Outsourcing and India: Complete Coverage

Taxation of BPO units will be guided by double taxation treaties to define what constitutes a permanent establishment. However, the notification stops short of the demand made by the information technology industry to exempt such profits from tax.

Today's notification is based on a draft circular issued by the finance ministry in August. The distinction between core and non-core activities was made in a circular on January 2, which was vehemently opposed by the information technology industry.

The industry's key objection was that the concept of "core service" was contrary to international practice, had virtually no global precedence, and it gave income-tax officers the authority to decide on merits what portion of the parent company's profit could be attributed to its Indian BPO operations and taxed.

Tuesday's notification says taxation of BPO units will be guided by double taxation treaties to define what constitutes a permanent establishment.

However, the notification stops short of the demand made by the information technology industry to exempt such profits from tax.

Specifying the definition of a permanent establishment, the notification says, "a non-resident or a foreign company is treated as having a permanent establishment in India under Article 5 of the Double Taxation Avoidance Agreements, entered into by India with different countries, if the said non-resident or foreign company carries on business in India through a branch, sales office or through an agent (other than an independent agent) who habitually exercises an authority to conclude contracts or regularly delivers goods or merchandise or habitually secures orders on behalf of the non-resident principal".

The notification says BPO entities operating in India, as permanent establishments of foreign companies, will be taxed to the extent that such profits are generated here.

The income-tax department will establish if BPO units are observing a fair pricing principle in their business dealings with their head offices.

It also says in determining such profits, expenses incurred for permanent establishments, including executive and general administrative expenses, will be allowed as deduction.

"Profits to be attributed to a permanent establishment are those that permanent establishment would have made if instead of dealing with its head office, it had been dealing with an entirely separate enterprise under conditions and at prices prevailing in the ordinary market," it said.