The Hindu Business Line : Different strokes on BPO taxation

THE LATEST GOVERNMENT circular on taxation of business process outsourcing seeks to reassure foreign entities having such captive operations in India that their global profits are not under the taxman's gaze. It has done this by reiterating that the `arm's length' prices for transactions between the local outfit and the foreign enterprise outsourcing its business processes would be the basis for determining the incidence of income tax. The reassurance has to be seen in the context of the circular issued early this year which had created an impression that the Government viewed the outsourced operations as being at the heart of the business activity of a non-resident entity and, as a corollary, would like a fair share of its global profits to be offered for taxation under Indian laws. It spoke of `incidental' and `core' activities of a non-resident entity's business outsourced and if that was not suggestive of a paradigm shift to the conventional thinking on this front, actually went on to assert that the latter ought to be subject to taxation under the Indian laws.

While, in theory, the old circular would have been perfectly in accord with the fundamental principles of income tax, it is out of tune with the larger commercial realities. Thus, for instance, the activities of a Microsoft development centre in India might well be the key to a chunk of profits from new products of the software major. But to seek to tax all such revenues takes one into the realm of subjective judgement and is, therefore, bound to meet with resistance. That the Indian administrative machinery for tax collection does not enjoy the best reputation for probity and fair conduct worsens the case. Recent episodes of illegal gratification to minister's aides for staff transfers to lucrative circles and raids on residences of tax officials unearthing assets disproportionate to their known sources of income are cases in point. In any case, the above approach to tax assessment can also be faulted on the ground that it ignores the value of, to take the above example, Microsoft's brand equity and the fact that market dominance in proprietary software services can be successfully leveraged to generate profits from new venture. Far more realistic, then, would be to price the services at the market value of the software programmers engaged by Microsoft for assessing the income of the local outfit for tax purposes. The latest circular seeks to do just that.

The tax laws of a country often involve a compromise with the pure notions of income taxation. Accordingly, a different yardstick is applied when it comes to income-generating resources/activities that have total mobility across national borders as they shop for the most favourable tax environment as a host nation seeks desperately to shore up employment opportunities for its citizens. Thus, foreign investment institutions may enjoy a tax regime that is not available to resident Indians. Or, shipping companies may enjoy tax rates that their counterparts in other industries do not. So it is with BPO. As the economy evolves, the country may be able to dictate terms. But in the short run at least, India has to go along with a tax regime that is dictated by investment dollars flowing in rather than seek to enforce unalloyed principles of taxation.

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