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MoF: Submission requesting for clarity on eligibility to claim exemption under S.10AA of Income Tax Act, 1961

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With the onset of COVID-19 pandemic, there has been a paradigm shift in the ways of working whereby employees have been working from home. In light of the growing impetus on technology front, there is an increasing demand for providing flexibility to work remotely, especially in the Information Technology (IT) – IT enabled Services (ITeS) sector. This has led to the  requirement of a clarification on the eligibility of units in Special Economic Zones (SEZs) to claim deduction under S. 10AA of Income Tax Act, 1961 (IT Act).

S. 10AA(1) of IT Act provides for deduction from total income, of the profits and gains derived from export of articles manufactured or produced, or by providing any services, from its unit established in a SEZ, subject to fulfilment of conditions specified in the section. As per S. 10AA(4), the undertaking should begin to provide services from April 1, 2006, in any SEZ unit. Further, as per Explanation 1 to S.10AA, services should be exported, i.e. provided out of India from SEZ by land, sea, air, or by any other mode, whether physical or otherwise.

In light of the above provisions, in situations where employees of SEZ unit are working from a place outside the SEZ, an issue may arise regarding the eligibility of units to claim deduction under S.10AA in respect of profits of the SEZ unit.

In order to avoid litigation, we made a submission to Ministry of Finance (MoF) on September 23, 2021 requesting them to issue a clarification that the place of providing the services ought not to matter and as long as there exists a direct nexus between the SEZ unit and the work done outside the SEZ unit, it should be in compliance with the provisions of S. 10AA of IT Act.

It is important to note that a similar clarification was issued by the Central Board of Direct Taxes (CBDT) vide Circular No 694 in 1994 and Circular No 1 of 2013 in the context of onsite development of software services. It was clarified that a unit should not be denied tax-holiday under S. 10A or 10B on the ground that the computer software was prepared ‘on-site’, as long as it was a product of the unit, i.e., it is produced by the unit. Pursuant to these Circulars, an amendment was introduced in S.10A/ 10AA by way of insertion of an Explanation to clarify the above. Accordingly, CBDT had earlier clarified that as long as there exists a direct and intimate nexus or connection of development of software done abroad with the eligible SEZ units set up in India and such development of software is pursuant to a contract between the client and the eligible unit, the claim of deduction should not be denied.

Similar clarification issued in the context of work being performed by employees outside the SEZ unit in the current scenario will ensure that the intended benefits of the SEZ scheme continue to be available to units that generate significant employment and export revenues, and will help avoid uncertainty and potential litigation.

We will pursue this request with MoF and will keep you posted on further developments in this regard.