Taxation of Business Process Outsourcing Units – BPO

Taxation of business process outsourcingBusiness Process Outsourcing is a process of hiring another company to handle business activities for you. A BPO is different from the aspects of an IT outsourcing as an IT outsourcing units focuses on hiring a third-party company or service provider to do IT-related activities, such as application development & management, data center operations etc.

In the recent years BPO has gained much importance as it includes employee benefits management too. Now it is common for organizations to outsource financial and administration (F&A) processes, human resources (HR) functions, call center and customer service activities and accounting and payroll. These outsourcing units generate millions of dollars as it involves multi-year contracts. Some of the common outsourcing service providers in the BPO fields include US companies IBM, Accenture, and Hewitt Associates, as well as European and Asian companies Capgemini, Genpact, TCS, Wipro & Infosys.

As every business entity has to involve in tax payment and other related tax aspects, these outsourcing units are also included in it. These units are also required to pay taxes, but they are not governed by the Income Tax Act, 1961 but the tax aspects are given in Circular No. 5/2004 dated 28/9/2004 issued by CBDT.

The tax provisions for BPO are as under –

  1. A non-resident entity may outsource certain services to a resident Indian entity. If there is no business connection between the two, the non-resident entity will not be liable to tax under the Income Tax Act.
  2. Where the non-resident entity has a business connection with the resident Indian entity, then the resident Indian entity should be treated as the Permanent Establishment of the non-resident entity and then the non-resident entity will be liable to tax in India. But the extent to which the profit of the non-resident enterprise is to be attributed to the activities of such Permanent Establishment in India has been under consideration of the Board.
  3.  The profit attributable to the business activities carried out in India by the Permanent Establishment is chargeable to tax in India.
  4. The profits attributable to the Permanent Establishment in India will be determined as if the profit, it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar conditions and dealing, independently with the enterprises of which it is a Permanent Establishment.
  5. It also states that in determining the profits of the Permanent establishment, there shall be allowed as deductions, expenses which are incurred for the Permanent establishment including executive and general administrative expenses so incurred, whether the state in which the Permanent establishment is situated or elsewhere. But those expenses are determined in accordance with the accepted principles of accountancy and the provisions of the Income Tax Act, 1961.
  6. It further provides that the profit attributable to the Permanent establishment are those which that Permanent establishment would have made, if instead of dealing with its Head office, it had been dealing with an entirely separate enterprises under conditions and at prices prevailing in the ordinary market. This corresponds to “arm’s length principle.”
  7. However, in determining the profits attributable to an IT enabled BPO unit constituting a Permanent Establishment, it will be necessary to determine the price of the services rendered by the Permanent Establishment to the Head office or by Head office to the Permanent Establishment on the basis of “arm’s length principle”.

The “arm’s length price” would have the same meaning as in the definition in Section 92F (ii) of the Income Tax Act. The arm’s length price would have to be determined in accordance with the provisions of Section 92 to 92F of the Act.

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