India’s outsourcers face higher taxation

Export revenue of a large number of Indian outsourcing companies was brought under the tax net in the country’s federal budget. The tax could be the first of measures by the government to reduce tax benefits for the country’s outsourcing industry.

Prices that outsourcers charge their customers are unlikely to go up as a result, but profit margins will be affected, said N. Ramachandran, chief financial officer of outsourcer iGATE Global Solutions.

In his budget speech before India’s Parliament Wednesday, Indian Finance Minister P. Chidambaram announced the decision to extend a minimum alternate tax (MAT) to income that is currently covered under tax exemptions.

There are other tax issues looming for the Indian outsourcing industry, consisting of software services, business process outsourcing (BPO), and call center companies. A large number of the operations of these companies were set up under an export-promotion scheme called the Software Technology Parks of India (STPI), which entitled them to tax breaks under the Indian Income Tax Act.

However, the STPI scheme ends next year. Although the industry and the National Association of Software and Service Companies (Nasscom) have asked for an extension of the scheme for another 10 years, the finance minister made no reference to this request in his budget speech.

The imposition of MAT is disappointing, as is also the absence of any announcement on the continuation of tax benefits beyond next year, said Ananda Mukerji, managing director and CEO of Firstsource Solutions, a BPO company in Mumbai. If the STPI scheme is not renewed, outsourcing companies will have to locate themselves in special economic zones (SEZs) for tax benefits. Under the STPI scheme they could locate their facilities where it was most viable for them from the point of view of cost and availability of staff, Ramachandran said.

A small group of executives in India’s outsourcing industry, including N. R. Narayana Murthy, chairman of Infosys Technologies, believes that the outsourcing industry is now large enough to pay taxes at levels similar to other industries in India.

The finance minister has also brought employee stock options (ESOPs) under a fringe benefit tax. This move will make current ESOPs expensive, and will make it difficult for the IT industry that uses ESOP as a major tool to attract talent, said Deepak Ghaisas, CEO of the India operations and chief financial officer of i-flex solutions ltd., a financial software company that is majority owned by Oracle.

The focus of the budget this year was on the agriculture sector, where growth is faltering. India’s gross domestic product is forecast to grow by 9.2 percent in the year to March 31, with 11.3 percent growth in the manufacturing sector, and 11.2 percent growth in the services sector. Growth in the country’s agriculture sector is likely to be only about 2.3 percent. There are about 115 million families engaged in agriculture in the country.