PwC Analysis: Sectoral Analysis

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Information Technology/Information technologies enabled Services (ITeS)

Proposal to levy service tax on information technology (IT) software services for use in the course or furtherance of business or commerce.

Impact Analysis
Software can broadly be categorised as general software and specific software. General software, also known as packaged software, is a mass-market product typically available in shrink wrapped-packaged form off the shelf in retail outlets. Specific software, known as customised software, is tailored to the specific requirements of the customers for whom it is created.

Packaged software sold off the shelf is correctly treated as goods and subject to both excise duty of 8 per cent and the applicable state VAT, generally at the rate of 4 per cent. However, there was a lack of clarity whether customised software should be treated as goods or as services.

Although customised software is subject to NIL rate of excise duty, there were disputes whether it was subject to state VAT, in the absence of a clear definition of the terms "packaged software" and "customised software" in the state VAT laws.

The IT industry is involved in significant litigation on the applicability of VAT on customised software. In view of the proposal to introduce service tax on customised software services, there should be clarity on the consequent non applicability of VAT, although the possibility that both service tax and VAT could be sought to be applied cannot be ruled out.

Further, with effect from March 1 this year, packaged software will be subject to excise duty at the enhanced rate of 12 per cent. Accordingly, all packaged software, including those intended for educational purposes, will be subject to excise duty at the enhanced rate, besides, of course, the state VAT. This is a significant cumulative indirect tax incidence on such goods. The idea, as articulated, is that software, in both its manifestations of packaged as well as customised versions, should pay a uniform 12 per cent tax, either as excise or as service tax.

In order to ensure that all computer software related activities are comprehensively covered under service tax, the definition of IT software services has been so framed as to include development, study, analysis, design and programming of software as also adaptation, upgrade, enhancement, implementation and other similar services in relation thereto.

The definition also covers consultancy on matters related to IT software such as conducting feasibility studies on the implementation of a system, providing specifications for database design, providing guidance and assistance during the start-up phase of a new system, and advising on proprietary IT software.

Besides these, acquiring the right to use IT software for commercial exploitation, right to use software components for the creation of and inclusion in other IT software products, and the right to use IT software supplied electronically are specifically included within the taxable category of IT Software services. The concern here is that the word 'acquiring' is used in this part of the definition. The right word should be 'granting'. Acquisition cannot be a service but the grant is. This will need to be immediately addressed as it can have unintended consequences.

Consequential amendments have also been made to other taxable categories such as business auxiliary services, consulting engineering services, technical testing and analysis services, and technical inspection and certification services to ensure that all software related services are fully covered under the gamut of service tax.

Since all such services rendered to the domestic customers will now be subject to service tax, there could be an increase in the costs of IT and IT related services, although in many instances the customers could offset these taxes against their output taxes.

Further, the IT companies would be eligible to avail credits on input and input services. It is very early to comment on the overall impact of these changes for the domestic market. However, the major benefit for the industry is that the software exporters will now be entitled to claim refund of input service taxes, which they were unable to claim till date. As reflected in the chart below, IT services exports is targeted to reach US$ 40 billion by 2010-11.

The exporters of IT services will now be able to avail the benefit of exemption from tax on their exports under the Export of Services Rules, as well as claim refunds/rebates of their input taxes. The software export industry is currently facing the challenge of rupee appreciation and a slowdown in consumption in the US and other markets. This major relief of refund of input taxes is therefore very opportune. The hope is that such refunds are quickly granted to the software exporting community.

Pharma Industry

Reduction in Customs and excise duty rates and change in abatement under MRP-based valuation

Basic Customs duty (BCD) reduced from 10 per cent to 5 per cent on the following products:

Specified life saving drugs/kits and bulk drugs used for manufacture of specified raw materials by manufacture of Enzyme Linked Immuno Sorbent Assay (ELISA) kits.
Excise duty reduced from 16 per cent to 8 per cent on drugs and pharmaceuticals.
Excise duty exempted on anti-AIDS drug, Atazanavir, and bulk drugs used as inputs for manufacture of Atazanavir.


Reduction on maximum retail price (MRP) for payment of excise duty on medicaments, other than those which are exclusively used in Ayurvedic, Unani, Siddha, Homeopathic or Bio-chemic systems, from 42.5 per cent to 35.5 per cent.

Impact Analysis
Reduction in Customs and excise duty
The reduction in BCD from 10 per cent to 5 per cent on six specified drugs, on bulk drugs used as inputs for their manufacture and on specified raw materials for manufacture of ELISA kits reflect the efforts of the government to make available medicines at affordable rates.

However, the major relief for the pharmaceutical sector in this Budget is the halving of the excise duty rate from 16 per cent to 8 per cent on drugs and pharmaceuticals. Apart from drugs, certain specified medical products like sterile surgical catgut, sterile absorbable surgical and sterile tissue adhesive for wounds closure etc, will also attract the reduced rate.

However, the problem with the aforesaid reduction is the possible emergence of an inverted duty structure whereby the locally procured inputs continue to be chargeable to excise duty at 14 per cent. This will lead to accumulation of input tax credits which cannot be offset and hence become sticking costs. The benefit trickling down to the consumers could therefore not be as significant as envisaged.

Change in rate under MRP-based valuation.

The abatement percentages on MRP for medicaments, other than those which are exclusively used in Ayurvedic, Unani, Siddha, Homeopathic or Bio-chemic systems, have been reduced from 42.5 per cent to 35.5 per cent.

MRP-based excise levy was introduced for pharma products some years ago. Consequently, several manufacturers shifted their operations to excise free zones like Himachal Pradesh and Uttarkhand. With respect to these units, the Budget proposals translate into benefits accruing in the form of a reduction by 2 per cent in the duties paid on inputs procured by them for use in manufacture. For manufacturers not located in these zones, the extent of the duty reduction has been diluted to a certain extent by a reduction in the abatement percentages.

Further, the important point is that the reduction in the rate of excise duty has created level playing field for pharma manufacturers in non-excise free zones and those based in excise free zones. Units set up in excise free zones are, of course, not liable to pay excise duty on their final products. However, the excise and service tax paid by them are costs.

Compared to this, regular units are liable to pay excise duty on finished products after taking a set off of input credits of excise duty paid on inputs and input services. The impact of the Budget proposal is explained below by way of an illustration.

Let us assume that the MRP of a product is Rs 100. With the revised abatement of 35.5 per cent, post-Budget, the assessable value for excise duty would be Rs 64.50. On this basis, the manufacturer in a non-excise free zone will be liable to pay excise duty of Rs 5.31 (8.24 per cent on Rs 64.50). The manufacturer is, however, entitled to off-set the excise duty paid on inputs.

In the above example, if inputs are assumed to be valued at Rs 40 and continue to be charged to duty at 14.42 per cent, the excise duty paid on these would be Rs 5.77. There would thus be no net cash outflow and indeed the build up of credits, as explained above, would have commenced.

In the case of a unit in an excise free zone, there is no output excise liability and the excise duty borne by them on inputs ie Rs 5.77 in the example, is a cost. Thus, post-Budget 2008, the net duty implications for units in excise free zones and those in other areas could possibly be the same. Thus, units in excise free zones have lost the competitive benefit they had when the excise duty on final products was 16 per cent, which they were exempted from paying.


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