India seen extending IT tax break as business slows

Employees seen at a call centre provide service support to international customers, in Bangalore in this March 17, 2004 file photo.

MUMBAI (Reuters) - India is expected to extend in next week's budget a tax holiday scheme for outsourcing firms that is due to end in March 2010, giving a breather to a sector that is facing shrinking orders and a sharp earnings slowdown.

Unless extended, earnings of outsourcing firms will take a hit from the fiscal year starting in April 2010 as the tax rates rise to 20-22 percent from 15-18 percent now, said Srivathsan Ramachandran, a technology analyst at Spark Capital Advisors.

Brokerage Religare Hichens, Harrison said in a report the budget for 2009/10, to be presented on Monday, was expected to extend the tax-break benefits by another three years, boosting earnings by 5 to 8 percent for software firms.

India had announced a 10-year tax holiday for the facilities located in technology parks to encourage growth in the showcase sector that employs more than 2 million people and accounts for more than 5 percent of the gross domestic product.

Under the tax holiday scheme, firms in the technology parks pay taxes only on the business they get from India. Most of them get more than three-quarter of their revenue from exports.

"The sector has faced significant challenges in FY09," Kotak Securities said in its budget preview. "The budget is expected to focus on maintaining an environment conducive to the future growth of this largely export-oriented industry."

Ramachandran said an extension would boost sentiment at a time when the software services firms were battling a severe downturn in technology spending and pressure on prices.

An army of low-cost English-speaking engineers has driven an outsourcing boom in India, but turmoil in global markets and a recession in the United States, which accounts for more than half the sector's revenue, have halted the scorching pace of growth.

Infosys Chief Financial Officer V. Balakrishnan has said the Nasdaq-listed firm's tax rate would increase to 20 to 22 percent from 15 to 16 percent now if the tax holiday ends.

PINC Research said Infosys' earnings per share would drop to 131.35 rupees in the fiscal year starting April 2010 if the tax rate goes up to 22 percent compared with the brokerage's forecast of 141 rupees at the current tax level of 16 percent.

Infosys gets 90 percent of its revenue from units located in tax-free technology parks, PINC said in a report.

TOUGHER FOR SMALLER FIRMS

Analysts said while large companies had the option to move to special economic zones to avail tax incentives, smaller firms would not find it feasible to relocate operations as high rentals and far-away locations of such zones were barriers for them.

Morgan Stanley said in a report last month if the tax holiday was extended it would benefit smaller firms such as Hexaware, Mphasis, and Patni Computer Systems more than larger outsourcing firms.

"Larger vendors are likely to continue expanding their SEZ presence," it said, referring to special economic zone.

Earnings per share target of smaller firms would be revised upwards by 8 to 10 percent if the tax holiday was extended, Harit Shah, a sector analyst with Angel Broking, said.

"If it does not happen in the budget, it will have a negative impact on sentiment," he said.