Some foreign banks and call centres that had planned to outsource jobs to India are reviewing their decision and looking at alternatives.
Others who have already set up base in the country are reconsidering whether or not to shift more new jobs.
All this because the Central Board of Direct Tax has decided to cash in on the boom in business process outsourcing and call centre industry.
Outsourcing and India: Complete Coverage
"The extent to which global profits of a non-resident enterprise is to be attributed to the activities of the BPO unit in India in these various circumstances, has been under consideration in the board," stated CBDT's circular dated January 2.
Taxing foreign companies outsourcing services to India in the country is seen as subjecting foreign entities' balance sheet to taxation in the country.
CBDT sees this as part of the Double Taxation Avoidance Agreement (or under section 9 of the Income Tax Act, 1961). However, no other country is understood to be taxing BPO operations.
By setting the precedent, this could make India unattractive as a BPO destination, said PricewaterhouseCoopers (PWC) executive director Vivek Mehra.
"Enquiries are coming from overseas as to whether concerned foreign companies outsourcing jobs to India will attract litigation on the taxability front," said Mehra.
Meanwhile, the Income Tax Department has asked existing call centres and BPOs for detailed information on their outsourcing activities for the last four years, he added.
BPOs fear that the circular issued by CBDT on January 2 this year could be with retrospective effect.
The financial sector has attracted many jobs to India. The global insurance sector alone is creating over 10,000 jobs in the country, while foreign banks have added far many more and are in the process of increasing the number of jobs being shifted to India.
Offshore outsourcing and creation of jobs was on the rise despite discontent from the US and British governments. However, this growth could take a back-seat.
"Some of the call centres overseas had plans to sub-contract a part of their business to India. However, the recent tax implications have scared away some of the potential business," said a senior official heading a call centre in Navi Mumbai.
Giga Information Group, an IT researcher, stated that by 2015, a total of over 472,000 jobs will move from the US to overseas destinations, with India being among the most favoured regions.
Ernst & Young has set up its shared services company in Bangalore, which takes care of some of its US business.
"Arguably with better quality of manpower in India and cheaper labour costs, India has become an attractive destination. Globalisation is here and it is no longer a matter of where a job is done, provided it benefits stake holders," said Ernst & Young Far East Head (group financial services) John Lyngaas.
"If global insurance companies are to maintain their competitiveness, they have to outsource jobs to destinations that offer cheaper labour," said Aviva (India) CEO Stuart Purdy.
Aviva Plc recently announced that it will create 3,700 jobs in India by 2004 end to service the group's UK and Canadian businesses.