Foreign firms get BPO tax breather

The controversy over the taxation of business process outsourcing units in India has been resolved partially. The Income-Tax department on Monday said tax would be attributed to a foreign company only if its dependent BPO outfit in India was a "permanent establishment".

However, the Income-Tax department's circular failed to provide any cheer to the industry, which had been demanding exemption from any such tax.

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The circular was in response to hectic lobbying by BPO companies, which had objected to an earlier circular of the department issued in January this year. The January note had introduced a distinction between the core and non-core businesses, for determining the activities to be taxed.

The department has now withdrawn the circular. Instead, it has said the tax on profits of foreign companies from the operation of their permanent establishment will be based only on fair pricing rules.

In determining the profits attributable to an information technology-enabled BPO unit constituting a permanent establishment, it will be necessary to determine the price of the services rendered on the basis of arm's length principle, it states.

It also says the definition of arm's length price or transfer pricing will be the same as stated in Section 92F(iii) of the Income Tax Act, 1961.

Transfer pricing specialist Shyamal Mukherjee of PricewaterhouseCoopers said the new circular had only reiterated the provisions of the Double Tax Avoidance Treaty between India and the US, without giving the industry a tax break.

He said tax officials would now have the right to tax companies that outsoure their back office operations to India.

The circular has stated two types of relations between a BPO and an overseas company. First, if a non resident entity outsources certain services to an Indian company but has no business connection with it, there will be no tax liability on the former.

Second, if there is a business connection between the two, the Indian entity will be considered a permanent establishment of the non-resident and will be taxed accordingly.

It says in the last decade there has been a steady growth of outsourcing of business processes by non-residents or foreign companies to IT-enabled services entities in India.

While these entities perform numerous functions, the non-resident entity will be taxable in India only if the IT-enabled BPO unit in the country happens to be a permanent establishment of the former.