In a move that will significantly ease the tax burden on Indias biggest information technology (IT) companies, the government has decided to amend the income tax law relating to tax exemption for units operating out of special economic zones (SEZs).

SEZs set up by IT majors like Infosys, Wipro and TCS under the parent companies will soon be able to enjoy 100% tax exemption on profits on par with SEZs set up as separate entities.

Prime Minister Manmohan Singh, who is also handling the finance ministry, has agreed to change the relevant norms under the Income Tax (I-T) Act, a commerce department official has said. The finance ministry will soon issue a notification changing rules under Section 10AA (7) of the I-T Act, which will allow all SEZ units to be treated as separate entities. They will, thus, be eligible for 100% tax exemption on profits for the first five years of operation.

We have finally been able to convince the finance ministry that Section 10AA(7) of the I-T Act is an anomaly. All SEZs should be entitled to 100% tax exemption on profits. The relevant notification will be issued by the Central Board of Direct Taxes shortly, a commerce department official told ET.

Section 10 AA (7) of the I-T Act states that only a proportion of profits of a SEZ unit, based on the proportion of export sales from the unit to the total turnover of the parent company, will be exempt from taxation. For instance, if an SEZ unit exports 50% of the companys total turnover, then the tax exemption on the profit that the parent company makes from exports will be restricted to only 50% instead of 100% as otherwise stated in the SEZ Act.

While most SEZs are not affected by the section, as they have been set up as individual entities, the three IT majors set up their zones under the parent company. They were thus entitled to minimal tax exemption on profits instead of 100% exemption that SEZs are entitled to in the first five years of operation. The SEZ Act also provides for 50% exemption on export profits for the next five years while for the following five years, units get up to 50% exemption on reinvested profits.

Interestingly, the provisions in the I-T Act on 100% export-oriented units allow EoUs to be treated as separate entities for the purpose of calculation of income tax exemption.

According to LB Singhal, director general, export promotion council for EoUs and SEZs, the Prime Ministers decision to change Section 10 AA would remove uncertainty for all SEZ units, including SEZ manufacturing and IT sector units. He said that the clarification should be applicable with effect from February 10, 2006, when the SEZ rules were notified.

We are grateful that the ambiguity is being removed. It was clear that this was an inadvertent omission as we cannot compare two uncomparables, Mr Singhal said.