A tax thorn in the rosy BPO story

The BPO industry in India has rapidly grown over the last two decades due to variety of reasons such as the associated cost effectiveness, more time for a foreign company to concentrate on its core business, improving customer satisfaction, benefit gained from the time zone advantages etc.

However, with the advent of the significant ruling by the Delhi Tax Tribunal in the case of eFunds Corporation, outsourcing work to an Indian subsidiary may require a deeper thought as it may result in serious tax implications in India.

In the aforesaid ruling, a company incorporated in and tax resident of USA (the assessee), not having any assets, presence, business or liaison office in India, provided services to customers outside India. It sub-contracted or assigned the execution of such contracts on principal to principal basis, to its Indian subsidiary.

The latter rendered services such as call centre services, financial shared services and data entries and software development services. Remuneration paid for the same was assessed to tax in the hands of the Indian subsidiary.

The Indian subsidiary had an international division and a sales team to oversee operations of eFunds group entities globally and undertook marketing efforts for affiliates of the assessee. It is not uncommon for any subsidiary of a foreign company that is set up as a BPO to have the above mentioned characteristics.

Based on the facts, the lower tax authorities held that the assessee had a permanent establishment in India under the India-US tax treaty and attributed further profits to the permanent establishment in India.

Having heard the contentions of the assessee and the tax department, the Tax Tribunal held that eFunds Corporation has a business connection and a permanent establishment in India and accordingly, the profits attributable to it would be taxable in India. Various factors considered by the Tribunal in arriving at this conclusion were:

The US parent and the Indian subsidiary, both were under legal obligation to provide services to clients

The Indian subsidiary did not have adequate resources to perform its functions independently

No or zero risk was undertaken by the Indian subsidiary and the ultimate responsibility was borne by the US parent

The Indian subsidiary had an international division and a sales team which undertook operations for the group globally and reported to the US parent.
l the Functional, Asset and Risk analysis is highly important and that if correct arms’ length price is determined, no further income would be liable to tax in India. It observed that the Indian affiliate had not been remunerated on an arms’ length price and thus further income need to be attributed.

The aforesaid ruling can have serious repercussions on the BPO industry, as the foreign parent may be challenged to prove as to why its Indian BPO should not be considered as its permanent establishment.

Further, all BPO companies will need to have a robust transfer pricing study in place, considering the functions performed by them and the risks assumed and take other measures to prove that the income received from the foreign parent is at arm’s length.

Given the recent trend of intensive investigation into cross-border tax transactions by the Indian tax authorities, it will be desirable to have a separate, well-defined policy or appropriate guidelines in this regard so as to bring in the much-needed certainty on the tax front for the foreign companies outsourcing work to India.

Monani is executive director, PwC and Sheth is manager - tax & regulatory services, A tax thorn in the rosy outsourcing story