Tuesday, April 08, 2008

Tax Impact on India Heritage IT / ITES Provider Revenues

posted by ShyK at 22:47

Over the last couple of years, there has been a considerable brouhaha about the Indian Government doing away with the tax SOPs for the IT & ITES industry. But. the actual impact on of the STPI scheme going away is about 7% of revenue though the worst case scenario calculation tends to put it around 13-15%. Here's how.

Give or take a few % points, for every $1 earned by India Heritage players they spend about 30 cents on wages and 25 cents on infrastructure & other fixed costs thus getting an EBIDTA of about 45 cents or there about. Currently there is a Minimum Alternate Tax of 11% applicable on these earnings – so about 5 cents go towards tax and accounting for the other expenses the operating margin is about 23 cents (23%).

The change in STPI scheme means two things as far as I can understand. There could be some 11% tax applicable on some of the non-wage costs. In the worst case scenario this means that Indian Heritage players would spend an extra 3 cents on the 25 cents towards on Infra & other fixed costs. More importantly the companies need to pay 35% tax on their profit from export revenues. Using the reduced EBIDTA of 42 cents as a basis (for worst case scenario) that is an additional 10 cents paid in taxes. So in the worst case scenario the operating margin is reduced to 10 cents (23-3-10) - a reduction of 13%.

In reality, this impact is expected to be the much lower 6-7% given that even now, the companies service India market, deliver from SEZs (tax holiday for 10 yr beyond inception) etc. There are multiple ways to look at even this impact.

For one, the reduced operating margin of 16-17% for Indian Heritage players would still be about twice the margin of the established global players. So while the share-holders may not like it, they still can swallow the hit.

On the other hand Indian Heritage players, still operate at lower blended average hourly rates than most Global players. Even if they bump up the rates by 6-7%, the blended rates of Indian players would continue to be lower than the blended rates of the global players.

Furthermore, traditionally Indian players have focused relatively less on reusability and automation than Global players. The margin pressures both in terms of taxes and wage inflation is driving and will continue to drive Indian players to rely less on tapping the vast pool of inexpensive programmers / operators and start automating / reusing components to a greater extent.

Finally, the Indian Government may relent and extend the tax scheme as others have pointed out. Or maybe they will implement the suggestion made during the Nasscom leader-ship summit by one very vocal proponent of Indian BPO industry – take away the STPI benefits from the Indian IT providers / revenue but continue providing this benefit to the Indian ITES industry / revenue. After-all the Indian IT industry has existed for 30 odd years while the ITES industry is still a baby at 10 odd years.

This post inspired by Phil Fersht's write-up on How severely will the expiration of India's STPI tax scheme impact the Indian outsourcing industry?

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