Income Tax 31 Jan,2020
SEZ Tax Holiday – Unfair treatment to IT/ ITeS sector
Sridhar RPartner – Grant Thornton India LLP


The Information Technology & Information Technology enabled Services ('IT / ITeS') sector in India is undergoing rapid evolution and is changing the shape of Indian business. The Government of India has been instrumental in ensuring making India is one of the largest IT/ ITeS exporter in the world. This includes time to time provision of incentives , such as the creation of IT / ITeS specific export-focused zones / parks including Software technology parks, Electronic hardware technology parks which enjoy tax benefits, both under Income-tax and Indirect tax laws.

These measures were improved upon by the introduction of policies around Free trade zones, Special economic zones, etc. Especially, the policies of Special Economic Zone (SEZ) accelerated the export performance of the IT industry, particularly those of computer software undertakings.

Sector Concerns

Section 10AA of the Income-tax Act, 1961 (the Act) gives a graded tax holiday to SEZ units that is spread over a 15-year period. The last 5-year holiday in this section is tied to a condition that 50% of the profits derived from exports is credited to a 'Special Economic Zone Re-Investment Reserve Account'. The amount credited to this Reserve is to be utilized for acquiring machinery / plant only which is to be put to use within a three year period.

Unlike traditional companies engaged in manufacture of goods, software development companies do not have significant investment in capital goods. Predominantly, software product development businesses make only incremental investments in computers and computer equipment and other software licenses while a significant part of their investment and asset base comprises of land and building costs and manpower costs that are incurred towards development and improvement of intangibles (patents/ software codes / other Intellectual Property Rights / etc.).

Using a narrow definition and restricting the utilisation of the Reserve (created in the last 5 year tax holiday period) to acquisition of traditional plant and machinery have rendered the provisions of section 10AA(2) of Act ineffective in the case of software product development undertakings. This has seriously hampered the utilization of the tax holiday sop and reinvestment for expansion in the last 5-year period of the tax holiday period.

Possible Solutions

Expanding the scope of Sec 10AA(2)(a) of the Act to allow the amount credited to SEZ Re-investment Reserve Account (in the last 5 years of the 15-year tax holiday block) to also be utilized for the development of intangibles that are capitalised in the books of the company (as per applicable accounting standards) would be beneficial for obtaining the tax holiday benefit under the section. Typically, these costs that are capitalised include costs incurred in setting up new units or developing and improving the software products that the company develops, which inter-alia includes:

 a.  Additional investment in land, buildings and capital assets (other than traditional Plant and Machinery which is anyway covered) that are incurred for development and improvement of software products; and

 b.  Salaries of technical manpower engaged in developing and improving its software products

Furthermore, there are several judicial precedents in Indian Income-tax law that have interpreted the term 'plant' from a wider perspective:

  •  CIT vs Kanodia Cold Storage1 – The term 'plant' includes within its ambit buildings and equipment used for manufacturing process.

  •  Addl. CIT vs Madras Cements Ltd.2 –The expression 'plant' has to be construed in the context of particular kind of trade / manufacture carried on by the assessee and if in the context it could be taken as plant as understood in the popular sense, it would be treated as 'plant'.

  •  CIT vs Technico Enterprises (P.) Ltd.3 – The Act has defined 'plant' in an inclusive manner and conceptually, anything that is a tool of trade is a plant. The term 'tool of trade' signifies close and direct connection with the trade and such plant must be employed directly in the manufacture.

While the aforesaid case laws have enhanced the scope of the term 'plant', these only cover traditional manufacturing enterprises. This is on account of the fact that these cases are decades old, when the IT/ITeS is in its embryonic stage. Considering the current economic scenario, the tax provisions need to be widened to accommodate the sector requirements.

It shall be useful to refer the applicable accounting standards (IND AS 38) also, expenses incurred towards the development and improvement of intangible assets are to be capitalised and disclosed separately as 'capital assets under development'.

As a consequence of this accounting treatment, the development and improvement costs that are capitalised by the SEZ unit are anyway treated as intangibles on which only 25% depreciation is allowed under income tax law (unlike a 100% deduction of these costs – if these were to be treated as revenue expense). So, it is only reasonable for the government to consider these expenses as valid use as reinvestment in plant or machinery.

What we can expect?

Considering the above aspects, the growth of software development industry is seriously hampered in the last 5-year period of the tax holiday, providing no practical tax holiday benefit for the software development undertakings operating in SEZs.

A clarification from the Government is expected to treat the costs incurred towards additional investment in land, buildings and capital assets and salaries of technical manpower as re-investment made from the SEZ Re-Investment Reserve Account as per sub-section (2) of Section 10AA.

Sridhar R, Partner – Grant Thornton India LLP with inputs from CA Subham Kumar, CA Pranaav Murali and CA Bhavesh Kumar


 1.  [1975] 100 ITR 155 (Allahabad)

 2.  [1977] 110 ITR 281 (Madras)

 3.  [1994] 206 ITR 36 (Calcutta)