The issue of taxing Indian back offices of foreign companies refuses to go away with the government planning to ask the Supreme Court to revisit its July decision that ruled that US investment bank Morgan Stanley would not have to pay tax in India on global income earned on account of the firm’s captive back-office unit in the country.
The ruling will have a bearing on the around 110 captive back offices that exist in India that serve parent companies, including Standard Chartered Bank, Fidelity Investments and ABN Amro.
“We are filing a review petition (in the Supreme Court). We had presented quite a bit of evidence which is not there in the judgement,” said an official of the income-tax department, who did not wish to be identified.
The government says the decision overlooked some nuances of the issue and that it could set a wrong precedent. The work carried out by captive Indian back offices of foreign firms is increasing in terms of volume and sophistication.
Third-party back offices charge customers market rates for their services, and they are simply taxed on their profits.
A review petition goes to the same set of judges who gave the original decision, and it means that the litigant is trying to bring to their notice the fact that there is an “error on the face of record,” said a New Delhi-based lawyer, who did not wish to be named.
Once the review petition is filed by the litigant (the income-tax department in this case), the original judges decide if there is enough cause for the case to be heard all over again.
Captive back offices often show up as cost centres in a company’s books and the only way to tax them is to tax that portion of a company’s profits arising on account of them. If the income-tax department is able to prove that the captive unit has made a contribution, Indian revenue authorities can raise a tax claim on that part of the parent’s global profits that can be traced to its Indian operations.
This issue has a lot of grey areas and its significance will increase as more work gets outsourced to India, a senior official of the finance ministry told Mint soon after the July judgement.
For instance, an overseas software product development company could open a research and development centre in India and get some of the development work on a new product done here for a fee.
This situation could lead to a difference of opinion between Indian revenue authorities and the overseas product development company, the finance ministry official had said. The overseas company might feel the tax demand should be based on the payment its Indian arm has received, while Indian authorities might feel they have the right to raise a tax demand on the share of profits that can be directly traced to the product development work done by the Indian arm, he had added.
In its July ruling, the Supreme Court said that Morgan Stanley’s local back-office unit would have to pay tax only on profits generated locally. Some tax experts say the judgement may have glossed over the complexities that come with a business process outsourcing (BPO) operation.
In the July issue of BNA International, a monthly journal of tax planning developments, Rahul Krishna Mitra and Sanjay Tolia, partners at audit firm PricewaterhouseCoopers, India, wrote: “One would have been happier if the subtle and intricate issues relating to PE (permanent establishment) and profit attribution would have received better justice from the Supreme Court, although there is not much negative fallout, as such, from the ruling.” A foreign company’s profits are taxable in a country only if it is deemed a PE in that country.
A foreign-owned entity carrying out any business for at least six months in India is considered a PE; the definition excludes branches or liaison offices.
A partner with a large audit firm, who did not wish to named, said the income-tax department “has cause for concern.” The “simplistic” manner in which the July Supreme Court ruling uses the term BPO could result in work with sharply varying sophistication being clubbed under the term, he added.