The BPO tax round table

Nothing has alarmed the Indian BPO industry as much as the government's proposal to tax some BPO activities. In this "virtual" round table organised by Ernst & Young, BPO company heads and experts sound the alarm bells

At variance with global tax principles

Mukesh Butani

We have not experienced this phenomenon in the past "� a new industry blossoms, explores new markets, builds its own strong momentum and creates jobs, particularly in a difficult economic environment.

And then, the government comes along, is struck by this perplexing inspiration to "clarify" things for the industry, and stirs the pot, eventually spreading growth-decelerating angst and confusion all round.

Given the fact that this industry was granted tax free status until March 31, 2009, it seems that the tax man has changed his mind.

A case in point is the recent circular issued by the department of revenue to clarify the basis and principles on which a non-resident foreign company would be liable to tax in India, in cases where an Indian business process outsourcing (BPO) unit constitutes a permanent establishment (PE) or a business connection (BC) for such foreign entity.

The famous circular No 1/2004 dated January 2, 2004, released on New Year's Eve appears to have conceptualised a rather strange distinction between "incidental" and "core" activities carried on by an Indian BPO unit.

While tax treaties, in general, recognise this distinction for the constitution of a PE, they do not make such a distinction for income attribution purposes.

It is often practically difficult to make such a distinction between incidental and core activities. Also, as such, a distinction is acutely fact specific and it could lead to conflicting interpretations.

The circular also does not seem to be fully aligned with the commonly accepted international tax principle that where a service-provider BPO unit is compensated on an arm's length basis, there is no additional taxable income in India for the foreign company.

The examples provided in the circular to illustrate the distinction between incidental and core activities, while being contradictory to some extent, are also unclear, since activities such as software development and software maintenance do not normally constitute either a PE or business connection in the first place to warrant the application of the circular.

Courts in India have held in an ambiguous fashion that circulars are not binding on the taxpayer and tax treaties will override the provisions of domestic law.

Hence foreign companies can continue to opt for the taxation and profit attribution principles laid out in the relevant tax treaty, which clearly would be more beneficial.

Furthermore, the Supreme Court has held on many occasions (Navnit Lal Jhaveri, Keshavji Ravji and UCO Bank's case) that departmental circulars are binding upon the tax payer to the extent that it confers a benefit (and not cause hardship, which seems to be the case with this circular).

BPO units would therefore be well advised to focus their attention on determining an appropriate arm's length price for their services.

In recent years, the BPO sector has delivered meteoric growth to the Indian economy, and there have been a number of economic multiplier benefits from it.

It is unfortunate that the industry is being thrust with a government-created fiscal uncertainty that could impede and decelerate its growth momentum. The import of the recent circular is far from clear, and additional guidance from the government would be essential and welcome, to set at rest the prevailing confusion.

This is clearly a case for reviewing the circular. The other alternative is for the tax payer and the revenue department to litigate the matter in the courts for years.

India will lose out to rivals

Kiran Karnik

The Indian BPO industry is booming, with an expected growth of 54 per cent this year to reach U$ 3.6 billion. It has the potential to make far-reaching contributions to the Indian economy through more foreign investment, higher employment and higher tax collection from employees.

The industry was eagerly awaiting a clear statement of policy laying down that foreign companies outsourcing business processes to India would not be subject to income tax in India.

Instead, the Central Board of Direct Taxes circular reflects the myopic view of a tax gatherer, without looking to the overall economic benefits brought by outsourcing activities.

Foreign companies looking at migrating high value-added service will discourage sending activities to India and India may well lose out to other countries such as Philippines, Vietnam and China.

The window of opportunity is open only for a few years and India must make all efforts to utilise it to the fullest extent by offering a dispute-free and industry friendly environment.

The circular has already started a needless debate on what constitutes incidental activities, what constitutes core revenue generating activities and who will decide what is core and what is incidental.

A dispute which arises out of the circular itself is how, by any stretch of imagination, debt collection services in the case of a credit card company can be "core activity."

Notwithstanding this, outsourcing activities as a whole should be tax exempt and we should not be bogged down by the technicalities of the nature of services.

Complete tax exemption for non residents outsourcing to India should be encouraged, as it will benefit the Indian economy and the BPO industry.

These include huge employment potential at low per capita cost; equal employment opportunities for women; a tremendous boost to the construction industry, with consequences for the steel and cement industries and for labour; a boost to the telecommunications industry; a boost to the transportation industry; additional tax revenues "� a large percentage of BPO revenues go into salaries from which taxes are deducted at source "� and increased foreign direct investment.

In the interest of sustaining the growth momentum of this industry, there should be a clear-cut policy declaration totally exempting from taxation foreign companies outsourcing to India.

Kiran Karnik's views are personal and do not reflect the views of Nasscom.

Taxing future government revenue

Sujit Baksi

India's BPO juggernaut today is attracting worldwide attention and its emerging status as the future BPO destination of the world has provided the foundation for stunning industry projections of $13.8 billion in the next three years (source: a Gartner study) and potentially $50 billion by 2010.

However, nothing comes free "� inherent in these heady projections are assumptions of strategic leadership and cooperation between the government and the industry, such as encouraging government policies, continued large investments in infrastructure and a focused quality orientation of BPO players to create a lasting value proposition that extends beyond the generic cost advantages.

Taxing BPO services runs the risk of stunting growth by freezing further investments in the short term and reversing the goodwill that India has succeeded in generating till now, in the long run. It will lead corporations to reassess potential benefits in comparison to other destinations and options.

The key arguments against the imposition of taxes on outsourcing of core services, at this juncture are:

• Increased taxes will impair the ability of the current BPO players to fuel growth in the still nascent space through the large investments required in information technology, telecom and physical infrastructure. The heavy front-loaded investment and the aggressive depreciation policies adopted by BPO companies today are, as it is, causing a strain on profitability. Taxing such income could make these units unviable.
• The BPO industry has spawned a host of supporting industries in the transportation, recruitment, education and training and telecom industries. As the BPO industry has become the single largest employment generator in India in recent times, there have been substantial gains to the exchequer from employee income tax, the increased spending power of a large employee base and the growth of the supporting industries. This healthy tax flow has the potential to grow significantly if the BPO industry is unfettered "� the results would far outweigh the direct gains from taxing the BPO industry.
• Reports about BPO companies being taxed may provide further ammunition to the anti-outsourcing lobby in the West and could be touted as a further blunting of any existing advantages in outsourcing to India.
• The proposed tax laws will redirect management attention from growing the market and creating more value for clients, with needless time and effort having to be spent in understanding and discussing subjective decisions, taxation issues and litigation.

The bottom line is leadership, both in the government and industry. The test of leaders today will be their ability to adopt a far-sighted, strategic, growth-enabling approach and to defer small gains from taxes today for potentially colossal future revenues that could reshape the country's industry and society.

The opportunity to create a national brand of India as the service capital of the world is there for us to seize. However, that day will only come with extraordinary leadership.

No taxes, please

Sanjeev Agarwal

India is increasingly seen as the BPO destination of the world. Multinationals and entrepreneurs alike are committing huge sums of money for business development in India.

If the government resorts to any taxation at this stage of BPO "� whether of core functions or incidental operations "� it would do more harm than good.

Even though the fiscal implication is low (given the existence of a double tax treaty arrangement between countries) this move will lead to a short-term deferment of offshoring decisions.

A business flourishes more when it is left to itself "� which is what the government mostly did with the software industry.

An investment-conducive environment bodes well in the long run not just for the government's coffers (and pride) but also for common people who stand to gain from the huge employment opportunities created through new business growth.

In my opinion, in the larger interest of the economy and its people, the government should desist from setting up any barriers to business for the BPO industry at the moment.

Instead, it should devise ways to give a further impetus to the BPO industry in India to enable India to gain an edge and increase its share of the growing BPO pie.

If the government resorts to any taxation at this stage for the BPO industry, international clients will go to other tax-friendly countries like the Philippines or Mauritius.

The BPO industry in India has greatly added to the overall growth of the Indian economy in terms of the employment generated and the creation of ancillary industries like transport, catering and training, which in turn are generating substantial tax revenue.

A tax-free status for the entire BPO industry will enable us and our clients to invest more in India and further benefit our economy.

What CBDT said

"Where a non-resident or foreign company outsources the whole or part of its core revenue generating business activities to an IT-enabled entity in India, such as the services of a travel agent, software developer, software maintenance, investment consultant, debt collection service etc, and the IT-enabled entity in India renders the services either directly to customers abroad or through the non-resident principal, a considerable portion of the profits derived by the non-resident or the foreign company from its customers abroad would certainly be attributable to the activities performed by the IT-enabled entity in India. If such entity constiutes a permanent establishment of the non-resident or foreign company in India, such attributed profits would be taxable under the Income Tax Act, 1961, in accordance with the provisions of the relevant tax treaty."