Hyderabad / Bangalore: US President Barack Obama has proposed changing the US tax system, including the elimination of a tax deduction that American firms get when they invest in subsidiaries outside the US, including in India. Obama touched a raw nerve in India when he said he didn’t want a tax code that allows American firms to pay less tax to “create a job in Bangalore, India, than if you create one in Buffalo, New York”. Mint looks at the implications of the proposed change.
What is the tax advantage derived by American firms with overseas operations?
US companies with operations elsewhere, such as in India, are allowed tax exemptions on expenses incurred by way of investment in those units. They are also allowed to defer the effective 35% tax on income they generate from overseas operations. Taxes need to be paid only when such income is brought back to the US in the form of investment or dividends.
Why does the Obama administration want the tax code changed?
The Obama administration argues that because the tax code offers incentive to invest and keep income abroad, American companies tend to reinvest it in foreign locations, such as India, and expand there, depriving the US of jobs and tax income.
What is the counter-argument in India’s case?
American firms that have built sizeable operations in India have done so because it has a highly skilled, large and inexpensive labour force, and a potentially lucrative market, and not because they have been making huge profits. Also, India’s corporate tax rate on foreign companies can be far higher than the 35% the US levies.
What does the US administration propose to do?
Obama wants to reform regulations related to tax deferral on foreign income so that companies have no incentive to support offshore investment. They would instead have to pay taxes in the US on their offshore profits. The US Treasury estimates that the move would generate $60.1 billion (Rs2.97 trillion) in tax revenue between 2011 and 2019.
What are the offshoring channels that would be affected?
US companies offshoring to captive centres abroad are proposed to be covered by the change to the tax code. Pharma and IT firms as well as banks with large operations in India could also be affected. There is still uncertainty over whether US companies offshoring to independent service providers such as Indian outsourcing firms and Indian firms operating in the US, and farming out part of their work to India would be affected.
How much money is at stake in India?
Nearly $18 billion a year in the IT sector alone. According to industry body Nasscom, nearly 30% of the $60 billion information technology-business process outsourcing sector is controlled by foreign service providers or captive units of foreign companies. This could be affected depending on how US firms crunch the numbers vis-à-vis savings from cheaper operating costs and the burden of increased tax.
New offshoring contracts from 2011 may be affected. If the tax changes get implemented in their proposed form, US companies may prefer to invest in their home country to be eligible for tax benefits.
Who are the top US-based firms with operations in India? How many do they employ?
IBM Corp. with an estimated 75,000 people, Hewlett-Packard Co.-Electronic Data Systems Corp. with 60,000, Accenture Ltd with 30,000 and Microsoft Corp. with about 10,000 people are among the firms with sizeable operations and staff in India that could face an increased tax burden starting 2011. General Electric Co. has about 14,000 employees in India and Citigroup Inc. nearly 10,000.
Pramod Bhasin, chief executive of Genpact Ltd and chairman of Nasscom
“There may be minimum impact on captives. This is a domestic tax issue; it will not have an impact on outsourcing. People don’t make strategic business decisions based on tax rates. Microsoft and IBM will not go back, they are here for the market.”
Nishith Desai, founder of Nishith Desai Associates, legal and tax consultancy firm
“This is kind of a wake-up call for India. The tendency towards protectionist measures has clearly surfaced in the president’s speech, which follows proposals to restrict the number of H-1B visas. It is not just going to affect the IT industry, to a large extent it will affect investments in pharma, contract research and manufacturing as well as media.”
(‘The New York Times’ contributed to this story.)