Confusion over BPO tax

The Central Board of Direct Taxes (CBDT) in its circular No. 1, dated January 2, 2004, stated that "during the last decade or so India has seen a steady growth of outsourcing of business processes by non-residents or foreign companies to IT-enabled entities in India".

The CBDT went on to clarify the circumstances under which the global profits of a non-resident enterprise could be attributed to the activities of the BPO unit and be subjected to tax in India.

As per the CBDT instructions where the entire or major portion of the revenue generating activities of the non-resident enterprise is performed by the BPO unit in India, and the said BPO unit 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 enterprise from its customers abroad would be attributable to the activities performed by BPO unit in India. Such attributed profits will be taxable under the Income Tax Act in accordance with the provisions of relevant tax treaty.

On the other hand, where the core revenue generating activities (like manufacturing and sale of goods or merchandise or provision of services outside India) are performed outside India, and the foreign enterprise outsources some incidental activities only, no income shall separately accrue or arise or be deemed to accrue or arise to the non-resident principal in India.

The circular also clarifies that in order that no part of non-resident's income be taxed in India, it is necessary that the charges paid to the BPO unit should be at arm's length/fair market price.

It is rather unfortunate that the CBDT clarification will only add to the prevailing confusion. Following questions need immediate attention of the CBDT.

• What is meant by transfer of whole or part of core-revenue generating activities?
• How will it be determined whether foreign enterprise has transferred its core-revenue generating activities, or has outsourced only ancillary or auxiliary activities?
• How will profits attributable to BPO units in India be calculated?
• How will it be determined whether the price paid to the BPO unit is at arm's length or fair market price or not?

Looking to the importance of BPO activities in India, which have become a major source of foreign exchange earnings and employment, it was expected that Finance Bill, 2004 would not only clarify the legal position but might also give tax exemption to foreign enterprises, which were outsourcing their activities to IT-enabled entities in India.

But not only that the Finance Bill is silent on the issue, Finance Minister Jaswant Singh also made a non-committal statement. "BPO has scope for employment generation. It has been clarified that if outsourced services are ancillary and auxiliary in nature and adequate remuneration is paid to the Indian call centre, then there shall be no tax on such foreign company as has outsourced its activity to India. This policy is on the lines of OECD norms and double-taxation avoidance agreements," Singh said.

Thus, until a further clarification is issued by the CBDT or the law is adequately amended, foreign enterprises will be advised to outsource their activities to Indian BPOs in such a manner that they do not establish any "permanent establishment" for the foreign enterprise in India.

Further, the foreign enterprises should also ensure that they adhere to transfer-pricing norms while dealing with BPOs in India.

agar@nda.vsnl.net.in