9. Income Taxes

Income before income taxes for the Company’s U.S. and foreign operations for the years ended December 31, 2012, 2011 and 2010 was as follows:


	2012		2011		2010
	(in thousands)
U.S.		$16,453		$3,577		$12,359
Foreign		223,475		150,859		121,302

		$239,928		$154,436		$133,661

Income taxes for the years ended December 31, 2012, 2011 and 2010 consisted of the following:


	2012			2011			2010
	(in thousands)
Current:
Federal		$5,913			$4,501			$2,650
State		1,064			821			483
Foreign		54,419			34,457			23,423

Total current provision		61,396			39,779			26,556

Deferred:
Federal		(422	)		(3,320	)		651
State		(77	)		(606	)		119
Foreign		(6,512	)		(4,273	)		(7,258	)

Total deferred (benefit)		(7,011	)		(8,199	)		(6,488	)

Total provision for income taxes	$	54,385		$	31,580		$	20,068

The components of net deferred tax assets as of December 31, 2012 and 2011 are as follows:


	2012			2011
	(in thousands)
Deferred tax assets
Valuation allowance		$0			$0
Carry forward losses of subsidiaries		22			147
Minimum alternate tax credit of subsidiaries		16,831			15,796
Property, plant and equipment		1,205			1,589
Accrued expenses and allowances		9,624			7,053

Total deferred tax assets		27,682			24,585

Deferred tax liabilities
Provision for branch tax on dividend equivalent in India		(1,726	)		(1,726	)
Provision for tax on unrealized gains in India		(258	)		(77	)

Total deferred tax liabilities		(1,984	)		(1,803	)

Net deferred tax assets		$25,698			$22,782

The balance sheet classification of the net deferred tax asset is summarized as follows:


	2012		2011
	(in thousands)
Deferred tax asset, current	$	7,694	$	7,121
Deferred tax asset, non-current		18,004		15,661

	$	25,698	$	22,782

Syntel’s software development centers/units are located in Mumbai, Chennai Pune and Gurgaon, India. Software development centers/units enjoy favorable tax provisions due to their registration in Special Economic Zone (SEZ), as Export Oriented Unit (EOU) and as units located in Software Technologies Parks of India (STPI).

Units registered with STPI, EOU’s and certain units located in SEZ were exempt from payment of corporate income taxes for ten years of operations on the profits generated by these units or March 31, 2011, whichever was earlier. Certain units located in SEZ are eligible for 100% exemption from payment of corporate taxes for first five years of operation and 50% exemption for the next two years and a further 50% exemption for another three years, subject to fulfillment of criteria laid down. New units in SEZ operational after April 1, 2005 are eligible for 100% exemption from payment of corporate taxes for first five years of operation, 50% exemption for the next five years and a further 50% exemption for another five years, subject to fulfillment of criteria laid down.

Six SEZ units located at Mumbai have already ceased to enjoy the above-mentioned tax exemption. One SEZ unit located at Mumbai completed tax holiday period on March 31, 2012. Further, three more SEZ units located at Mumbai have completed their first five years of 100% exemption from payment of corporate taxes effective April 1, 2008, 50% of the profits of the stated units would only be eligible for tax exemption which expires on March 31, 2013. Also, the EOU located at Chennai has ceased to enjoy the above-mentioned tax exemption effective April 1, 2007. During the year ended December 31, 2008, Syntel started a Software Development unit in the Pune SEZ and during the year 2009, the Company started one more Software Development unit in the Pune SEZ. During the year ended December 31, 2010, the Company started a Software Development unit in the Syntel-Chennai SEZ. Further, the Company’s four STPI units ceased to enjoy tax exemption effective April 1, 2011 due to expiration of the statutory period for tax exemption. During the three months ended September 30, 2011, the Company started a Software Development SEZ unit in Airoli, Navi Mumbai. Further, one SEZ units located at Chennai have completed their first five years of 100% exemption as on March 31, 2012.

Syntel KPO units located in Mumbai and Pune were exempt from payment of corporate income taxes on the profits generated by the unit up to March 31, 2011. During the year ended December 31, 2008, Syntel started a KPO unit in the Pune SEZ. During the three months ended June 30, 2011, Syntel started a KPO SEZ unit in Airoli, Navi Mumbai.

Syntel’s Special Economic Zone (SEZ) in Pune, set up under the SEZ Act 2005, commenced operations in 2008. The SEZ for Chennai commenced operations in 2010. Income from operation of the SEZ, as a developer, is exempt from payment of corporate income taxes for ten out of 15 years from the date of SEZ notification.

Provision for Indian Income Tax is made only in respect of business profits generated from these software development units, to the extent they are not covered by the above exemptions and on income from treasury operations and other income.

The benefit of the tax Holiday under Indian Income Tax was $24.6 million $19.1 million and $25.0 million for the years ended December 31, 2012, 2011 and 2010, respectively.

The Company intends to use the remaining accumulated and future earnings of foreign subsidiaries to expand operations outside the United States and accordingly, undistributed earnings of foreign subsidiaries are considered to be indefinitely reinvested outside the United States and no provision for U.S. Federal and State income tax or applicable dividend distribution tax has been provided thereon. If the Company determines to repatriate all undistributed repatriable earnings of foreign subsidiaries as of December 31, 2012, the Company accrued taxes of approximately $183.9 million.

The following table accounts for the differences between the actual effective tax rate and the statutory U. S. Federal income tax rate of 35% for the years ended December 31, 2012, 2011 and 2010:


	2012			2011			2010
Statutory rate		35.0	%		35.0	%		35.0	%
State taxes, net of federal benefit		0.2	%		0.1	%		0.3	%
Foreign effective tax rates different from U.S. Statutory Rate		(12.4	%)		(12.0	%)		(19.6	%)
Tax reserves		(0.1	)%		(2.7	%)		(0.7	%)

Effective income tax rate		22.7	%		20.4	%		15.0	%

During the year ended December 31, 2012, 2011 and 2010, the effective income tax rates were 22.7%, 20.4% and 15.0%, respectively.

The tax rate for the year ended December 31, 2012 was positively impacted by the reversal of provision of uncertain tax liability of $0.24 million.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:


	(in millions)
	2012			2011
Balance as at January 1		$18.41			$19.71
Additions based on tax positions relate to the current year		7.37			5.81
Reductions for tax positions of prior years		(0.24	)		(3.46	)
Foreign currency translation effect		(0.60	)		(3.65	)

Balance as at December 31		$24.94			$18.41
Income taxes Paid, see below		(20.58	)		(18.24	)

Amounts, net of Income taxes Paid		$4.36			$0.17

The above table shows the unrecognized tax benefits that, if recognized, would affect the effective tax rate.

The Company has paid income taxes of $20.58 million and $18.24 million against the liabilities for unrecognized tax benefits of $24.94 million and $18.41 million, as at December 31, 2012 and 2011, respectively. The Company has paid the taxes in order to reduce the possible interest and penalties related to these unrecognized tax benefits.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits as part of tax expense. During the years ended December 31, 2012 and December 31, 2011, the Company recognized a tax charge towards interest of approximately $1.46 million and $0.0 million. Furthermore, during the years ended December 31, 2010, the Company reversed $0.33 million towards interest previously accrued.

The Company had accrued approximately $1.40 million and $0.06 million for interest and penalties as of December 31, 2012 and December 31, 2011, respectively.

The Company’s amount of unrecognized tax benefits for the tax disputes of $1.6 million and potential tax disputes of $3.2 million could change in the next twelve months as litigation and global tax audits progress. At this time, due to the uncertain nature of this process, it is not reasonably possible to estimate an overall range of possible change.

The Company records provisions for income taxes based on enacted tax laws and rates in the various taxing jurisdictions in which it operates. In determining the tax provisions, the Company provides for tax uncertainties in income taxes, when it is more likely than not, based on the technical merits, that a tax position would not be sustained upon examination. Such uncertainties, which are recorded in income taxes payable, are based on management’s estimates and accordingly, are subject to revision based on additional information. The provision no longer required for any particular tax year is credited to the current period’s income tax expenses. Conversely, in the event of a future tax examination, any additional tax expense not previously provided for will be recognized in the period in which the actual liability is concluded or the management determines that the Company will not prevail on certain tax positions taken in filed returns, based on the “more likely than not” concept.

Syntel Inc. and its subsidiaries file income tax returns in various tax jurisdictions. The Company is no longer subject to U.S. Federal tax examinations by tax authorities for years before 2009 and for State tax examinations for years before 2008. During 2012 the IRS had commenced an examination of Syntel Limited’s U.S. income tax return (form 1120F) for the tax year 2010. The examination is ongoing.

Syntel Limited, the Company’s India subsidiary, has disputed tax matters for the financial years 1996-97 to 2007-08 pending at various levels of tax authorities. Financial year 2008-09 and onwards are open for regular tax scrutiny by the Indian tax authorities. However, the tax authorities in India are authorized to reopen the already concluded tax assessments and may re-open the case of Syntel Limited for financial years 2005-06 and onwards.

The tax rate for the year ended December 31, 2011 was impacted by a favorable adjustment of $3.5 million as a result of the Company’s review of its global uncertain tax liabilities provided on the “more likely than not” concept and other tax positions, which are based on the expiration of the statute of limitations related to certain global tax contingencies and the completion of certain tax audits. $2.6 million of $3.5 million is related to particular tax position reversed during the year 2011 after netting of the tax of $0.6 million charged during the nine months ended September 30, 2011. The Company also reversed $1.2 million based on the reconciliation of actual tax liability as per the tax returns and the tax provision as per the books. Further, a $0.6 million reversal of tax reserve has arisen on account of the reversal of a valuation allowance, created in the past, against deferred tax assets recognized on the allowance of doubtful accounts. During the year ended December 31, 2011, the Company reviewed the filing requirements for certain U.S. State Income Tax returns. The Company had updated the profit apportion method in those certain States. Accordingly, the Company had provided $1.3 million, out of which $0.8 million relates to the prior years. Without the above, the effective tax rate for the year ended December 31, 2011 would have been 23.0%.

The tax rate for the year ended December 31, 2010 was impacted by a favorable adjustment of $1.28 million as a result of the Company’s review of its global uncertain tax liabilities provided on the “more likely than not” concept and other tax positions, which are based on the expiration of the statute of limitations related to certain global tax contingencies and the completion of certain tax audits. The Company also reversed $0.5 million based on the reconciliation of actual tax liability as per the tax returns and the tax provision as per the books. Further, the Company also recorded a deferred tax asset of $0.2 million and credit of carry back of losses of $0.2 million. Without the above, the effective tax rate for the year ended December 31, 2010 would have been 16.6%.

Syntel Limited has not provided for disputed Indian income tax liabilities amounting to $1.65 million for the financial years 1996-97, 1997-98 and 2001-02, which is after recognizing certain tax liabilities aggregating $0.85 million.

Syntel Limited received orders for appeals filed with the Commissioner of Income Tax Appeals (“CIT (A)”) against the demands raised by the Income Tax Officer for similar matters relating to the financial years 1996-97, 1997-98, and 2000-01. The contention of Syntel Limited was partially upheld by the CIT (A). Syntel Limited has gone into further appeal with the Income Tax Appellate Tribunal (“ITAT”) for the amounts not allowed by the CIT (A). Syntel Limited received favorable orders from the ITAT. The Income Tax Department filed further appeals before the Bombay High Court. The Bombay High Court dismissed the Income Tax Department appeals and upheld the ITAT orders on December 15, 2009. The Income Tax Department has filed a review petition before the Bombay High Court. The Income Tax Department review petition was rejected due to filing defects. The Income Tax Department may rectify the defects and re-submit the review petition.

Syntel Limited has also not provided for disputed Indian income tax liabilities aggregating to $4.94 million for the financial years 2002-03 to 2004-05, which is after recognizing tax on certain tax liabilities aggregating $0.80 million provided for uncertain income tax positions, against which Syntel Limited has filed appeals with the CIT(A). Syntel Limited has received the order for appeal filed with the CIT (A) relating to financial year 2002-03 and financial year 2003-04, wherein the contention of Syntel Limited has been partially upheld. Syntel Limited has gone into further appeal with the ITAT for the amounts not allowed by the CIT(A). The Income Tax Department has also filed a further appeal against the relief granted to Syntel Limited by the CIT(A). Syntel Limited and the Income Tax Department appeals which were re-fixed for hearing before the ITAT on February 20, 2013 have been adjourned and are now fixed on March 14, 2013. Syntel Limited has obtained opinions from independent legal counsels, which support Syntel Limited’s stand in this matter.

For the financial year 2004-05, the appeal of Syntel Limited was fully allowed by the CIT(A). The Income Tax Department filed a further appeal with the ITAT for the amounts allowed by the CIT(A) except with regard to one item. The Income Tax Department’s appeal was rejected by the ITAT. The Income Tax Department has filed a further appeal before the Bombay High Court for the amounts allowed by the ITAT, except an item on which CIT(A) granted relief to Syntel Limited and the Income Tax Department did not appeal. Accordingly, Syntel Limited reversed a tax provision of $0.33 million during the year ended December 31, 2010 with regard to that one item. The Income Tax department has filed further appeal before the Bombay High Court. The Bombay High Court has dismissed the Income Tax Department Appeal. The Income Tax Department has filed a Special Leave petition with the Supreme Court of India on January 24, 2013, challenging the order passed by the Bombay High Court. The petition will come up for admission in the near future. For the financial year 2005-06, the Indian Income Tax Department decided against Syntel Limited with respect to a particular tax position, and Syntel Limited filed an appeal with the CIT(A). During the year ended December 31, 2010, Syntel India’s appeal for the financial year was fully allowed by CIT (A). The Income Tax Department has filed a further appeal with the ITAT for the amounts allowed by the CIT (A). The Income Tax Department appeal is fixed for hearing before ITAT on June 10, 2013. For the financial year 2006-07, the Indian Income Tax Department decided against Syntel Limited with respect to a particular tax position and Syntel Limited filed an appeal with the CIT(A). During the three months ended September 30, 2011, the Company received an order for appeal filed with CIT(A) that partially upholds Syntel Limited’s contentions. Syntel Limited has filed a further appeal with the ITAT for the amounts not allowed by the CIT(A). The Income Tax Department has filed a further appeal for the amounts allowed by the CIT(A). Syntel Limited and Income Tax Department appeal is fixed for hearing before ITAT on January 15, 2014. For the financial year 2007-08, the Indian Income Tax Department decided against Syntel Limited in respect to particular tax position and Syntel Limited has filed an appeal with the CIT(A). During the three months ended September 30, 2012, the Syntel Limited received an order for appeal filed with CIT(A) that upholds Syntel Limited’s contentions. The Income Tax Department has filed a further appeal for the amounts allowed by the CIT(A). The appeal is scheduled for hearing on January 15, 2014.

For the financial year 2006-07, the Indian Income Tax Department decided against the Syntel KPO entity in respect to a particular tax position and the Syntel KPO entity filed an appeal with the CIT (A). During the year ended December 31, 2011, the Syntel KPO entity received an order for appeal filed with CIT (A) wherein, the contention of Syntel India was upheld. The Income Tax Department has filed a further appeal for the amounts allowed by the CIT (A). The Income Tax Department appeal is fixed for hearing before ITAT on April 8, 2013. For the financial year 2007-08, the Income Tax Department decided against the Syntel KPO entity with respect to a particular tax position and the Syntel KPO entity has filed an appeal with the CIT (A). For the financial year 2007-08, the Income Tax Department also decided against Syntel International Private Limited (SIPL) in respect to a particular tax position and SIPL has filed an appeal with the CIT (A). During the three months ended September 30, 2012, SIPL has received order for appeal filed with CIT(A)and the contention of SIPL was fully upheld. The Income Tax Department filed further appeal to the ITAT for the amounts allowed by the CIT (A). However, recent High Courts orders are in favor of the tax position taken by SIPL. Based on the CIT (A) and recent High Court orders, SIPL reviewed Uncertain Tax Position (UTP) of $0.24 million and reversed the aforementioned tax provision in September 2012. The Income Tax Department has filed a further appeal for the amounts allowed by the CIT (A). The Income Tax Department appeal is fixed for hearing before ITAT on January 15, 2014.

All the above tax exposures involve complex issues and may need an extended period to resolve the issues with the Indian income tax authorities. Management, after consultation with legal counsel, believes that the resolution of the above matters will not have a material adverse effect on the Company’s consolidated financial position.

SERVICE TAX AUDIT

During the three months ended September 30, 2010, a service tax audit was conducted for the Adyar facility in Chennai; the scope of the audit was to review transactions covered under the Central Excise and Customs Act, by the office of Accountant General (Commercial Receipt Audit). The Development Commissioner (DC) has issued a letter stating the audit objections raised by the officer of the audit team. Most of the observations are pertaining to the service tax and are for an amount of $3.85 million. Syntel Limited has filed a reply to said notice and further information.

Further to our reply and information filed earlier, Syntel Limited has received a letter dated July 13, 2011 from the DC, indicating that the audit objections amounting to $3.0 million, out of the total amount of $3.85 million, have been closed. Syntel is pursuing closure of the balance of the audit objections of approximately $0.85 million.

Syntel Limited has obtained the views of a tax consultant in this matter and has filed an appropriate reply to the audit observations. The letter does not constitute any demand against Syntel Limited. The Company believes that, Syntel Limited will be in a position to defend the objections raised, and therefore no provision has been made in the books.

A Syntel KPO entity, State Street Syntel Service Pvt. Ltd., regularly files quarterly refund applications and claims tax refunds of unutilized input of service tax on account of export of services. During the three months ended September 30, 2012 the Company has received orders for the rejection of a service tax refund for the period April–September 2011 of $0.50 million. Per the rejection order, there is no nexus of input services with the export of services justifying the claim of refund of service tax. The Company had filed appeals before the Commissioner of Appeal against the aforementioned order. In view of the aforementioned order, the disputed and potentially disputed service tax refund amount is $5.30 million. The Company’s tax consultant is of the view that the aforementioned orders are contrary to the wording of the service tax notifications and provisions. The Company therefore believes that its claims of service tax refunds should be upheld at the appellate stage and the refunds should be accordingly granted. Accordingly, no provision has been made in the Company’s books.

Syntel International Pvt. Ltd. regularly files service tax returns and has filed a refund application claiming a tax refund of unutilized input service tax on account of export of services. The Company received a show cause notice on October 23, 2012 for service tax demand of approximately $2.23 million. The Company has filed submissions with the service tax department to oppose the aforementioned show cause notice. However the service tax department has passed an order dated February 11, 2013 confirming the said demand. The total demand raised along with penalty amounts to $ 4.3 million. Interest @18% p.a. is also payable up to the date of payment of the demand. The Company is in process of filing an appeal against the said order and also an application for stay of demand. The Company’s tax consultant is of the view that the aforementioned demand is contrary to the wording of the service tax notifications and provisions. The Company therefore believes it is in a strong position to defend the aforementioned demand and that the order passed by the tax department will be quashed. Accordingly, no provision has been made in the Company’s books.

Local Taxes

As at December 31, 2012 the Company has recorded a local tax liability of approximately $4.3M equaling to $2.7M net of tax, relating to local taxes including employer withholding taxes, employer payroll taxes, business license registrations, and corporate income taxes.

Minimum Alternate Tax (MAT)

Pursuant to the changes in the Indian income tax laws, Minimum Alternate Tax (MAT) has been extended to income in respect of which deduction is claimed under section 10A and section 10AA; consequently, the Company has calculated the tax liability for current domestic taxes after considering MAT. The excess tax paid under MAT provisions over and above normal tax liability can be carried forward and set-off against future tax liabilities computed under normal tax provisions. The MAT Credits can be carried forward for a period of 10 years and can be utilized against the taxes payable as per provisions of the Indian Income Tax Act. The MAT Credits as on December 31, 2012 of $16.82 million shall expire as follows:


Year of Expiry Of MAT Credit	(in millions)
2017-18		$0.24
2018-19		0.33
2019-20		4.15
2020-21		6.00
2021-22		0.96
2022-23		5.14
		$16.82