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A breather for captive BPOs
July, 21st 2007

The Supreme Court has held that BPO companies in India doing back-office work for parent companies will not constitute a PE under Article 5(1) of the treaty.

Much of the uncertainty about taxation of captive BPOs has ended.

Establishing business units in other countries, either as subsidiaries or branch offices, is becoming commonplace for multinationals (MNCs) which want to expand their activities in the globalised world economy, and more so for IT majors, investment bankers and communication service companies. Subsidiaries registered in India are domestic companies taxable at 30 per cent. Other business outfits of foreign companies operating in India are taxed as non-domestic comp anies at 40 per cent, by recourse to the PE concept. Subsidiary companies of MNCs or their branches do multifarious work in India for their parent company thanks to lower employee cost and availability of suitable talent at short notice both for expanding business here and carrying out back-office work of the parent.

The Income-Tax Department wants its share of the global income of the MNCs when an Indian subsidiary does some work; under the PE rules, the subsidiary itself is an assessable unit as a domestic company, having been registered in India.

Uncertainty resolved

The uncertainty surrounding taxation of MNCs setting up captive BPO outfits seems to have been resolved, at least to some extent, with the apex court stating recently that the I-T Department cannot attempt to tax a part of the global incomes of an MNC by attributing it to its Indian BPOs as PE. So long as the back office services rendered to the parent are compensated on arms length basis, and the transaction falls under the purview of the transfer pricing chapter of the I-T Act, the department cannot drag in the parent to taxation in India under PE rules.

The Supreme Court upheld the views of the AAR (Authority of Advanced Ruling) that BPO companies in India doing back-office work for parent companies will not constitute a PE under Article 5(1) of the treaty. On a functional and factual analyses of the activities done for the parent company, the back-office work will not amount to carrying on the business of the parent from a fixed place of business. This BPO service is legitimately compensated by the parent company to its Indian subsidiary on arms length basis

It also confirmed that as the BPO arm in India has no power to conclude any contract on behalf of the parent company, it does not give rise to agency PE under Article 5(4)

The contention of both the appellant and the Department was whether it would be a service PE under Article 5(2)(i) on different counts. The Supreme Court upheld the appellants view that stewardship activity will not lend support to applying Article 5(2)(i) and, therefore, the BPO centre will not be a PE.

This is so held for the reason that the parent company is interested in the confidentiality and the quality of work.

Monitoring the work by sending its employees as stewards, the parent company protects its interests and achieves the aforementioned purpose. When the Indian subsidiary company draws employees from the parent company on deputation for assisting in performance of its duties, the apex courts opinion seems to favour the Department in that there is service PE, as the work of the parent company is sought to be done on Indian soil. And to this extent, the the apex courts view leaves scope for further doubts.

Impact of the decision

Though much of the uncertainty about taxation of captive BPOs has ended, the deputation issues may pose some problem at the time of assessment of the Indian subsidiary as assessable unit in respect of income earned here. Attribution of a portion of its profits to the part performed by the deputationists and assessability in the hands of the parent company might lead to litigation.

Here again, the argument could be that so long as the cost of deputation is paid by the subsidiary on arms length basis, the transaction might be one of transfer pricing transaction and subject to compliance under that chapter. Even so, trying to carve out a portion of the pie towards income under the PE route may not have any legitimacy.

R. Bupathy
(The author is a practising chartered accountant)
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