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Taxing of outsourcing units still awaits clarity

Tax experts and management consultants are still unclear about the recent Supreme Court ruling on taxing the captive BPO unit of Morgan Stanley, reports Venkatesh Ganesh.
Hindustan Times | By Venkatesh Ganesh, Mumbai
UPDATED ON JUL 16, 2007 01:15 AM IST

Tax experts and management consultants are still unclear about the recent Supreme Court ruling on taxing the captive BPO unit of investment bank Morgan Stanley that says that being a part of the company, it would be exempt from taxation.

Third-party BPO units that perform work for other clients are currently taxed like normal business houses. But the Supreme Court earlier this month overturned the Income Tax department’s appeal that a part of Morgan Stanley’s ‘global profits’ should be taxed in India, since the BPO unit does work for the company out of the country.

The court said the BPO unit of an overseas firm cannot be termed as a “permanent establishment” that undertook work for Morgan Stanley and hence the income could not be taxed.

The BPO sector which accounts for exports of around $10 billion has created lakhs of jobs built around outsourced services has been grappling with the tax ambiguity since January 2004.

“What constitutes an arm’s length and ‘transfer pricing’ is still a grey area,” said Dinesh Kanabar, executive director and tax leader, PricewaterhouseCoopers. Ttransfer pricing refers to the pricing of goods and services within a multi-divisional organisation to account for work done. In market terminology, “arm’s length” refers to the separation of departments in multi-divisional organisations in such a manner that they function like independent units. In such a context, it becomes tricky whether to treat a department like a separate company with cost and revenue implications are not.

Sreeram Iyer, CEO, Scope International, the BPO arm of Standard Chartered said the issue was a complex one. “The six methods of pricing that falls under ‘arm's length’ are very complex and there needs to be a simpler way to compute taxes,” he said.

While industry observers say that this ruling won’t significantly alter the amount of investments coming into the country in the form of additional captives, there is still a cause for concern with regards to the taxation laws in the country.

“India needs to get into the ‘Advance Pricing Mechanism’, which is prevalent in other countries like Mexico, Korea, Taiwan that offer offshore services,” says Kanabar.

“This would allow the taxpayers to disclose all relevant facts to tax authorities and obtain a binding ruling on the overall taxation,” said Kiran Karnik, president of the National Association of Software and Service Companies. “Almost every country has such a mechanism in place,” says a senior official at a leading Mumbai-based law firm.

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