India to trap outsourcers in tax net

A new tax being debated in the Indian parliament could raise costs to US firms outsourcing work to the subcontinent

Events unfolding in New Delhi could have far-reaching repercussions, as the Indian parliament deliberates changes to its tax code that could deeply affect businesses in the States.

Whereas some believe the pending legislation is "business-neutral," one specialist I spoke with said that the proposed changes could cost American businesses with Indian subsidiaries or Indian outsourcing initiatives a significant amount of money.

Don Jones, partner at BDO Seidman, an accounting and advisory firm, sees the potential changes as part of a larger trend, in which Indian tax authorities and its legislature have become more aggressive in the past few years when dealing with foreign entities that seek to do business in India.

As the Indian tax system matures, and as its international business increases, India wants to capture more revenue in their taxing net, says Jones.

This year, the Indian federal budget is pursuing that goal more aggressively than ever before.

Here, as Jones laid it out for me, are the specific changes that will make it more expensive for US companies to do business in India if the legislation is passed.

Transfer pricing

Most countries establish a profitability tax at a rate of anywhere from six per cent to eight per cent for services rendered to the parent company or to the company hired by a foreign company. In other words, if a US parent company requires R&D services from its Indian subsidiary, the government would take between six per cent and eight per cent of the fee for those services as tax for profit.

The legislation currently before the Indian parliament would increase that percentage to between 15 per cent and 25 per cent.

Add to this the fact that 7,000 miles away, our own IRS will not accept those rates when the US company tries to write it off.

Tax holidays

The tax holiday that India granted for units registered under its software technology parks provisions expire on March 31, 2009. There is nothing in the current legislation that will renew the tax holiday for tech companies, meaning they will have to pay the incorporated tax of 33.99 per cent beginning in the second quarter of 2009.

Capital gains

An increase in India's short-term capital gains tax from 10 per cent to 15 per cent has been proposed as part of the current legislation.

Jones says this is the government's attempt to decrease the volatility of the Indian stock market.

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Filing deadline shortened

The legislation will abbreviate the deadline for corporate tax filing from October 31 to September 30. As a result, more companies will be captured in the penalty net.

It's a bit like a speed trap, I suppose.

Increase in excise tax

This portion of the changes in the tax code will impact the software community directly. Packaged software will be subject to an increase in the excise tax from 8 per cent to 12 per cent.

While companies such as SAP and Oracle might be exempt from the increase because their software is technically not "packaged" software, companies such as Microsoft will be directly affected.

Broadening the definition of a service

The 12.3 per cent service tax will be levied on a wider array of services, including maintenance and consultancy services related to software. In other words, services provided for IT -- that is, software for use in the course of the furtherance of business and commerce -- is now considered a taxable service.

This will be another direct increase in the cost of doing business in India.

Also included in the services tax net will be Internet-oriented services and telecommunications services provided through the Internet. This includes services provided in relation to Internet backbone services, carrier services, Internet traffic, and access services.

Add to this a turnover rate now being pegged at 105 per cent, plus the weak dollar, and we can see that outsourcing in India is going to cost US firms a great deal more going forward.