The withdrawal of tax exemptions granted under Sections 10A and 10B and alternatives recommended by the Vijay Kelkar Committee "will be a setback to the software industry", the National Association of Software and Services Companies said on Friday.

The withdrawal of the 10-year tax exemption up to 2009, was "destabilising", Nasscom said.

"Competitors are working hard, China among them with its advantage of better infrastructure, strong fiscal incentives and faster decision-making. The Indian industry is confident of taking on them, but not with an unstable policy regime," it added.

According to experts, the recommendations will impact acquisitions involving stock-swap. It can also hit the market valuation of Indian firms, and lower their ability to acquire companies.

Nasscom president Kiran Karnik said: "We urge the government to retain the full tax exemption under Section 10A/10B as originally envisaged."

Though alternatives proposed were step forward from the initial consultation paper, but neither of them met the industry's needs, he added.

The Kelkar panel has recommended elimination of Section 10 and 10B of the Income-Tax Act for all tax payers other than those engaged in manufacturing computer software.

In case of software companies, the government must take steps to negotiate with foreign governments to enter into a comprehensive totalisation agreement leading to a single-point incidence of taxes, it added.

It has recommended amendment to Section 91 of the Income-Tax Act to allow full credit for payment of foreign country's federal and state income taxes. But no refund of such foreign tax credit should be allowed.

Alternatively, the panel said since the arrangement was transitory in nature the benefit of tax exemption under Section 10A and 10B for manufacturing of software only might be continued till a totalisation agreement with trading partners had been entered into.

But distribution of dividend by computer software manufacturing companies availing of deductions under the two sections should be subjected to a dividend distribution tax of 30 per cent.

Similarly, the long-term capital gain arising from transfer of equities of such companies should also be subjected to tax, like long-term capital gains from any other asset.

Karnik said: "We appreciate and support the committee's thrust towards simplification of the tax system and the extensive use of information technology in the administration, we oppose the withdrawal of the tax incentives. The government had declared a 'no-tax' regime for software exports up to 2009, and the industry's requests it to abide by the same."

Executives in software industry said the impact of the proposed withdrawal of an announced policy extended beyond the software and infotech sectors, as all other assurances/guarantees by the government would be doubtful and subject to sudden change.

In the software sector, both Indian and foreign investors had made investment and business plans on the basis of the 10-year tax-free commitment.

"Going back on this, will be unfair and hurt not only future investment, but also present players," Karnik added.