To Tax or Not to Tax

Over the years, after a persuasive and determined battle to bring sanity in software taxation, the government recently introduced a circular with regard to taxation. With the changes brought in taxation policy, it is bound to impact the industry. In times to come and as the industry starts to put into practice the policy, the companies will understand the nuances and the impact of the changes.

Harvinder Salwan, secretary, ISODA said, "The government has been issuing clarifications ever since the changes were brought in budget 2008, and every notification and budget has added to more confusions. The last clarification in June 2012 happened after ISODA took up the issue with the new committee formed by the Ministry of Finance. ISODA took up the issue with NASSCOM and highlighted the issue of TDS being faced at every level." Salwan further added, "Ideally in software trading there are four levels, and at each level 10% of the sale price was being paid to the government as TDS. The government understood the issue and came out with the circular for single level of TDS, preferably at the point of import of first sale, so that government gets the revenue that it needs and the subsequent chain is relieved of deducting TDS and suffering TDS deduction on its sale. This will help bring more members back to sell software who had left the business since 2008, as they were losing their valuable working capital in the sales process. The prices will also come down since the partners have started buffering the TDS in their margins to save their working capital."

However, Dr SM Lodha, Sujata Computers said, "Distribution industry for software is already running haywire, and here the government is just playing with this industry to get maximum chunk out of it. Now they have added the word royalty to software and it clearly indicates the direction in which the government is thinking." On the other hand, Alok Gupta of Softmart Solutions said, "The new changes will have a positive impact, due to the decrease of TDS deductions in the channel and increased cash flows."

Elaborating further on this aspect, Pavan Sanghvi of Technofirm Software said, "With the changes in taxation policy, it will definitely help the channel community in terms of finance to get relaxation and there will be no due with the government. However, at the same time, one has to be very much careful in terms of finance. We need to show the first importers PAN no who has paid withholding tax to the government, so on every invoice we need to give the declaration using the PAN no. If the TDS is already paid, we have to put a request not to deduct TDS against the invoice. One has to be more accurate on the same as any mistake will create problem in the whole channel and allow the laymen to raise query, which might bring our account under scrutiny."

The new changes have raised a lot of queries, for which the channel partners will have to find answers.

Who will give declaration for existing stocks? It will be difficult to track the retail products with the declaration.
How to manage these accounts? It will be difficult to manage with the consumer and the small reseller, especially for the distributors.
What will be the ideal way to handle it? If a channel partner buys online software to sell, withholding tax deduction will be difficult. Generally, withholding tax rate is higher than the TDS. One has to get the clarity instead of withholding which is generally 15-20%, will TDS suffice?
For every withholding tax certificate a Chartered Accountant usually charges around Rs 1,000-2000 per transaction. So, how does a partner consider taxation if one is not able to pay the withholding and what will be the accounting entries?

Impact on Distribution

Now looking into the impact on the distribution of software, it seems there is a lot of work for the distributors as they are the first in the chain of supply. Explaining this, Salwan said, "The distributors who are the first in the chain will now have the responsibility to deduct tax, pay to the government and issue the necessary declaration as shared, stating that no modification is done on the software, the section of deduction of the TDS viz 194J or 195 for withholding tax and their PAN number. The distributor will have to track every purchase with sale and link it to the tax paid so that they have no claims during the assessment." He further added, "Even the reseller has to tag every purchase to his sale for tracking during assessment. Every invoice will have to be made based on the section of TDS deducted and it will be complex to bill multiple types of tax deduction in a single invoice, so that compliance during audit is not an issue. (for example one should avoid invoicing two items that have suffered deduction under 194J and 195, ie, local sales and import sales in the same invoicing.)"

Voicing a distributor's opinion, Sanghvi said, "In one way we can say it will be of great help to the vendors and distributors. The second and third level channel has to buy the product from a genuine source only that believes in following all the rules and regulations of the government. If at all it is not coming from the right source, will he not be able to give the declaration; and if at all anyone has imported the software with hardware or vice versa, that can not be debundled and sold, so that will bring the stability in prices and help vendors for more satisfied channel."

Although it is a good move, like every coin it also has two sides. Explaining this, Sanghvi said, "But at the same time it is very much difficult who works with consumer products in a sub-distribution, volume resellers, or retailers. To track on declaration on every product is too difficult. With an average daily billing of 50-500 per counter, one can imagine how difficult it can be to track it on a daily basis. For a person who sells consumer products, hardware components and at the same time antivirus boxes and other consumer products, how much difficult the invoicing will be?
Either they have to ignore the rules, which will result in injustice to small reseller who bought from them, or needs to have a separate team which will help other resellers for separate invoicing for software at a later stage, resulting in re-work or mess up their entire work."

Highlighting another aspect on this subject, Dr Lodha said, "Basically, there is a difference between software making and software distribution. Government has placed both on the same platform. It will be very risky to do business without knowing the hidden meaning of the laws." On the contrary, Gupta believes that there will be no change in software distribution business.

Impact on distis and dealers

With the policy in place, there is no way the distributors or dealers are not going to be impacted. If the business will undergo changes, so will the entire chain of distribution.

On this aspect, Salwan said, "The impact of distributors would be managing the links between deduction and purchase, and for the reseller it will be linking every purchase with the sale and ensuring that the declaration does not mix up with two different purchases and sales." Adding to this, Gupta said, "The TDS deductions will be much lower now," while Sanghvi said, "Our capital will not be blocked but at the same time one has to work with right source, or the partners who are having creditability in the market. It will result in two channels-one which works according to all the rules and regulations of the government and the other which does not. This will affect the retail business."

Also, there is definitely going to be an increase in the backend work that needs to be completed by each node in the distribution system. Dr Lodha said, "Indeed, it will affect the distributors and channel partners. Henceforth, there will be a lot of paper work, complicated tax rules, which, if not understood correctly, might ruin the distributor and the channel."

Impact on Pricing

Any changes in the system, especially related to finance, invariably affect either directly or indirectly the pricing of the product. Adding to this, Salwan said, "As stated earlier, the pricing would come down, as the channel which was adding margins to buffer the TDS would be restrained to do so now. Now, there would be TDS only at one level, saving the net 20-30% which was being taken away by the taxes, bringing down the prices marginally for the end user."

Sanghvi says, "Yes, there will be an impact on pricing. However, the price has to be stable and there will be a sizable gap, if at all, with or without the genuine source." He further added, "If someone misuses the declaration with anyone's PAN number, there is no way to verify the same, whether what all declared is correct or not. And the partner can only come to know from the government after years, when they come under scrutiny. One company's cheating can create a big problem for the entire reseller community."

The distributors were already deducting withholding tax and with the issue of this notification, the partners would not deduct TDS of the distributor; it will result in a positive cash flow for the distributors and so for the members down the chain till the last mile.

Pricing of the product will also have an implication on the margins earned by the partner community. Dr Lodha states it in one statement, "The profit margins will get tremendously downgraded." Adding to this, Sanghvi said, "The gross margin will increase, but expense will increase in terms of manageability of business. It will reduce the level of distribution and will also result in a more managed channel."

This is contrary to what many think will be the outcome of the policy implementation. Gupta mentions, "Cash losses will be reduced, which will directly impact the overall capital."

Future Hopes

Going ahead, we can expect more reforms in the taxation policies. The association and the partner community are voicing their concerns through the association bodies. There is still a long way to go for all.

Sanghvi recommends, "There must be some verification mechanism as to whatever is declared is correct or not. If the government does not have this, then there must be with a toll free or a legal mail id for verification at the association or the vendor level, which can give correct answers without bias. And the association has to design a legal format if the declaration found is incorrect, and the associated losses or penalty the company has to bear following that. Only after such a system, can one start purchasing from them."

The market dynamics either change or evolve and with the right impetus provided by the government in the form of effective taxation policies, there will be much efficient and effective business eco-system. Sanghvi states, "We hope there are more and better reforms in the policy. Taxation has to be simple. We can not work with low margin as the finance cost is more on every transaction now. Software trading is not like hardware trading where one can work with low margin. You are answerable for every sale you do for years." Further explaining the gravity of the situation, Dr Lodha feels, "Very difficult time is about to approach because of non study of government about the infrastructure of distribution. We are seriously training our sales force on how to tackle the situation to survive in the current and coming market scenario."

Gupta said, "We are waiting for GST-Goods and Services Tax which will provide a level playing field across India. We will be delighted if it is implemented in 2013-2014, but we may have to wait till 2014-2015 due to the lack of consensus and lack of systems required." On similar lines, Dr Lodha said, "If and when GST will get introduced, let us hope for justice to the channel. The basic rule for tax collection about channel is to collect tax from user and then pay to the government. But now the things have changed, a businessman has to pay taxes. Whether he has got from the user or not, it is injustice."

Today, only one skill does not help to start or grow a business. One has to consider the finance division even at the start-up stage, and it will be difficult for emerging entrepreneurs to afford a skilled finance team. As Sanghvi puts, "IT association should do live training for the account people of the community the way vendors arrange the training for their products. This will bring the awareness about the sensitivity of the business. Now the invoice is not just the product, it is much more that that and includes ingredients like price, quantity, total tax plus other charges if any." He further added that the second change they are expecting from the distributors is with regard to the MRP Sticker, wherein they should put a PAN number with the declaration sticker on every product."

There is still a long way to go and every unit in the software business ecosystem will have to perform its optimum roles. With the right support of the association bodies, the government can bring about more reforms in the existing system. However, only time will tell how things turn out.

Box: Role of ISODA
ISODA was born in 2008, ever since the issues were faced by the community, and has been raising the issues at every forum be in the form of representation, court cases, and finally when we got recognition we were invited for pre-budget representations and being involved in various meeting by leading industry bodies like Ficci, CII, Assocham, Nasscom, who are now seeking our views. We are glad that in the last 3-4 years ISODA has been recognized as the industry voice for the packaged software industry.

The association is moving towards working with the government to make the software selling/developing business more beneficial for the creator and also for the government and make it much more affordable by bringing down the taxes, and also getting software out of retrospective amendment done by treating it as royalty with retrospective effect to 1976.

The association would be actively taking up the issues of retrospective amendments, bringing down taxations on software and also opening up benefits for local manufacturers of software products, so that they are encouraged to develop more products locally and sell in the global markets.

ISODA is optimistic of the future and we see with the changes coming in terms of moving from physical/electronic delivery to cloud based offering. There is still a lot to be done on the ground before it becomes a reality in the Indian market.