The Hindu Business Line : Experts decry I-T dept move to tax BPO units

Some tax experts have been stumped by the Income-Tax department's latest decision to distinguish between "incidental activities" and "core revenue generating business activities" for arriving at the tax treatment for BPO units in India.

"Even though taxation of BPO units depends on the facts of each case, a dispute can always arise on what is incidental and what is core. This is a grey area even though the circular does have some examples of incidental activities like conclusion of contracts and procurement of orders," Mr Samir Gandhi, Tax Partner of Deloitte, Haskins & Sells, told Business Line.

Some experts even said that the decision to bring the "considerable portion of the profits" derived by foreign entities from outsourcing of their core activities to India runs counter to the prevailing practice of extending support to the growth of the IT-Enabled Services (ITES) industry.

"I don't see enough logic on the path being adopted. The circular is negative as it may discourage many from outsourcing core revenue generating business activities to India," said Mr Rahul Garg, Executive Director, PricewaterhouseCoopers.

"On one side, we are giving tax concessions like Section 10A and 10B to push industry forward and on the other side we say that considerable portion of the profits derived by foreign entities from outsourcing core activities would be taxed."

He cited the presence of a precedent in Income-Tax law, which does not tax a foreign company that procures goods from India.

"I see no reason why a foreign company procuring services from India should be taxed."He added that the latest stance of the department on taxation of BPO units in India might also discourage Indian industry from taking up "high-end activities".

In a recent circular issued on January 2, the department had declared that a "considerable portion of the profits" derived by foreign entities from outsourcing of their core revenue generating business activities to India would be taxable under the Income-Tax Act if the Indian entity were to constitute a "permanent establishment" (PE) of the non-resident or foreign company in India.

In cases where a non-resident company outsources the "incidental activities" to an IT-enabled entity in India, which constitutes the permanent establishment of the non-resident principal, the department has held that the "insignificant profits" from "incidental activities" can be considered as embedded in the income of the PE taxable in India., if the price charged by the PE is an arm's length/fair market price.

In such a situation, no income would separately accrue or arise to the non-resident principal in India.

The immediate fallout of the circular may be a re-rating of India as a low-cost destination for BPO.

"Foreign companies who are outsourcing their core revenue generating activities to India would now be required to factor in a tax cost. The gap between India and competing countries will narrow down," Mr Samir Gandhi said.

Tax experts said that the controversy on taxation of BPO units in India has arisen in cases where the Indian entity becomes a deemed agent under Section 9 of the Income-Tax Act or Article 5 of the tax treaty.

In such a case, there are issues on how the amount of profit attributable to the PE is to be determined in practice.

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