Why Three Laws Don't Agree
When an Indian company provides services to an overseas client, it intuitively feels like an "export." But FEMA, GST, and Income Tax were enacted by different ministries with different policy objectives — and each draws the boundary of "export" differently.
This misalignment creates real compliance risk. A software company that correctly claims GST zero-rating on its exports may still owe income tax if the service income is structured incorrectly under Section 10AA. An intermediary earning commission from a foreign principal may receive money under FEMA's current account rules but face 18% GST on the same transaction because Section 13(8)(b) deems the place of supply as India.
Each law uses a different lens: FEMA looks at the residency of the parties and the currency of payment. GST looks at the place of supply of the service. Income Tax looks at whether the income is "derived" from export activities and whether conditions like separate accounting are met. A single transaction must pass all three tests independently.
The FEMA Test for Export of Services
Under FEMA, an export of services is permissible as a current account transaction (no RBI approval needed) if three conditions are met:
- Residency: The service provider is a person resident in India
- Currency: Payment is received in freely convertible foreign exchange (FCY) through normal banking channels
- Permissibility: The service is not on the Negative List under Schedule I of the Foreign Exchange Management (Current Account Transactions) Rules, 2000
FEMA compliance requires: realisation of export proceeds within 9 months of rendering the service (for companies; 15 months for SEZ units), reporting in SOFTEX for software exports, and maintaining forex realization records for potential RBI inspection.
| Law | Key Test | What Qualifies | What Fails |
|---|---|---|---|
| FEMA | Residency + FCY payment + Permissibility | IT services, consulting, management fees in USD/EUR | Services paid in INR even to foreign entities |
| GST (IGST Act) | 5-condition test under Section 2(6) | Principal-to-principal IT/consulting to overseas client | Intermediary services (Section 13(8)(b)) |
| Income Tax (Sec 10AA) | SEZ unit + export earnings + separate accounts | SEZ-located unit with proper accounts | Non-SEZ unit claiming Sec 10AA; or mixed domestic/export books |
The GST Test — Five Conditions That Must All Be Met
Under Section 2(6) of the IGST Act, a "zero-rated supply" of services (i.e., eligible for export refund or LUT) requires five conditions to be satisfied simultaneously:
- The supplier of service is located in India
- The recipient of service is located outside India
- The place of supply is outside India (this is where Section 13 becomes critical)
- Payment is received by the supplier in convertible foreign exchange or in Indian rupees wherever permitted by RBI
- The supplier and recipient are not merely establishments of a distinct person (i.e., related party / branch / PE rules)
Condition 3 — the place of supply test — is where most disputes arise. For most services, the place of supply is the location of the recipient (outside India), and the export qualifies. But for specific services enumerated in Sections 12 and 13 of the IGST Act — including intermediary services (13(8)(b)), immovable property services (13(4)), performance-based services (13(5)) — the place of supply is India regardless of where the recipient is located.
The Income Tax Test — Section 10AA for SEZ Units
Section 10AA provides a tax holiday for units established in Special Economic Zones (SEZs): 100% deduction of export profits for the first 5 years, 50% for years 6–10, and 50% of reinvested profits for years 11–15.
The conditions are strict and frequently breached:
- The unit must be physically located in a notified SEZ
- The unit must maintain separate books of account showing export turnover distinctly from domestic turnover
- The deduction is on "profits derived from the export of articles or things or services" — so only export-attributable profit qualifies, not the entire unit profit
- The "export turnover" definition under Section 10AA is specific: it excludes freight, insurance, and other costs incurred outside India — meaning SEZ units should not gross up their export invoices with these items
Common SEZ trap: A unit provides both domestic and export services but maintains combined books. The AO recomputes the Section 10AA deduction by apportioning profits based on gross revenue — often arriving at a much lower deduction than the unit claimed. Separate books from day one are non-negotiable.
Structuring Transactions to Pass All Three Tests
The practical solution for businesses that want GST zero-rating, FEMA compliance, and Income Tax benefit on the same export transaction:
For Non-SEZ Units
- Ensure all five GST conditions are met — particularly that you are acting as principal (not intermediary) in your service agreement
- Price services in FCY and receive payment through banking channels within FEMA timelines
- File LUT (Letter of Undertaking) before the export to avoid IGST payment and claim refund under Rule 96A
- For income tax, export profits from non-SEZ units are taxable at normal rates but may qualify for Section 80HHC or other deductions (where applicable)
For SEZ Units
- Maintain rigorously separate books — separate P&L, separate bank accounts, separate employee allocation records
- Ensure contracts are with foreign entities and payment is in FCY into the SEZ unit's EEFC (Exchange Earners' Foreign Currency) account
- GST zero-rating for supplies from SEZ is automatic (supplies from SEZ are deemed exports under GST law)
- File Form 56F (Audit Report for Section 10AA) signed by a CA — this is a mandatory compliance frequently missed by smaller SEZ units
When Things Go Wrong — Common Disputes
Three disputes we see most frequently in this area:
- IGST refund denied on export of services — typically because the transaction is reclassified as intermediary services under Section 13(8)(b). Challenge: file a representation with detailed contractual analysis showing principal-to-principal arrangement.
- FEMA show-cause notice for delayed realisation — proceeds not received within 9 months. Remedy: apply for extension through AD bank to RBI's FEMA Management Cell.
- Section 10AA deduction disallowed because export turnover computation is contested. Common ground: AO adds back forex expenses to domestic turnover. Challenge before ITAT with Section 10AA-specific turnover computation.
R B Shah & Associates advises export-oriented IT, consulting, and manufacturing businesses on cross-law structuring for their international services — ensuring that the same transaction satisfies FEMA, earns GST zero-rating, and qualifies for applicable Income Tax benefits simultaneously.