The Hindu Business Line : There's confusion in the `core'

THE business process outsourcing (BPO) industry would not be feeling too good about the `feel-good' wave that is sweeping the country. The reason is Circular No 1/2004 of January 2, 2004, issued by the Central Board of Direct Taxes (CBDT), clarifying that the taxation of BPO units in India has put a spoke in their juggernaut pace. Judging by the initial response, the circular has done everything but clarify the situation.

The circular starts off with a known statement that a non-resident or a foreign company is treated as having a permanent establishment (PE) or business connection in India under Article 5 of the Double Taxation Avoidance Agreements (DTAA) or under Section 9 of the Income-Tax Act, 1961, 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 in India on behalf of the non-resident principal.

Coming to the nuts and bolts of the taxation, the circular states that if a non-resident carrying on the manufacture and sale of goods or merchandise or provision of services outside India outsources some of its incidental activities (which enables the core activities to be carried on outside India) to an IT-enabled entity in India which is a permanent establishment (PE) of the non-resident principal and the price charged by the PE is an arm's length/fair market price, then the insignificant profit is difficult to determine and, hence, no income shall separately accrue/arise or deem to arise to the non-resident principal in India.

The CBDT has also given specific examples of such cases:

A foreign company manufacturing computers abroad and also selling such computers to customers abroad, engages or sets up a call centre in India to procure orders from or conclude contracts with customers abroad and also to answer sales-related queries on telephone.

A foreign insurance company insuring risks in countries other than India appoints or sets up a call centre in India to attend to calls from customers outside India regarding acquisition of new insurance policy or revision of existing policy, to disseminate relevant information and accept insurance proposal from customers — while the actual policy issuance and collection of premium is done outside India;

A foreign credit card company issuing credit cards to customers other than India, sets up a call centre to attend to calls from customers outside India seeking to acquire a new credit card, disseminate relevant information and accept the issue of a credit card, while the actual card issuance and delivery are being done outside India.

When one thought that the going was good till now comes the death blow — para 5 which states that where a non-resident or a foreign company outsources the whole of part of its core revenue generating business to an IT-enabled entity in India, such as the services of a travel agent, software developer, software maintenance, investment consultant, debt collection service, and so on, and the IT-enabled entity in India renders the services either directly to the 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 be attributable to the activities performed by the IT-enabled entity in India and, hence, such attributable profits would be taxable under the Income-Tax Act, 1961 read with the DTAAs.

It is small wonder that the trade is trying to interpret this circular as closely as possible. The examples give two diametrically opposite views. While, on the one hand, the CBDT is saying that if you answer a phone-call on behalf of a US parent and charge the parent an arm's length price, you would not be separately taxed. On the other hand, it says that if a travel agent makes out a ticket and its parent abroad prints it and gives to a client abroad, they would be taxed.

The CBDT appears to be hoping that the travel agent in question prints out the ticket in India and sends it to the client abroad. Talking of debt service collection one hopes that the CBDT is not thinking that Indian IT-enabled debt service collection physically collect debts in Seattle. By giving these examples, the CBDT seems to have lost its case.

The confusion in the industry stems from the fact that the CBDT seems to want to tax core services rendered in India for clients abroad while they want to leave the non-core portion free of tax.

Since the word core has not been defined as can be expected in a circular of such a general nature, the industry is trying to interpret it as they want it. The fact is that the very nature and variety of services provided by the BPO industry in India is mind-boggling that it would be better to steer clear of attempting to define the impossible.

India has entered into DTAAs with almost all major countries of the world. Most of these agreements involve a soft rate of tax for income earned in other countries. Imposing a tax at this time on the industry in India could hamper new investments into the area.

Many of the players in the BPO market today have export obligations which give them a moratorium from payment of tax. However, a few units come under the Minimum Alternate Tax regime under which they pay a nominal tax.

The circular is quiet about the position of these two vis-à-vis the BPO tax. The very nature of the BPO industry is that foreign companies outsource to India functions that are not core to their activities but are a cash-burn. The industry is maturing to a level where even core activities too are being outsourced.

The CBDT would do well to make a micro-level study of the industry along with NASSCOM or other bodies and the issue a clear-cut circular. The current circular appears to be incomplete and seems to have been done in a great hurry.

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