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BPO Taxation in India

BPO Taxation in India.
A segment of E-Commerce Taxation.
27th February, 2004

Rashmin Chandulal Sanghvi
Naresh Atmaram Ajwani
Chartered Accountants.


"The copyrights to this article vests with IBFD and this article, with some modifications, has been published in the April, 2004 issue of Asia-Pacific Tax Bulletin".



Contents


Sr. No. Particulars
I. An Emerging Process of Taxation.
II. Arrangement of the Paper.
III. The Paper.
1. Outsourcing & Business Process Outsourcing.
2. Core Vs. Incidental. Illustration 1 – British Airways.
3. Focus of the Controversy in India. Illustration 2. Glaxo.
4. Certain terms used in Business.
5. Permanent Establishment. Illustration 3. Microsoft.
6. Business Connection. Illustration 4.
7. Does the Circular tax what is otherwise not taxable !
8. Discussion on Illustrations given in the circular.
9. Some other principles of international taxation.
IV. Should Non-Residents be granted further exemption!.
V. Conclusions
  Annexure


BPO Taxation in India.

I. An Emerging Process of Taxation :

Business Process Outsourcing (BPO) is an important part of E-Commerce business activities. Business Outsourcing of physical products has been going on for a long time. It has not created any controversies. However, “Long Distance Commerce” through the modern communication systems which use any part of converging technologies of computers, internet, telecom and television; and any other systems which may be helpful; has created a new opportunity and style of doing business. It has challenged the existing understanding of international taxation.

The tax-legal-world is still trying to evolve correct principles of taxing E-Commerce. As yet, no accepted standards have evolved.

The E-Commerce business does not wait for someone to develop the standards. It goes on increasing rapidly. It makes profits.

Tax departments have to pass their assessment orders. In the absence of any new principles, they are trying to do the best with their imagination and available tax principles.

India is one of the place where this activity is emerging strongly.

Recently - CBDT (Central Board of Direct Taxes) have issued a new circular to grant certain reliefs : Circular No. 1 of 2004. It tries to simplify BPO taxation. It has become a subject of intense & heated discussions.

The BPO industry and profession is almost demanding that the - “BPO industry in India is already exempted from Income-tax under several sections. Now, even the non-residents, foreigners, who do business in India through E-Commerce should be exempted from Income-tax”.

We are making our humble submissions in the process of evolving tax law on this subject.

II. Arrangement of the Paper.

The paper on the subject of income-tax on BPO activity is arranged as under.

II.1 Summary of the circular :

1.1 The circular does not even touch taxation of Indian residents. It provides that, where, due to its business activities within India, under the existing law, a non-resident becomes taxable in India; it shall be given certain relief from tax.

The non-resident’s Indian activities are divided into - “Incidental activities” and “Core activities”. Several illustrations are given for explaining the difference between the two.

Then the circular provides that the profits attributable to incidental Indian operations; which are, under the existing law taxable in India; shall be exempted from Indian tax. This is an administrative relief.

However, if the non-resident carries on “Core” activities in India in such a manner that it is taxable in India; then it will be taxable as per the existing law.

1.2 Link to the website for the full text of the circular is given in Annexure. Links to other related materials referred to in this paper are also given in Annexure.

II.2 Short Forms

Following short-forms are used in this paper :
BC - Business Connection.
BPO - Business Process Outsourcing.
DTA - Double Tax Avoidance Agreement.
E-Commerce - All the commercial activity that can go under the broad title of E-Commerce.
H.O. - Head Office - referring to the main/non-resident entity.
I.T. - Income-tax.
I.T.R. - Income-tax Reports.
(Indian Income-tax case law reporter journal.)
Ltd. - Limited.
Mn - Million/s.
MS - Microsoft.
PE - Permanent Establishment.
Pvt. - Private.
R & D - Research & Development.

II.3 Main issues discussed in the paper.

In this paper, we will see :

3.1 The difference between “Core Activity” & “Incidental activity”;

3.2 Permanent Establishment & Business Connection - PE & BC.

3.3 Consequences of doing business with India through a DTA country Vs. a non-DTA country. (DTA country = a country with which India has signed Double Tax Avoidance Agreement).

3.4 Some concepts & hypotheses are discussed in this paper. To elaborate/clarify the same, some illustrations are given. The illustrations are given with variations to cover both PE & BC; DTA & Non-DTA tax payers.

However, if the non-resident carries on “Core” activities in India in such a manner that it is taxable in India; then it will be taxable as per the existing law.

Clarification : In several illustrations, names of existing companies are used. However, all figures & facts are purely imaginery. The names are used to provide some reference to the activities considered under BPO. Except for this help in identifying the activity, the illustrations given have absolutely no relevance with the facts of those companies.

II.4 Other issues considered :

Apart from the above main/core issues, some other issues are also discussed. We have seen & heard the discussions going on in the media & professional conferences. Some other issues raised in such circles have been considered. The following issues have been numbered in this paragraph. Same numbers are given subsequently where they are discussed.

The issues raised in India are as under :

4.1 What is the difference between a “core” activity & an “incidental” activity? The circular provides no guidelines for determining the difference. (See paragraph III.2.)

4.2 How to attribute profits to the Indian entity! The circular provides no guidelines for the purpose. (See paragraph III.9.2.)

4.3 Government of India have given tax exemptions to BPO companies under Section 10A & Section 10B. By issuing the current circular No. 1, Government is actually withdrawing the benefit already granted. When a 100% tax exemption is given, how can a circular withdraw the exemption?
On this count, the circular is “anti development”. (See paragraphs, III.7, III.8, III.9.3 and IV.)

4.4 Sale of computers is an illustration given in the circular. When a person enters into a contract in India, profit accrues in India. How can the circular give such wide scale exemption? (Paragraphs III.6, III.8.2 & III.9.1.)

4.5 CBDT Circular 23 of 1969 provides that certain incomes of the Non-resident shall not be taxable. Relevant paragraph of the circular is 6(c).

The incomes considered are the incomes accruing or arising to a Non-resident; through a Business Connection in India under Section 9 of the Income-tax Act. The circular provides that - “where a non-resident’s sales to Indian customers are secured through the services of an agent in India, the assessment in India, of the income arising out of the transaction will be limited to the amount of profit which is attributable to the agent’s services …. . If the agent’s commission fully represent the value of the profit attributable to his service, it should prima facie extinguish the assessment”.

Now the argument is that same logic should be applied to BPO unit in India. If the BPO is paid its service charges at “arm’s length price”; it would cover the whole of the profit ‘attributable to’ the BPO operations. Hence no further profits should be attributed to the Non-resident. There should be no further tax on the Non-resident.

The argument further is, that to this extent, the Circular No. 1 of 2004 is contrary to the Circular No. 23 of 1969.

Please see paragraph III.9.4.1 of this paper for our response to this argument.

4.6 Some people have commented that it would have been better if the circular had avoided the words “incidental” & “core”; and used the words “preparatory or auxiliary” - which are used in the DTA. Indo-U.S. DTA - article 5(3)(e).

Please see paragraph III.9.5.

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