Date:11/09/2004 URL: http://www.thehindubusinessline.com/2004/09/11/stories/2004091100020900.htm

Back Is there fish in the outsource pond?

Mohan R. Lavi

Mohan R. Lavi on why BPO taxation has to be handled with care

CALVIN Coolidge framed the Coolidges law: "Anytime you don't want something, you invariably get it". Business processing outsourcing (BPO) companies in India, which did not want a dose of taxation, got it twice. The Central Board of Direct Taxes (CBDT) issued a Circular No 1/2004 complicating taxation of BPO companies by attempting an impossible distinction between core and non-core activities of BPO companies.

A flurry of protests, representations by NASSCOM and almost by everyone connected to the IT sector, forced the CBDT to reconsider the circular and issue a new one in August 2004. This time, the CBDT has been more careful — the circular has no number and is stated to be a draft and comments are invited before finalisation.

Taxation of BPO companies

What the new Circular has done is to remove the concept of core and non-core business proposed in the old Circular. It instead rivets its attention to one of the basic foundations of international taxation — the concept of a permanent establishment (PE). Having decided that PE would be the basis, the Circular propounds the basis for taxing BPO companies:

A non-resident or a foreign company is treated as having a PE in India under Article 5 of the Double Taxation Avoidance Agreements (DTAAs) entered into by India with different countries, if the said non-resident or foreign company carries on business in India through a branch, sales office, and so on, or through an agent (other than an independent agent) who habitually exercises an authority to conclude contracts or regularly delivers goods or merchandise or habitually secures orders on behalf of the non-resident principal.

Paragraph 1 of Article 7 of the DTAA provides that if a foreign enterprise carries on business in another country through a PE situated therein, the profits of the enterprise may be taxed in the other country but only so much of them as is attributable to the PE.

Paragraph 2 of Article 7 provides that subject to the provisions of Paragraph 3, there shall in each contracting state be attributed to that PE the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a PE. This corresponds to the `arm's length principle'.

Paragraph 3 of the Article provides that in determining the profits of a PE there shall be allowed as deductions expenses which are incurred for the purposes of the PE, including executive and general administrative expenses so incurred whether in the state in which the PE is situated or elsewhere.

We are different

What the new Circular has simply done is to bring BPO companies that have a PE in India on the same platform as other companies. They will be taxed on the basis of their profits based on `arm's length principle'. In so doing, the CBDT seems to have overlooked a couple of facts:

The advantage of BPO companies in India has been their costs. Although most BPO companies would be charging normal market rates considering the competition in the sector, there are quite a few which have been established only on the basis of the low costs that India offers. British Airways has a call centre in Mumbai that ferrets out information about ticket status, and so on, to customers all over the world. One cannot compare the costs of this centre to similar ones set up by Indian Airlines or Jet Airways simply because of the nature of services rendered. In the case of such unique businesses, getting comparable prices to determine the arm's length price could be as impossible as India topping the medals table in the Olympics.

The OECD, which has done a lot of work in the area of international taxation, has ruled that simply setting up an office in a foreign nation would not be sufficient to fasten the label of a "permanent establishment" on it. The nature of the activity carried out at the centre would be more relevant to determine whether a PE exists or not. This appears to have been ignored in the circular.

It would be necessary for the CBDT to study the industry thoroughly with the assistance of NASSCOM, and so on, before embarking on any new scheme of taxation.

(The author is a Hyderabad-based chartered accountant.)