In recent months the growing phenomenon of off-shore outsourcing – particularly to India – has featured in many news headlines. One of the key factors underlying the decision to outsource off-shore is cost and India has rapidly captured a significant share of the US and European market for off-shore outsourcing, particularly for business process outsourcing ("BPO"), on the basis of low cost high quality services. However, a recent tax circular may be about to change things.
On 2 January 2004 the Indian Central Board of Direct Taxes ("CBDT") issued Circular No. 1/2004 which seeks to tax the earnings of foreign companies attributable to the outsourcing of "core" activities. Already there have been reports of multinational corporations revisiting plans to outsource call centres and other activities to India.
Under Indian tax rules, a non-resident or foreign company is taxable in India on the profits of its business activities where the company has a business connection in India or has a "permanent establishment" in India under article 5 of the United Kingdom/India double taxation treaty. The difficulty with the CBDT circular is that its language creates confusion by implying that outsourcing activities, the majority of which would not give rise to a "permanent establishment" under the India/UK tax treaty, might well be subject to additional tax as if a permanent establishment had been created. The Indian government has sought to allay fears and to reassure multi-nationals with investments in India, and those considering investing, by stating that the CBDT circular was no more than a clarification of the existing law.
In his Interim Budget on 3 February 2004 the Indian Finance Minister, Jaswant Singh, stated that the earnings of foreign companies derived from BPO activities in India would be exempt from taxation in India if the BPO activities were "ancillary and auxiliary" in nature. However, he stated that the Indian government’s view was that companies who outsource their core business activities to India will be liable to Indian tax on such activities on the basis that such activity creates a permanent establishment.
The difficulty with the "clarification" lies in determining what constitutes an "ancillary and auxiliary" rather than a "core" activity. Some guidance is offered by the CBDT circular. If a non-resident company is engaged in the manufacture and sale of goods or merchandise, or the provision of services, outside India and it outsources activities - such as the conclusion of contracts which enable the core activities to be carried on abroad - to an IT-enabled entity in India, the use of the Indian entity is likely to create a permanent establishment for the non-resident company in India. Profits then attributable to the conclusion of such contracts would form part of the income of the permanent establishment and would be taxable as such in India. It is important to note that the tax only arises where the permanent establishment has charged an arm’s length (a fair market price) to the non-resident company for the services that it has rendered. Consequently the non-resident company would not be subject to taxes in respect of its non-Indian activities.
Examples of the activities that should benefit from this clarification and which, according to the CBDT circular should not be subject to tax in India include:
Procurement and Sales Call Centres:
A foreign company manufacturing and selling items abroad, engaging or setting up a call centre in India to procure orders from or conclude contracts with customers abroad and also to answer sales related queries on the telephone.
Insurance Company Call Centres:
A foreign insurance company insuring risks in countries other than India appointing or setting up a call centre in India to attend to calls from customers outside India in relation to the acquisition of new insurance policies or revision of existing policies and providing relevant information and accepting insurance proposals from customers. Actual policy issuance, as well as premium collection, is done by the non-resident company outside India.
Foreign Credit Card Company Call Centres:
A foreign credit card company issuing credit cards to customers living outside India, appointing or setting up a call centre in India to deal with calls from overseas customers seeking to acquire a new credit card, providing relevant information and accepting requests for the issue of a credit card. Actual issue of the credit card, and collection of charges, is done by the non-resident company outside India.
While the position is now clearer where the activities that are outsourced are similar to those listed in the examples above, there is still a substantial grey area as to what services can be outsourced without establishing a taxable presence in India. Until the promised further clarification of what activities will be considered ancillary and auxiliary, there is likely to be uncertainty over the tax consequences outside these limited examples. The key question is whether, under Indian law, the presence in India constitutes a permanent establishment. The CBDT circular notes that it is of particular relevance whether it is the whole or merely part of the non-resident company’s core revenue generating business activities that are outsourced to an IT-enabled entity in India (such as the services of a travel agent, software developer, software maintenance business, investment consultant, debt collection service etc.). Where the IT-enabled entity in India renders the services either directly to the non-resident company’s customers abroad, or through the non-resident company, a considerable portion of the profits derived by the non-resident company from its customers abroad could, in the CBDT’s view, be taxable in India.
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