Taxation of BPO in India

During the last decade or so, India has seen a steady growth of outsourcing of business processes by non-residents or foreign companies to IT-enabled entities in India. Such entities are either branches or associated concerns of the foreign enterprise or an independent Indian enterprise. Their activities range from mere procurement of orders for sale of goods or provision of services and answering sales related queries, to the provision of services itself, like software maintenance service, debt collection service, software development service, credit card/mobile telephone related service, etc. But sometimes, the entire or major portion of the

revenue generating activities of the non-resident enterprise is performed by the BPO (Business Process Outsourcing) unit in India.

 

Taxation

 

From tax perspective, there is a question of whether the captive BPO units could be regarded as ‘dependent agents’ of their parent organizations and therefore ‘Permanent Establishment’ or PE of their parent organizations in India. Foreign companies are taxable in India in respect of income attributable to their Permanent Establishment in India.

 

As the business is run by non-resident or foreign company, the extent of profit to be considered for taxation in India is a problem. The manner and extent of such attribution of profits will evidently depend on the facts of each case and the nature of services rendered by the BPO unit, and the same has to be determined in accordance with the provisions of the treaty applicable and the domestic law.

 

A non-resident or a foreign company is treated as having a Permanent Establishment in India under Article 5 of the Double Taxation Avoidance Agreements entered into by India with different countries, if that company carries on business in India through a branch, sales office etc. or through an agent (other than an independent agent) who habitually exercises an authority to conclude contracts or regularly delivers goods or merchandise or habitually secures orders on behalf of the non- resident principal. In such a case, the profits of the non-resident or foreign company attributable to the business activities carried out in India by the Permanent Establishment become taxable in India under Article 7 of the Double Taxation Avoidance Agreement.

 

CBDT had come out with a circular on 2 January 2004, regarding which there were many controversies. It was withdrawn and in it’s place, a new and final circular was introduced on 28 September 2004.

 

New circular

 

In the Circular No.5/2004 dated 28-09-2004, CBDT has clarified the following:

 

1. A non-resident entity may outsource certain services to a resident Indian entity. If there is no business connection between the two, the non-resident entity will not be liable to tax under the Income Tax Act.

 

2. Where the non-resident entity has a business connection with the resident Indian entity, then the resident Indian entity should be treated as the Permanent Establishment of the non-resident entity and then the non-resident entity will be liable to tax in India. But the extent to which the profits of the non-resident enterprise is to be attributed to the activities of such Permanent Establishment in India has been under consideration of the Board.

 

3. Article 7 of DTAA provides that the profit attributable to the business activities carried out in India by the Permanent Establishment is chargeable to tax in India.

 

4. Article 7 of the DTAA provides that profits attributable to the Permanent Establishment in India will be determined as if the profit, it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar conditions and dealing, independently with the enterprises of which it is a Permanent Establishment.

 

5. Article 7 of the DTAA further provides that in determining the profits of the Permanent establishment, there shall be allowed as deductions, expenses which are incurred for the Permanent establishment including executive and general administrative expenses so incurred, whether the state in which the Permanent establishment is situated or elsewhere. But those expenses are determined in accordance with the accepted principles of accountancy and the provisions of the Income Tax Act, 1961.

 

6. It further provides that the profit attributable to the Permanent establishment are those which that Permanent establishment would have made, if instead of dealing with its Head office, it had been dealing with an entirely separate enterprises under conditions and at prices prevailing in the ordinary market. This corresponds to “arm’s length principle.” Hence, in determining the profits attributable to an IT enabled BPO unit constituting a Permanent Establishment, it will be necessary to determine the price of the services rendered by the Permanent Establishment to the Head office or by Head office to the Permanent Establishment on the basis of “arm’s length principle”.

 

7. The “arm’s length price” would have the same meaning as in the definition in Section 92F(ii) of the Income Tax Act. The arm’s length price would have to be determined in accordance with the provisions of Section 92 to 92F of the Act.