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Indian
BPO Firms Come
Under IRS Glare
in US
Compliance is
the
Crucial Mantra
By Lloyd Pinto
Over the years,
the United States
has been one of
the biggest markets
for the Indian
Outsourcing /Offshore
Development Provider.
Despite local
protests and growing
competition from
other Asian and
European countries,
the India Business
Process Outsourcing
(BPO) providers'
tryst with American
companies is growing
at a fast clip
and is spread
across the length
and breadth of
the 50 states
in the US.
However, as the
US Internal Revenue
Service (IRS)
is getting more
in sync with the
modus operandi
of such businesses,
it is looking
to play a more
active role in
seeking to tax
the income that
arises from activities
that are rendered
onshore in the
US. One may argue,
how is this relevant
for India BPO's
since their work
is entirely done
offshore. It is
very important
to note that the
tiny bits and
pieces of the
work that is being
done onshore,
could also potentially
open up a tax
exposure for the
Indian companies.
Let us look at
the typical modus
operandi of an
Indian BPO company.
Marketing executives
travel to the
US for making
a client pitch
and winning contracts.
Once the contract
is won, a small
team of operational
and technical
personnel travel
to the US to understand
and document the
process that is
sought to be offshored.
During this process,
the employees
of the Indian
company are typically
working onshore
at the client
location in the
US. Subsequently
the team back
in India is then
trained and gradually
the process is
started to be
made operational
from India.
While everything
done in India
is not subject
to the tax in
the US, it is
important to analyse
whether any of
the bits of work
done in the US
would give rise
to a taxable presence.
This article will
primarily deal
with the US taxation
and compliance
aspects in respect
of such Offshoring
Businesses.
Taxation Aspects
US domestic law
As per Section
861 of the US
Internal Revenue
Code of 1986,
income from the
rendering of services
will be considered
to be US source
income if the
services are performed
in the US.
Hence it is clear
that if any services
are rendered onsite
in the US, income
attributable to
such services
would be taxable
in the US.
DTAA between India
& US
The treaty provides
a slightly broader
perspective for
the taxation of
services. Income
will be taxable
in the US, only
if the Indian
company has a
permanent establishment
in the US.
Reproduced below
is an extract
of Article 5 of
the Indo-US DTAA
which deals with
the definition
of Permanent Establishment.
(l) the furnishing
of services, other
than included
services as defined
in article 12
(royalties and
fees for included
services), within
a Contracting
State by an enterprise
through employees
or other personnel,
but only if:
• activities
of that nature
continue within
that State for
a period or periods
aggregating to
more than 90 days
within any 12-month
period; or
• the services
are performed
within that State
for a related
enterprise (within
the meaning of
paragraph 1 of
article 9(associated
enterprises).
Thus it needs
to be analysed
whether the employees
of the Indian
company are rendering
services in the
US for a period
exceeding 90 days.
This period of
90 days refers
to solar-days
and not man-days.
For example: A
10-member pilot
team working together
for 10 days onsite
in the US will
tantamount to
10 days and not
100 days.
However, the above
needs to be read
in light with
the exceptions,
which are provided
in Article 5(3)
of the India US
DTAA.
The article provides
and important
exception for
activities that
are “preparatory
and auxiliary”
in nature.
Thus even if the
activities rendered
in the US may
satisfy the requirements
of Article 5(2),
they will not
constitute a PE
if they are regarded
as preparatory
and auxiliary
in nature.
Diagram 1: Taxation
of service income
US Compliance
Aspects
Almost all Indian
BPO companies
dealing with the
US may be aware
of the Form W-8BEN.
This is a form
which is used
as a declaration
to avoid the levy
of US withholding
taxes on income
paid to the Indian
companies.
Now this is an
area of rising
concern today
in the US. The
US IRS has become
more vigilant
and its increasing
level of scrutiny
is adding to the
anxiety of the
US taxpayers to
be ultra conservative
and on the right
side of the law.
Until now, it
was common practice
for Indian companies
to simply sign
this form and
submit it to the
US Companies,
declaring that
none of their
income was taxable
in the US and
thus there was
no requirement
for the US customer
to withhold US
taxes. This declaration
was on the premise
that the entire
services have
been rendered
offshore and thus
under the US domestic
law, no portion
of the income
was sourced in
the US.
However, this
situation, though
existing before
is being seen
in a new light
now. US companies
are now insisting
that the activities
in the nature
of knowledge transfer
and initial process
documentation
are “services”
which are rendered
onsite, post winning
the contract and
thus a portion
of the services
are being rendered
in the US.
There could be
two potential
scenarios here
which are discussed
hereinafter. The
Indian company
may bill the US
company separately
for the onsite/knowledge
transfer phase
or it could be
one consolidated
bill for the entire
assignment on
the agreed terms.
Scenario 1 Separate
Invoice
In this scenario,
the Indian company
generally invoices
an agreed sum
for the onsite/transition/knowledge
transfer phase.
The fee agreed
could be considered
as having an income
element. The Indian
company would
not be able to
argue that the
services do not
give rise to US
source income,
since the entire
service which
is being billed
for would have
been rendered
in the US.
Further if the
onsite duration
exceeds 90 days,
it may constitute
a service PE.
Due to the separate
invoice raised,
one cannot even
argue about preparatory
or auxiliary services.
Thus this separate
fee for the transition
phase would most
likely attract
US withholding
tax.
Scenario 2 No
separate invoice
for onsite activity
In this scenario,
no separate invoice
is raised for
the onsite activity,
but it is built
into the overall
fee for the entire
assignment.
The argument of
the US customer
here is that a
portion of the
Indian company's
income would be
considered as
US source. This
would require
the US company
to withhold US
tax on a portion
of the income
of the Indian
company which
could be considered
as attributable
to such onsite
activities.
There are counter
arguments, that
if the transition
phase is not successful,
then the Indian
company could
lose the entire
contract and hence
the onsite portion
should not be
attributed any
income element.
However this may
be a very aggressive
position and the
tenability of
this argument
will depend on
the facts of each
case.
Option Available
to avoid with
holding
To avoid such
withholding the
only option available
with the Indian
company is to
analyse whether
its US onsite
activities constitute
a permanent establishment.
If there is no
permanent establishment,
the W -8BEN declaration
will need to be
modified in a
way to declare
that the income
is not taxable
in the US because
the Indian company
does not have
a permanent establishment
in the US as per
the India- US
DTAA.
To make such a
declaration, the
Indian company
needs to analyse
the following
potential PE implications.
Fixed Place PE
The fixed place
PE refers to a
fixed place of
business available
to the Indian
company through
which it carries
out it's own business.
In the present
case, the employee's
are working on
the client's site,
however it is
being used only
for the purpose
of servicing that
particular client
and not running
the entire business
of the Indian
company. Thus
it could be argued
that the Indian
company may not
have a fixed place
of business.
Service PE
This is a kind
of PE which may
be easily attracted
given the nature
of the business.
If services are
furnished through
employees for
a period aggregating
to 90 days within
a twelve month
period, then the
Indian company
could be said
to constitute
a Service PE.
Exceptions to
the PE
However, before
making an affirmative
declaration that
the Indian company
has a PE, one
needs to analyse
whether it falls
within any of
the exceptions
to the PE clause.
One of the important
exceptions refers
to “preparatory
and auxiliary”
activities. Based
on the facts of
the case, if it
can be argued
that the activities
of the Indian
BPO company are
preparatory and
auxiliary in nature,
then such onsite
activities would
not constitute
a Permanent Establishment.
Obtaining a Tax
registration
However it's not
so straightforward.
To make such a
declaration, the
Indian company
needs to obtain
an Employer Identification
Number (EIN) equivalent
to the Indian
Permanent Account
Number (PAN).
Concern areas
At the outset,
the form W 8BEN
is an internal
document of the
US customer and
is not provided
to the IRS. If
the US customer
is audited by
the IRS it may
be required to
provide such details
to the IRS.
Although just
by obtaining a
US EIN, it does
not necessitate
a filing of US
tax returns, Indian
companies are
wary of taking
such a step, as
it will at least
leave a footprint
or a trace which
may be dug up
later, if the
US customer were
to be audited
by the IRS.
Thus even though
the Indian company
may avoid US withholding,
the US compliance
requirements are
such that at least
a documentary
trail will be
created which
could potentially
be followed up
by the IRS.
Summary
To summarise the
discussion, Indian
companies must
be prepared to
face increasing
demands from US
customers and
adhere to the
increased level
of compliance.
It must have a
thorough review
of its onsite
operations and
its duration to
try and avoid
creating a permanent
establishment.
Further it must
have the appropriate
documentation
in place to prove
its claim to the
tax authorities
if the need arises.
(The
author is Manager-
International
Taxation, Tax
& Regulatory
Services Grant
Thornton)
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