Taxation of IT-Enabled Business Process Outsourcing Units in India

By  Circular No 1/2004 dated January 2, 2004,  India's Central Board of Direct Taxes ("CBDT") had indicated its approach to the taxation of Business Process Outsourcing ("BPO") Units in India. Broadly speaking, the approach was as follows :

In a case in which a BPO Unit constituting a Permanent Establishment ("PE") of a non-resident carried on in India only "incidental activities", e.g., conclusion of contracts or procurement of orders which enabled the core activities of the non-resident principal to be carried on outside India, the profit attributable to such incidental activities could be considered to have been embedded in the income of the PE (ordinarily and otherwise) taxable in India and no income attributable to such incidental activities was to be considered as having separately accrued or arisen in India to, or as being deemed to have accrued or arisen in India to, such non-resident principal.

On the other hand, if a BPO Unit carried on in India "core revenue generating business activities" of the non-resident principal (such as rendering the services of a travel agent or a software developer, or of software maintenance, or of investment consultancy or of debt collection), then -

1. a considerable portion of the profits derived by the non-resident principal would have been attributable to the activities carried on by the BPO  and


2. if the BPO Unit was a PE of the non-resident principal, such attributed profits would have been taxable in India in accordance with the provisions of the relevant tax treaty.

The CBDT has since reviewed its above Circular and has, by its  Circular No 5/2004 dated September 28, 2004 , titled "Taxation of IT enabled Business Process Outsourcing Units in India" [the "IT enabled" in the title being noteworthy], restated its position to be as follows :

If the BPO Unit neither has any "business connection" [Section 9(1)(i) of the (Indian) Income-tax Act, 1961] with its non-resident principal nor is such BPO Unit a PE of its non-resident principal, the non-resident principal would "not be liable under the Income Tax Act, 1961".

If the BPO Unit is a PE of its non-resident principal, the profits of such non-resident principal attributable to its PE shall be computed by determining the price of the services rendered by the PE to such non-resident principal or vice versa on the basis of he "arm's length principle". Further, the "arm's length price" (emphasis supplied) would -

1. have the meaning assigned to it in Section 92-F(ii) of the (Indian) Income-tax Act, 1961 and


2. be determined in accordance with th provisions of Sections 92 to 92-F of that enactment.

Consequent to the issue of   Circular No 5/2004 dated September 28, 2004, the CBDT has withdrawn  Circular No 1/2004 dated January 2, 2004  "with immediate effect" (emphasis supplied). Does this mean that for the period January 2, 2004 to September 27, 2004,  Circular No 1/2004 dated January 2, 2004 would continue to apply, inspite of the CBDT's manifest disavowal of its provisions ?

The links to the above Circulars are as follows :-


Circular No 1/2004 dated January 2, 2004

Circular No 5/2004 dated September 28, 2004