The Hindu Business Line : Opportunity for independent BPO units

According to a recent circular, if an independent entity undertakes BPO services for foreign companies and also renders services to others, it will not be treated as a permanent establishment in India of the foreign firm, thereby ensuring that the latter does not have to pay tax in India. This is a good opportunity for firms to set up BPO units in India providing high-value services at competitive prices to foreign companies, says H. P. Ranina.

A CIRCULAR, issued in September, pertaining to taxation of foreign enterprises that set up business process outsourcing (BPO) units in India has generated considerable interest, and adverse criticism in some quarters.

The circular deals with situations where a foreign company sets up IT-enabled entities in India, either through a branch or associated enterprise. If such branch or associated enterprise undertakes activities almost wholly for the foreign company, it is considered a permanent establishment of the foreign company.

The circular highlights that these branches undertake activities which range from procurement of orders for sale of goods or professional services, including answering sales-related queries, software maintenance/development, debt collection, credit card/mobile/telephone-related services, and so on. An important point the circular stresses is that the foreign company will be liable to tax in India only if the BPO unit constitutes a permanent establishment of the foreign company in India.

A non-resident entity or a foreign company is treated as having a permanent establishment in India under Article 5 of the Double Taxation Avoidance Agreement (DTAA) 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, etc., 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.

In such a case, the profits of the non-resident or foreign company attributable to the business activities carried out in India through the permanent establishment become taxable in India under Article 7 of the DTAA.

Thus, if the foreign company appoints an independent BPO, which undertakes activities for more than one foreign enterprise in the regular course of its business, the foreign company will not be liable to tax in India.

Consequently, there is great opportunity for BPO entities in India to act as independent agents for several foreign or multinational companies which would not be liable to pay tax in India because such independent entities would not be treated as permanent establishments of foreign companies.

An interesting decision on this point was given by the Authority for Advance Rulings where the issue of an independent agent has been considered. In this case, it was held that even if a business connection is deemed to arise in India under Section 9(1)(i) of the Income-Tax Act, 1961, the provisions of the DTAA would override those of Section 9(1)(i) of the Income-Tax Act.

Therefore, no tax would be payable by the foreign company in India which has no permanent establishment, in case such company is a resident of a state which has entered into a DTAA with India.

In Al Nisr Publishing, in re (239 I.T.R. 879), the applicant was a firm, resident in Dubai, in the United Arab Emirates, engaged in the business of publishing, printing and distributing newspapers. It published a daily English language newspaper called Gulf News. The applicant sold advertising space to clients in the UAE as well as other countries for publication in Gulf News and associated publications. In order to solicit orders for advertisement, the applicant entered into agency agreements with advertising representatives in several countries.

For India, an agreement was entered into by the applicant with BCL, under which BCL was appointed the exclusive agent for the solicitation of advertisements from recognised advertisement agencies and national advertisers in India for the applicant's publications.

Under the agreement, BCL agreed that it would not enter into any contract or accept any order on behalf of the company or act on behalf of the applicant or bind or attempt to bind it in any way. BCL had to inform prospective advertisers that all orders were subject to acceptance by the applicant on its standard terms and conditions.

The applicant alone had the power to accept orders for advertisements and reserved the right to refuse to accept any order. BCL was entitled to a commission at 30 per cent, which could be deducted by it from the charges collected by it before remittance to the applicant. The agreement left BCL free to act as advertising agent in India for other overseas newspapers, magazines and publications.

On these facts, the applicant sought an advance ruling on the question of whether any business profits or income accrued or arose in India in the hands of the applicant out of advertising revenue received/receivable from its agent(s) in India, and whether such advertising revenues remittable out of India by the agent(s) of the applicant were subject to deduction of tax at source under Section 195 or any other provision of the Income-Tax Act.

The Authority ruled that paragraphs 4 and 5 of the DTAA between India and the UAE are applicable only to a case where the person who acts as agent for the non-resident is not an agent of independent status within the meaning of paragraph 5.

BCL was an agent receiving advertisements and collecting advertisement revenues on behalf of the applicant in India. However, the agency was not exclusive. Its memorandum of association permitted it to carry on business as an advertising agent and, in exercise of this power and in the course of such business, BCL entered into contracts with several foreign newspapers to act as their representative in collecting advertisements in India.

The case thus clearly fell under the terms of paragraph 5 of Article 5 of the DTAA between India and the UAE. BCL, though an agent for the applicant, was an agent of independent status within the meaning of paragraph 5. This being so, the terms of paragraph 4 were not applicable because they apply only where the person carrying on business for the non-resident principal is one other than an agent of independent status referred to in paragraph 5.

Therefore, the advertising revenues received from India by the applicant were held by the AAR not to be taxable in the hands of the applicant in view of Article 7 read with Article 5 of the Indo-UAE DTAA.

The recent circular is in sync with the aforesaid ruling. Therefore, if an independent entity undertakes BPO services for foreign companies and also renders services for others, such independent entity operating in India would not be treated as a permanent establishment in India of the foreign company, thereby ensuring that the foreign company does not have to pay tax in India.

It may be mentioned that if the foreign company, for any reason whatsoever, undertakes BPO services through a branch or associated enterprise or through a dependent agent, the profits attributable to such permanent establishment in India would be taxed.

The profits so taxable would be equivalent to the profits made by separate and independent enterprises. Therefore, where a BPO unit is considered a permanent establishment of a foreign company, it would become necessary to determine the price of the services rendered by the permanent establishment to the head office on the basis of arm's-length price.

Such price would have to be determined in accordance with the provisions of Sections 92-A to 92-F read with the rules framed under these provisions. The arm's-length principle requires the price to be determined in uncontrolled conditions.

There are five generally accepted methods for determining the arm's-length price but the methods prescribed are so general and vague that no two individual can arrive at the same price. Hence, by setting up BPO units in India as a branch or associated enterprise or a dependent entity, a foreign company would be opening a Pandora's Box and could be subjected to immense litigation, apart from having to maintain elaborate records, documents and information.

On the other hand, by having independent BPO units that charge market-driven prices, the foreign company would be outside the purview of Indian taxation. This, clearly, is a great opportunity and advantage for professionally-managed entities to set up BPO units in India which would provide high-value services at competitive prices to foreign companies.

It is useful to note that under Sections 10-A/10-B of the Income-Tax Act, 1961, if a BPO entity is registered in a software technology park or operates as an export oriented unit, the tax holiday is extended up to the year ending on March 31, 2009.

Also available to units in Special Economic Zones that started operations after April 1, 2002 is deduction of 100 per cent of the profits for five years, and 50 per cent for the next two years. An additional tax holiday up to 50 per cent of the profits for the next three years is available where profits are transferred to a special reserve.

(The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in)

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