Killing the goose

The finance minister, Jaswant Singh, may not have realised it but he has just increased the risk of stunting India's nascent business process outsourcing (BPO) industry's growth""first, because of a tax interpretation that has logical flaws, and second, because this view of tax law will come in the way of the larger national interest, defined as allowing a sunrise and employment-intensive industry to grow to its full potential as quickly as possible.

Mr Singh has announced all manner of tax incentives if the NDA comes back to power "" for the power sector, for shipping, for the capital markets, even a promise to examine the possibility of an increase in the standard deduction levels; so it is odd that he should appear so unconcerned about the dangers to which the BPO industry now stands exposed.

He has of course been aware of the impact created by his ministry's recent circular on taxing the BPO subsidiaries of foreign firms that do "core" (as opposed to ancillary or auxiliary) work out of India, yet he has chosen to do nothing about it.

Indeed, while reiterating his government's stated position on the issue during his Budget speech, he has justified the taxman's stand by stating that the "policy is on the lines of OECD norms and double taxation avoidance agreements".

He may be right in what he says, for all one knows, but that is not the point. For starters, anyone familiar with the taxman in India and his counterpart in OECD nations would recognise there's a world of difference between the two "" which is why Mr Singh himself is trying so hard to curb the discretionary power of tax officials.

It does not take much to see that drawing a distinction between what is "core" and what is "ancillary and auxiliary in nature" is going to lead to all manner of fishing expeditions, extortion and litigation.

Because, after all, there is no firm and immutable definition of core activity in a firm. There are shirt companies that outsource all their manufacturing activity, is that core or non-core?

If a soap company hires a consulting firm to do its marketing, is that core or non-core? If a book publishing firm outsources its editing and/or printing work, is that core or non-core? In the days of the virtual firm, this is Neanderthal thinking.

This apart, there is the question of logic and consistency: why should a company have to pay taxes if it outsources some of its "core" activities to an Indian subsidiary, if it pays no tax when the same job is outsourced to an unrelated Indian BPO firm?

While it's difficult to predict the precise impact of Singh's view of the tax law, and how much global BPO business will be lost to countries like the Philippines and China, an interesting study has just come out from the credit rating firm Icra.

Examining the impact of the anti-BPO movement in countries like the US, Icra points out that when unemployment levels have risen in the US, imports of services into the US have fallen.

While this relationship needs to be treated with caution, it does suggest what is obvious "" that, with rising unemployment in the US, the backlash is going to increase.

Why, under the circumstances, would we want to make it less attractive for US companies to relocate some business processes here? It's also useful to keep in mind that close to 60 per cent of India's BPO business comprises captive units of overseas firms.