The strong growth in the IT spending in US seems to be unabated over the last few years. As per the IDC, the worldwide information technology industry comprising hardware, software, IT services and BPO, has aggregate revenues of US$ 1,452 bn in 2005. Globally IT services (including BPO) accounts for majority of the IT revenues with a share above 50 per cent and is followed by hardware and software.

India's market share, with estimated exports of US$ 24 bn (FY06), stands at a mere 2 per cent. As such, the growth potential for the sector continues to be immense. The strength of the Indian software industry is indicated by the fact that the export revenues has grown at a CAGR of 35 per cent ( FY00 to FY06E) (source: Nasscom).

Budget Measures Minimum Alternative Tax (MAT) would be applicable on IT companies Fringe Benefit Tax (FBT) would be levied on Employee Stock Option Plans Dividend Distribution Tax would be increased from 12.5% to 15%. Increased allocation to Rs 7.2 bn as against Rs 3.9 bn in the previous year for ambitious e-governance project A new scheme of manpower development for the software exports industry has been launched with allocation of Rs 330 m Benefits of investment in Venture Capital Fund (VCF) has been extended to Information Technology sector, by giving a pass-through status to the same  Budget Impact The software industry, which is already in the dilemma over the continuing battle between SEZ and Software Technology Park (STP) exemption will now have to shell out more in form of MAT at an effective rate of 11.22%. Companies will also have to pay FBT on ESOP, which was seen as a good tool to contain high attrition in this sector. Large IT companies having good track records in paying dividends will be hit as rate of dividend distribution tax has been raised to 15%. Companies that have a good domestic presence will benefit from the e-governance project for which the government has increased allocation.  Sector Outlook The Indian IT services market has witnessed strong growth over the past few years, on the back of increased offshore outsourcing initiatives from global corporations. More and more global corporations are trying to improve their cost efficiency and, thus, outsourcing their technology requirements to low-cost countries like India. In fact, it is the offshore component that has been seeing impressive traction, driven by increasing acceptance of the 'global delivery model'. The demand now seems to be shifting from low-end services to high-end ones, like IT consulting, package implementation and systems integration.  Company Impact TCS, Wipro and 3i Infotech are likely to benefit from the increased allocation to e-governance project  Industry Wish List NASSCOM Wish List A separate self-contained enactment dealing with Service Tax should be introduced. Continuation of STP scheme beyond 2009. Allow companies to file consolidated tax returns. Tax exemption to non-residents outsourcing their back office processing and call centre activities to India. Amend the domestic tax laws to bring them in line with the Double Taxation Avoidance Agreements (DTAAs) and allow foreign tax credits. FICCI and ASSOCHAM Wish List Removal of 8% excise duty levied on packaged software sold over the counter. Complete tax holiday for minimum 15 years. Levy state level taxes like Octroi and Mandi tax at a minimum rate of 3%-4%. Approve large number of IT parks in SEZs and should not cap the number of SEZs. Mr. Amar Chintopanth, CFO, 3i Infotech The tax concessions given to Software Technology Parks of India (STPIs), which is coming to a close in FY 2009-10, should be extended. The large IT companies can move to SEZs but for small and mid size IT companies the STPI exemption should continue as it will play important role in their future planning.  Budget over the years Budget 2004-05 Budget 2005-06 Budget 2006-07 Full excise exemption on computers (from 8% earlier). Bill for regulating Special Economic Zones (SEZs) to be introduced. Prepare an Investment Commission to facilitate investments (both domestic and foreign) in the area of telecom and high technology. Telecom FDI limit raised to 74%, from 49%. Service tax has been raised from 8% to 10%. Further, a surcharge of 2% on account of education cess will be imposed on this tax. Zero customs duty on items bound under the Information Technology Agreement. In order to provide a level playing field to the domestic industry, customs duty on specified capital goods and all inputs required for the manufacture of ITA bound items has been removed. Additional countervailing duty (CVD) at 4% has been imposed with immediate effect from 1st March 2005 only on items bound under the Information Technology Agreement, and on specified inputs/raw materials for manufacture of electronics/IT goods. Credit for the CVD will be available against payment of excise duty. IT software and documents of title conveying the right to use IT software will not be subject to this levy. Excise duty of 12% imposed on computers. Excise duty on DVD drives reduced to nil. Excise duty of 8% imposed on over-the-counter (OTC) packaged software, excluding software downloaded from the Internet and customised software. Duty on clearances to Domestic Tariff Area from Export Oriented Units or units in Electronic Hardware Technology Parks, Software Technology Parks etc. is being changed from 50% of the aggregate of customs duties to 25% of basic customs duty plus full CV duty. For the purpose of fringe benefits tax (FBT), valuing the benefit in the form of 'tour and travel' at 5% instead of 20%. The service tax has been increased from 10% to 12%. [Read more on Budget 2004-05] [Read more on Budget 2005-06] [Read more on Budget 2006-07]
Key Positives Huge outsourcing potential: Offshoring has been well and truly accepted as a major strategic decision that can enhance the competitive advantages of global corporations. The value proposition of offshore development has been proved beyond doubt and as an industry, offshoring is still very much in the growth phase. Even among the global 1000 companies, the offshoring penetration levels are not that high. This is a significant point, since these are companies with IT budgets in the range of US$ 500 m to over US$ 1 bn. The global market share of Indian companies is also miniscule. Thus, these pointers are clear indications that there is plenty of room for the Indian software industry to grow, given the immense and untapped potential. Offshore outsourcing to India offers considerable economical benefits for those who are prepared to exploit the advantages of outsourcing. Moving up the value chain: Indian software companies are consistently broadening their portfolio of offerings and moving fast up the value chain. Given that traditional services, such as application development and maintenance (ADM), are getting commoditised, it is imperative for these companies to move higher up the value chain into areas like consulting, package implementation and systems integration. Not only will this help Indian companies get higher billing rates from their clients, it will also give them an opportunity to work closely with the top managements of client companies. Other positives: Among other positive factors for the Indian software industry, the major ones are large availability of talented manpower, cost advantage and geographical advantages (time-zone advantages). The companies involved in IT outsourcing in India provide high quality work, meeting international standards and complying with the ISO & SEI-CMM standards. Three out of every four SEI-CMM 5 companies worldwide are located in India.		Key Negatives High reliance on the US markets: The US market's share in India's software and services exports is fairly high, at around 60% to 65%. Even though it has come down a little during the last year but such a large degree of dependence on a single geographical location spells high risk for the Indian software sector. Over that, the backlash in the US against outsourcing of jobs to low-cost countries like India has raised some medium-term concerns for Indian software companies. Decreasing competitive advantages: Increasing competition from global technology majors has not only threatened the Indian IT industry's cost leadership, Indian software companies have also been made to face intense competition for talent. All these pressures mean flat billing rates and higher employee costs going forward. This is likely to affect margins and, consequently, the profitability of Indian companies. The BPO service providers have achieved maturity in practices like relationship management and knowledge management. They need to diversify to employee engagement, process improvement, recruitment, migration planning and workforce management. If this is not done, the IT companies could find maintaining the current client satisfaction level as challenging. High rates of attrition: High attrition, especially in the middle and senior positions, continue to damage the performance of Indian software companies to a certain extent. The average industry rate is around 18% which when compared to other industries is on the higher side. The companies, in a bid to overcome high attrition rates, are recruiting science graduates and training them, which means higher training cost and loss of billable hours. Apart from competition for talent from MNC technology majors, internal factors like job dissatisfaction and higher aspirations (in case of BPO companies) have led to such high attrition rates in the Indian software sector.

Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.