The Hindu Business Line : Shadow-boxing in BPO taxation

THE LATEST DRAFT circular on taxation of business processes outsourced by a non-resident entity is disappointing. Even as a draft, the document, issued by the Central Board of Direct Taxes (CBDT), was expected to crystallise official thinking on the subject. But while seemingly breaking fresh ground on what will be taxed and what will not be, it merely harps back to a core principle of taxation reiterated in its January 2004 circular which, ironically enough, now stands withdrawn.

The draft circular talks about a non-resident entity outsourcing certain services to a resident Indian entity and explains that the latter will be treated as a `permanent establishment' if it has a business connection with the non-resident entity. In the absence of such a `business connection' it would be assessed to tax as a separate entity. So, it seems to suggest that, in the Government's thinking at least, there is no doubt that such an outsourced process inherently contains a profit element that ought to be taxed in India and that the only element of doubt is whether it would be treated as an appendage of the non-resident entity or viewed on a standalone basis. But the circular has also drawn a reference to the `Double Taxation Avoidance Agreements' entered into by India with other nations, even if it is by way of amplifying the meaning of `permanent establishment', referred by it initially. Now, these agreements help lay down the tax treatment of normal commercial activities such as the selling of goods and services by a non-resident entity in the destination country. But the latest controversy is over outsourced services of the non-resident entity that are meant for captive consumption. For instance, a customer-support centre located within India is an activity consumed internally, coming into operation as it does after the overseas principal had effected a sale. In that sense, the local outfit is not engaged in delivering some goods or services within the meaning assigned under the tax treaties between nations.

Taken as a whole, then, it is far from clear if the Government intends to exempt such activities from taxation, though they are a vital component of the profit-earning process of a business enterprise located abroad. In the circumstances, the endorsement by Nasscom — the industry body representing domestic players in IT and IT-enabled services — of the latest circular might be somewhat premature.

Taxation laws have always adopted differential yardsticks when it comes to resources/activities that have total mobility, as such operations shop for favourable tax environments even as their presence in a country holds beneficial consequences in terms of incremental economic activity. Thus there is a differential tax treatment for overseas capital or for domestic shipping vis-à-vis other commercial activities. If, as Nasscom apprehends, there is a danger of jobs from such outsourcing going elsewhere and it is a stated policy of the Government to put in place a beneficial tax regime to keep the jobs within the country's borders, then the proper course for the CBDT would be to spell this out unambiguously instead of indulging in legal shadow-boxing, as it seems to be doing at the moment.

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