Finance Minister Jaswant Singh exempted the earnings of foreign companies from business process outsourcing if the services were ancillary and auxiliary in nature.
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But in case of earnings from outsourcing core business activities, companies will have to pay taxes.
"BPO has a scope for employment generation. It has been clarified that if outsourced services are ancillary and auxiliary in nature and adequate remuneration is paid to the Indian call centre, there shall be no tax on such foreign company as has outsourced its activity to India. This policy is on the lines of Organisation for Economic Co-operation and Development norms and double-taxation avoidance agreements," Singh said while presenting the Interim Budget.
By doing this, the finance minister reiterated the Central Board of Direct Tax notification to tax the earnings of outsourcing core activities by a multinational company earlier this month. Indian BPO companies wanted exemption from taxes irrespective of their activities.
Indian firms had termed the move the biggest threat to outsourcing BPO to India because companies would not move core work to India and only low-value low-end work would come.
"We are disappointed at the government's proposal to continue to tax the earnings from outsourcing core activities. We hope the government will take steps so that the prospect of the sector is not impacted," said Kiran Karnik, president of Nasscom. There should be an uniformity in policies, he added.
At the time of the notification, Nasscom had said the move had at least three large companies holding back their plans to set up BPO units in India. It was also feared that without tax sops, investments would go to other countries.
On the government decision to give tax breaks to certain activities of the BPO companies, Sunil K Munjal, managing director of Hero Corporate Services and vice-president of the Confederation of Indian Industry, said, "We are glad that the government has recognised this sector's potential. This is a great move."
India's BPO sector has been growing at the rate of over 60 per cent and is projected to touch $21-24 billion by 2008. The Indian BPO firms employ about 170,000 and is projected to provide jobs to over 1.1 million by 2008.
Problems for BPO companies begun when the government in a notification late last year asked them to pay taxes on the earnings from outsourcing of core business process. The income tax department had also asked companies to furnish details of clients.
The BPO companies opposed the move saying since the goods of products sold did not touch the Indian shores, the overseas company should not be subject to tax.
Besides, BPO services were considered a part of infotech services as defined in Section 10A/10B of the Income Tax Act, which allowed a 10-year tax holiday to companies in this sector, they added.
They feared that the move to tax multinational companies outsourcing to Indian companies would squeeze by 50-60 per cent the growth of many companies causing substantial job and foreign exchange losses.
Companies like GE, Dell, Amex and Hewlett Packard were affected by the notification because they had huge operations in this sector in India. These companies set up BPO operations in India to save cost in terms of lower manpower and infrastructure expenses.
For example GE's BPO operations in India employs over 10,000 people, who service the global operations of the company. A tax on the BPO operations will severely impact its earnings by moving BPO operations to India.