiday would not be denied merely on account of physical relocation of the eligible unit from SEZ to another.

SKP’s comments:

This again reflects the broader view adopted by the CBDT in recognizing the commercial realities of the business.

Q(vii):       Whether new units / undertakings set up in the same location where there is an existing eligible unit / undertaking would amount to expansion of existing unit / undertaking (and consequently result in denial on tax holiday for the new unit)?

The CBDT has clarified that setting up of a fresh unit, in itself, will not make the unit ineligible for tax holiday, if the following conditions are fulfilled:

1. The new unit is set up after obtaining necessary approvals from Competent Authorities
2. The new unit is not formed by splitting up or reconstruction of an existing business
3. The new unit fulfills all other conditions prescribed by law.

SKP’s Comments:

This too is a welcome clarification and will aid to reduce the litigation involved in setting up of new units in the same location as that of the old unit.

Conclusion:
While the Circular is welcome and provides much needed clarity to tax payers, we believe that has it been issued earlier it would have been more useful. It is a bit late in the day now particularly for the tax payers claiming the incentives under section 10A and 10B since the benefits under section 10A and 10B have expired on 31st March 2011 and the assessment proceedings up to for FY 2008-09 are already concluded. Of course, the tax payers can take recourse to the said CBDT Circular during appellant proceedings since it conveys the interpretation of the CBDT in relation to section 10A, 10AA and 10B. The Circular will also be of assistance in reducing the litigation surrounding the areas covered in the Circular especially for units claiming benefit under section 10AA.