With the worldwide prevalence of information technology and voice/data communications infrastructure, it has become possible to provide routine service activities from countries that can perform those tasks in a much more cost-effective manner while maintaining quality standards.
The first wave of information technology brought efficiencies within the organization and reduced the internal cost of transactions and consequently the advent of newer modes of technologies / reforms along with the rapid penetration of the internet and a growth in its application, has shown a steady growth of the IT-BPO industry over the past few years.
With a spurt of growth in disruptive technologies, and ‘start-up culture’, the Indian IT & BPO industry is expected to leverage upon the global demand for its services with an expected addition of USD 13-14 billion, to its already existing revenues of USD 118 billion in 2015.1 Recognizing this potential, the Central Government has continued its support for the ‘Digital India’ program, with a continuous focus on the implementation of the ‘National Optical Fibre Network Programme’ and the announcement of a new initiative to promote startups with a focus on technology –the ‘Self-Employment and Talent Utilisation’ scheme.
The global sourcing market in India continues to grow at a higher pace compared to the IT-BPM industry. The global IT & ITeS market (excluding hardware) reached US$ 1.2 trillion in 2016-17, while the global sourcing market increased by 1.7 times to reach US$ 173-178 billion. India remained the world’s top sourcing destination in 2016-17 with a share of 55 per cent. Indian IT & ITeS companies have set up over 1,000 global delivery centres in over 200 cities around the world.
More importantly, the industry has led the economic transformation of the country and altered the perception of India in the global economy. India’s cost competitiveness in providing IT services, which is approximately 3-4 times cheaper than the US, continues to be the mainstay of its Unique Selling Proposition (USP) in the global sourcing market. However, India is also gaining prominence in terms of intellectual capital with several global IT firms setting up their innovation centres in India.
The IT industry has also created significant demand in the Indian education sector, especially for engineering and computer science. The Indian IT and ITeS industry is divided into four major segments – IT services, Business Process Management (BPM), software products and engineering services, and hardware.
The internet industry in India is likely to double to reach US$ 250 billion by 2020, growing to 7.5 per cent of gross domestic product (GDP). The number of internet users in India is expected to reach 730 million by 2020, supported by fast adoption of digital technology, according to a report by National Association of Software and Services Companies (NASSCOM).
Indian IT exports are projected to grow at 7-8 per cent in 2017-18, in addition to adding 130,000-150,000 new jobs during the same period.
Digital commerce market in India is set to grow at 30.4 per cent year-on-year to Rs 220,330 crore (US$ 34.11 billion) by December 2017, according to a report by Internet and Mobile Association of India and IMRB Kantar.
Indian technology companies expect India’s digital economy to have the potential to reach US$ 4 trillion by 2022, as against the Government of India’s estimate of US$ 1 trillion.
Digital payments in India rose 55 per cent in volume and 24.2 per cent in value year-on-year in FY 2016-17, stated Mr Ratan Watal, Principal Advisor, Niti Aayog.
Employees from 12 Indian start-ups, such as Flipkart, Snapdeal, Makemytrip, Naukri, Ola, and others, have gone on to form 700 start-ups on their own, thus expanding the Indian start-up ecosystem.! India ranks third among global start-up ecosystems with more than 4,200 start-ups##.
Total spending on IT by banking and security firms in India is expected to grow 8.6 per cent year-on-year to US$ 7.8 billion by 2017!!
The public cloud services market in India is slated to grow 35.9 per cent to reach US$ 1.3 billion according to IT consultancy, Gartner. Increased penetration of internet (including in rural areas) and rapid emergence of e-commerce are the main drivers for continued growth of data centre co-location and hosting market in India. The Indian Healthcare Information Technology (IT) market is valued at US$ 1 billion currently and is expected to grow 1.5 times by 2020^^. India’s business to business (B2B) e-commerce market is expected to reach US$ 700 billion by 2020 whereas the business to consumer (B2C) e-commerce market is expected to reach US$ 102 billion by 2020^^^.
Cross-border online shopping by Indians is expected to increase 85 per cent in 2017, and total online spending is projected to rise 31 per cent to Rs 8.75 lakh crore (US$ 128 billion) by 2018.!!!
Some of the recent trends in relation to the IT-BPO industry for the year 2015, as per various studies and industry bodies such as NASSCOM are below:2 –
- Export revenues are expected to grow by 13-15% to reach USD 97-99 billion in 2015.
- Domestic revenues are expected to grow at a rate of 9-12% percent and are expected to reach INR 1250 – 1280 billion during 2015.
- Largest private sector employer with workforce of over 3.1 million employees
- Global IT spending is projected to grow faster: IT by 3.9 per cent, BPM by 5.9 per cent;
- Emerging technologies present an entire new gamut of opportunities for IT firms in India. Social, mobility, analytics and cloud (SMAC) collectively provide a USD1 trillion opportunity.
- Cloud represents the largest opportunity under SMAC, increasing at a CAGR of approximately 30 per cent to around US$ 650-700 billion by 2020.
- Social media is the second most lucrative segment for IT firms, offering a US$ 250 billion market opportunity by 2020
- Largest share in total service exports at 38 per cent.
- Fourth largest urban women employer with more than 1 million women employees, 35-38 per cent share in total employees
- IT-BPM continues to remain the highest impact sector for India among all industries with the highest relative share in India’s GDP and exports among all services industries.
KEY VERTICALS OF THE IT INDUSTRY
1. Software Services & IT Infrastructure
This is the traditional sector of the IT industry which deals with development of software / hardware, adaptation, networking, updates, upgrades etc. This continues to be a steady growth segment for the IT companies in India.
2. Data Centers
Data centers are facilities used to house computer systems and associated components. Such centers usually include storage systems, security devices, backup power supplies, environmental controls (e.g. fire suppression), back-ups etc. To save costs and to ensure business continuity a lot of core business operations are being outsourced which increases the importance of data centers.
3. Mobile Applications
This segment has received a lot of traction in the recent past whereby pre-installed applications such as Apple’s iOS, Google’s Android, and Windows Mobile, have become prominent as they greatly influence the buyer’s in selecting a mobile phone. However, what has also been witnessed is that IT companies dedicate significant time / capital for the development of various independent/web based mobile applications which can be integrated with existing mobile platforms / operating systems.
4. Enterprise Software
Enterprise software consists of business oriented tools which are used to assist large organizations in resolving their enterprise problems. Such software is typically designed to be used in combination with other enterprise software across a variety of networks. An important extension of the enterprise software has been the popularity of smart phones and devices, which use proprietary enterprise software to allow users to get real time e-mail notifications and updates in conjunction with the enterprise software that the user’s organization utilizes. Other examples for the same would be automated billing systems, interactive product catalogues, content management system etc. With companies increasing their scale of operations, this sector promises to show continued growth.
5. Internet of Things
The concept of ‘internet of things’ which is derived from the idea of connecting objects of every day use, across platforms through the internet, is rapidly developing as a result of advancements in technology and the convergence of the internet with service providers.
With the evolution of the medium of online communications from computers to devices such as smart phones, tablets and even wearable devices, there has been a significant increase in the penetration of e-computing in our daily lives.
Today, there are approximately 1.9 billion devices connected to the internet of things, with numbers expected to reach 9 billion by 2018, roughly equal to the number of smartphones, smart TVs, tablets, wearable computers, and PCs combined.3
Some of the top business-to-business and government applications for the internet of things are big data analysis, remote healthcare, intelligent traffic management systems, smart electricity grids and a host of other network based systems that facilitate ease of access and communication. Increasing automation and driving efficiency, the ‘industrial internet of things’ is seen as the next big step for technology, with estimates suggesting that the ‘industrial internet of things’ can boost gross domestic product (GDP) of 20 of the world’s largest economies by an additional US$14 trillion by 20304.
Indian IT’s core competencies and strengths have attracted significant investments from major countries. The computer software and hardware sector in India attracted cumulative Foreign Direct Investment (FDI) inflows worth US$ 22.83 billion between April 2000 and December 2016, according to data released by the Department of Industrial Policy and Promotion (DIPP).
Leading Indian IT firms like Infosys, Wipro, TCS and Tech Mahindra, are diversifying their offerings and showcasing leading ideas in blockchain, artificial intelligence to clients using innovation hubs, research and development centres, in order to create differentiated offerings.
Some of the major developments in the Indian IT and ITeS sector are as follows:
- India plans to create wireless Technology 5G by the end of the year 2020 which will help India in realising its most important goals of “Increasing the GDP rate”, “Creating Employment” and “Digitizing the Economy”.
- Power2SME which serves as platform for raw material requirement of the small and medium scale enterprises (SMEs) has raised US$ 36 million from its investors which includes Inventus Capital Partners, Accel, Kalaari Capital, International Finance Corp. (IFC) and Infosys chairman Nandan Nilekani.
- Unacademy a platform that helps educators to create multimedia content which can be used for free of cost by users has raised US$ 11.5 million from Sequoia India Capital Advisors and SAIF Partners.
- The mobile wallet industry is expected to maintain its current pace of expansion and the value of its transaction is expected to reach Rs 32 trillion (US$ 480 billion) by 2022, growing at a rate of 126 per cent.
- India’s largest online retailer, Flipkart, has raised at least US$ 2.5 billion from SoftBank Vision Fund to maintain its dominance in the Indian e-commerce market and to fight against its arch rival Amazon India.
- Google plans to set up its first data centre in India in the city of Mumbai by 2017, to improve its services to local customers wanting to host their applications on the internet, and to compete effectively with the likes of Amazon and Microsoft
- SAP SE, in partnership with the Associated Chambers of Commerce of India (ASSOCHAM), has rolled out a knowledge sharing resource centre which will serve as a one-stop portal for businesses looking to adopt or migrate to technology that will make them future ready for the biggest taxation reform of goods and services tax (GST).
- Freshdesk, one of first companies from India to offer Software-as-a-Service (SaaS) to global companies, has raised US$ 55 million in the latest round of funding led by Sequoia Capital India and existing investor Accel Partners, estimating to value the company at US$ 700 million.
- Warburg Pincus LLC, the US-based private equity firm, plans to invest around US$ 75 million in series C round of funding to buy a significant stake in Capital Float, an online credit platform.
- Apple’s supplier and assembler, Taiwan-based Winstron, will set up an iPhone assembly facility in Peenya, Bengaluru’s industrial hub, thus making India the third country across the world to have an assembly unit for Apple’s iPhone.
- Paytm’s online marketplace unit raised US$ 200 million in a funding round led by a US$ 177 million investment to be made by Alibaba Group Holding Ltd, and balance by SAIF Partners.
- Intel Corporation plans to invest in Digital India related solutions such as India stack, Unique Identification (UID), e-government 2.0 and other government initiatives, and scale up operations of its data centre group (DCG), as per Mr Prakash Mallya, Director DCG, Asia for Intel Corporation.
REGULATORY FRAMEWORK AND EMERGING ISSUES
As per the foreign direct investment (“FDI“) policy, 100% FDI has been allowed in the software / IT industry on an automatic basis (i.e., there is no need to obtain prior government approval). Further, since the activities of BPO companies come under the purview of “IT enabled services“, 100% FDI is permitted under the automatic route for companies carrying on such businesses. However, the activities of a BPO are subject to the guidelines as issued by the Department of Telecommunications (“DoT“).
An emerging market is the e-commerce industry which has revolutionized the traditional means of buying and selling in India. To facilitate such growth along with the development of a secure regulatory environment for the multiparty use of information technology and electronic commerce, the Information Technology Act, 2000 (“IT Act“) was enacted.
Thus the basic legal framework governing online transactions is covered under the ambit of the IT Act.
In the recent past, there has been a significant amount of public debate on retail trading whereby the government (under the approval route) has permitted investments upto (i)100% in single brand retailing (Automatic Route up to 49%); and (ii) 51% in multi brand retailing (Government Route), subject to certain conditions.
While 100% FDI is allowed under automatic route in companies engaged in Business to Business (B2B) e-commerce activities, FDI is not permitted in companies engaged in retail trading, in any form, by means of e-commerce.
Data Privacy and Cloud Computing
With India being considered a global outsourcing hub and a renowned destination for IT services, terms and models concerning “Data Privacy / Security, “Cloud Computing“, “Virtual Servers” etc are becoming increasingly popular. One of the primary concerns in relation to the above was the protection / security of personal information which is accessed / processed by the IT-BPO companies while providing the desired services. The Government realizing the importance of protecting personal information introduced the Information Technology (Reasonable security practices and procedures and sensitive personal data or information) Rules, 2011 (“Rules“) under the IT Act. These Rules prescribed guidelines for the collection, usage and protection of sensitive personal data or information of natural persons.
However, since these Rules have been recently introduced there are a lot of practical implementation issues which are being faced by the IT-BPO industry who access / process personal information while providing services. A peculiar challenge in this regard is the applicability of these Rules to a foreign body corporate who accesses / processes personal information of Indian individuals while providing cloud computing or data storage or outsourcing services.
Since some of the Indian labour laws vary from state to state, one needs to ensure compliances depending upon the state in which the IT-BPO company(ies) are located. Further, for IT-BPO companies which work 24×7 to service their overseas client, additional compliances not limited to working hours, means of transport offered by the Company for employees working on night shifts etc need to be considered. Also, when employees are sent overseas for client projects(on-site) then certain rules / laws of international taxation may also get triggered and the same will need to be factored by the Indian IT-BPO company(ies).
Protection of Software
By the 1994 amendment to the Copyright Act, computer databases / computer programs were treated as literary works and subsequently were afforded protection under the copyright laws of India.
However, the question which is often asked is whether software in India is patentable as a “business method patent`. Historically, in nearly every country “business method patents” were dismissed as abstract and hence, were considered to be unpatentable. In the late 1990s, US courts for the first time allowed a business method patent and a patent for a computer program to track mutual funds.
In India, as per the 2002 amendment to the Patents Act “computer programs” per se “were not regarded as inventions”, causing debate on whether a computer program with any additional features such as industrial application, would be patentable. The President of India in 2004 via an Ordinance promulgated that although “computer programs” per se were not inventions, there could be certain exclusions when the “computer programs” had technical application to an industry and in combination with hardware could be identified as patentable inventions. However, the 2005 amendment to the Patents Act omitted the exclusions which were introduced by the 2004 Ordinance.
Thus as of today “computer programs” cannot be patented under Indian laws.
Work for Hire / First Owners
Since computer programs / computer databases are protected under Indian copyright laws, it is important to understand the issues and concept of “work for hire / first owners” when it comes to the ownership of such computer programs / computer databases.
The concept of “Work for Hire‟ though not expressly covered under the Indian Copyright Act, is implied under Section 17 of Act whereby, the copyright in any work created on a commissioned basis, shall vest with the person creating such work. In order to vest the copyright with the person commissioning the work, an assignment in writing shall be necessary.
Therefore, when any IT company commissions the development of any software / computer program to any third party, it needs undertake a valid assignment in writing which is in compliance with Indian laws to ensure ownership in the aforementioned software / computer program.
However, an interesting point to note is that if the software / computer program is developed by an employee during the course of his employment, then as per the Indian Copyright Act, the employer shall in the absence of a contract to the contrary be the owner of copyright.
With the expansion of other sectors / industries, a lot of cross border licensing / technical collaborations were witnessed in the recent past.
Prior to 2009, there were restrictions on outbound remittance for royalties and lumpsum fees paid towards transfer of technology as remittances made by Indian residents to non-residents was permissible without any prior regulatory approval to the extent of a lumpsum fee of USD 2 million along with royalty payments of 5% on domestic sales and 8% on exports.
However, the Indian government keeping abreast with global trends paved the way in 2009 by removing the aforementioned restrictions on outbound remittances paid towards transfer of technology.
In the Union Budget 2017-18, the Government of India announced the following key proposals:
- The Government of India has allocated Rs 10,000 crore (US$ 1.5 billion) for BharatNet project under which it aims to provide high speed broadband to more than 150,000 gram panchayats by 2017-18.
- Prime Minister of India, Mr Narendra Modi, has launched the Bharat Interface for Money (BHIM) app, an Aadhaar-based mobile payment application that will allow users to make digital payments without having to use a credit or debit card. The app has already reached the mark of 10 million downloads.
Some of the major initiatives taken by the government to promote IT and ITeS sector in India are as follows:
- The Government of India is planning to set wifi facility for around 5.5 lakh villages by March 2019 with an estimated investment of Rs 3,700 crore (US$ 555 million) and the government expects to start broadband services with about 1,000 megabit per second (1 gbps) across 1 lakh gram panchayats by the end of this year.
- All the 400 field offices of the Central Public Works Department (CPWD) have been connected through a special integrated portal. Annual payments worth Rs 20,000 crore (US$ 3 billion) will be done electronically after this digital transformation.
- Mr Ravi Shankar Prasad, Union Minister of Law & Justice and Information Technology, has launched a free Doordarshan DTH channel called DigiShala, which will help people understand the use of unified payments interface (UPI), USSD, aadhaar-enabled payments system, electronic wallets, debit and credit cards, thereby promoting various modes of digital payments.
- The Government of India plans to revamp the United Payment Interface (UPI) and Unstructured Supplementary Service Data (USSD), to make it easier for consumers to transact digitally either with or without an Internet connection with the aim of strengthening its push towards making India a digital economy.
- The Telecom Regulatory Authority of India (TRAI) will soon release consultation papers ahead of framing regulations and standards for the rollout of fifth-generation (5G) networks and Internet of Things (IoT) in India.
- The Railway Ministry plans to give a digital push to the India Railways by introducing bar-coded tickets, Global Positioning System (GPS) based information systems inside coaches, integration of all facilities dealing with ticketing issues, Wi-Fi facilities at the stations, super-fast long-route train service for unreserved passengers among other developments, which will help to increase the passenger traffic.
E-commerce taxation in India has been rapidly evolving in recent years with a number of cross-border e-commerce models coming under the scrutiny of the Indian tax authorities.
Various incentives have been made available to Indian technology players such as software companies. Although the exemptions available to export oriented units and software technology parks have been phased away, the tax holiday available to units set up in special economic zones (“SEZ“) continues to be available. However, the minimum alternative tax and dividend distribution tax related benefits that were available to SEZ units have expired. While there have been indications that the Government is set to revive the same, we are yet to see any movement on this front. While SEZ related benefits largely depend upon the physical location of the business unit in an SEZ, the Central Board of Direct Taxes has also recently clarified that a tax holiday should not be denied merely on the ground of physical relocation of an eligible SEZ unit from one SEZ to another; if all the prescribed conditions are satisfied under the Income Tax Act.
Further, acknowledging the need to reduce burdens on small technology driven businesses, the central government announced as part of the Budget – 2015, that the rates of tax on royalty and fees for technical services under the Income Tax Act, 1961 will be reduced from 25 % to 10 %, in an effort to facilitate the inflow of technology into the country.
With respect to foreign e-commerce players doing business with/in India, the major income tax issues broadly relate to income characterization, permanent establishments (“PE“) and transfer pricing.
Income characterization has assumed immense significance with the Indian tax authorities adopting counter-OECD positions with respect to taxation of various e-commerce models. For instance, the tax authorities argue that consideration for sale of off-the-shelf software from foreign vendors to customers in India should be characterized as royalty income which will be subject to withholding tax (of around 10% on a gross basis) in India. In ordinary cases (based on internationally recognized approaches) such income should be characterized as ordinary business profits since the sale of software does not lead to a license of the underlying intellectual property. The income arising from an ordinary sale of software would then be taxable in India only if the foreign vendor has a PE or a business connection (in the absence of a tax treaty) in India.
There has been some conflicting Indian case law on the issue of income characterization in various e-commerce models. Some of the major litigation pertains to the sale or license of off-the-shelf software. There is also case law dealing with e-commerce models such as access of data through online platforms, online services such as ticket reservations delivered electronically, etc. The Indian Supreme Court is yet to settle the various unresolved issues on income characterization applicable in the e-commerce context.
In 2012, a retroactive amendment was introduced (with effect from 1976) to clarify that income arising from transfer of the right to use computer software would be treated as royalty income. This clarification would however not override a more restricted definition of ‘royalty’ under an applicable tax treaty.
PE issues are also gaining increasing significance in e-commerce taxation in India. India has made certain reservations to OECD’s position and has suggested that scientific equipment may constitute a PE in certain circumstances. India has also suggested that intangible property or websites may also at times be viewed as giving rise to a PE.
Cross-border movement of employees, which is very common in the outsourcing sector also gives rise to a number of PE related issues. In a landmark case, the Indian Supreme Court held that deputation of employees by a US multinational to its Indian subsidiary (undertaking back-office functions) would give rise to a PE of the US multinational in India considering the specific terms of the arrangement. It was held that as long as the PE is compensated at arm’s length there is no question of any further attribution to the PE.
India is the topmost offshoring destination for IT companies across the world. Having proven its capabilities in delivering both on-shore and off-shore services to global clients, emerging technologies now offer an entire new gamut of opportunities for top IT firms in India. US$ 150 billion Indian IT industry’s export revenue to grow at 7-8% and domestic market revenue is projected to grow at 10-11 per cent in 2017-18. Exchange Rate Used: INR 1 = US$ 0.015 as on October 05, 2017
References: Media Reports, Press Information Bureau (PIB), Department of Industrial Policy and Promotion (DIPP) statistics, Department of Information and Technology, Union Budget 2017-18