Pre-Budget recommendations for improving competitiveness of BPO export sector

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Interim Budget Special | 12 Feb, 2009
The Indian BPO industry has been growing and maturing and has established itself a major outsourcing hub. As of today, India’s share of the global offshore outsourcing market for software and back office services is more than 40 percent. The sector employees more than 7,00,000 people. However, comparing past growth trends with the significant future market opportunity, the Indian BPO sector can set itself a stretched target of US $ 50 billion in export revenues by 2012. Such a growth in the Indian BPO market will add nearly 2.5 percent directly to India’s GDP from exports earnings and provide direct employment to about 2 million people.

There are certain challenges arising out of the financial meltdown in the consumer markets of USA and Europe some of which is as under

Challenges Faced by the BPO Sector:

A. Emerging risks & exposure in the market place

Increasing Global Competition
Sub prime mortgage crisis and subsequent financial problems
Slackening Consumer demand and currency risks
China is investing heavily to catch up in the service sector

B. Existing risks & exposure in the domestic industry

Rising Cost and non-availability of labour
Infrastructure deficiency and gaps which need to be covered on an immediate basis
It is now widely recognized that SEZ’s are non-starters
The ‘Talent gap’ would have huge consequences for the services sector and has the potential to be a dampener to the India growth story by as early as 2012.

C. Challenges arising out of fiscal & monetary policies

STP Units are to lose income tax benefits
High Interest Rates,
Lack of foreign exchange liquidity and pressure on domestic liquidity

D. Challenges arising out of Non fiscal issues

Terrorism , Threats of war , Global warming (State & City Level Responses , Citizen ID Program , Civilian and homeland security must be taken seriously)
Risk to India’s GDP
The likely impact of the slowdown in the Business Process Industry could effect as follows -
Loss of jobs
Loss of INDIA’S BRAND EQUITY in the global market as a leader in BPO services
Loss of confidence level within Indian industry as BPO employees start hunting for jobs in other Industry verticals, as the BPO industry has always been associated with liberalization and reforms.

Suggestions:

The likelihood and impact of the risk to GDP is significant for the Government to look at adequate response. We suggest the following risk response, sooner than later so that the negative impact gets addressed and contained well in advance: -

Financial Package at all levels of BPO’s as Domestic / International & Rural BPOs so that jobs can be generated. Each level of BPO’s work at different segments and price points. Together they make India BPO a competitive brand.
It is the recommendation that a corpus be set up for lending to SMEs, given that they are relatively more vulnerable to external developments and more adversely impacted by the non-availability of credit. RBI could as an immediate step look to reduce the risk weight for lending to SMEs. Simultaneously, the Finance Ministry and RBI could set up a SPV to ensure that SMEs are allowed credit at viable rates depending on the creditworthiness of the unit and the project.
Domestic liquidity and interest rates - Further reduction in the repo rate by at least 150 bps to 6.0% and the CRR by 250 bps to regulatory floor of 3% to ensure adequate liquidity and reasonable costs of funding. RBI could also consider a further reduction in SLR by 2%. The reverse repo rate also could be cut by 50 bps in a further effort to provide banks to lend to corporates and customers at lower interest rates.
Incentives for skill development and secondary education in Tier 2 and Tier 3 cities –
Extension of Duty Drawback and ECGC Scheme
Removal of “Bank Guarantee/Large Deposits “for carrying out Domestic/ International Calling from the same premises/PBX.
Applicability of MAT - In the rationale for MAT, it is mentioned that rupee is appreciating whereas factually the rupee has depreciated and currently is at the lowest level. However, recommendation for removal of MAT should be on fundamentals since prima facie, an STPI unit with 100% export revenue is exempt from Income Tax, and applicability of MAT does not make sense. For companies with domestic revenue and who claim benefit under 10A and 10B and has a profit on the domestic revenue, this recommendation may not meet with success but in that case we should recommend on profits arising out of domestic revenue only and not on the profits from export revenue. Hence we should address issues based on their merits.
Abolition of FBT on ESOPs
Removal of Service Tax: It is recommended that Circular 56 issued by the Ministry of Finance in April 2003, which exempts STPI units from being charged service tax, is rolled back. The circular clearly states that “Service Tax is destination based consumption tax and it is not applicable on export of services. Here again, we need to differentiate between 100% export revenue vs. STPI units with domestic revenue. The question of what constitutes a secondary service used by the primary service provider needs emphasis. E.g. transportation is key input to any BPO organization and should be eligible for Sales Tax exemption. Similarly all professional services for STPI units with 100% exports should be eligible for this exemption since it is used by the primary service provider for export. The levy of service tax actually makes the business untenable in an already highly competitive global market coupled with the current economic recession.
Dividend Distribution Tax of 16.995% is very high and is in addition to the corporate tax of 33.99%. The same needs to be removed.
FBT needs to be revisited for business related expenses since such expenses do not result in Fringe Benefits to the employees. E.g. provision of hospitality, gifts to customers; sales promotion expenses etc.
To do away with the 10% surcharge on Corporate Tax. The current recessionary market and its expected impact on the Indian BPO sector clearly demands abolition of the 10% surcharge on the corporate tax. This would help the sector in getting marginal relief on tax outflow.
Extension of I.T. benefits:
The Income-tax holiday under section 10A of the Indian Income Tax Act, 1961 (“the Act”) should be extended beyond March 31, 2010. This would provide the much needed fillip to gain the competitive edge over other countries, particularly China. This is also necessary to sustain the low cost India competitive advantage to meet the recessionary trends in the US and other developed countries, which accounts for significant business to India BPOs/ KPOs.
Urgent action required regarding foreign remittances by banks have been stopped with Chartered Account (CA) certificate leading to disruption / delay of operations by exporting units.
Transfer pricing: No transfer pricing adjustment should be made by the Transfer Pricing Officer during the scrutiny process, to the taxable income of the ITES companies once it is established that they are eligible for tax exemption under section 10A of the Act. This is primarily because the transfer pricing adjustments are essentially to prevent tax avoidance which is contemplated in cases where the income is clearly exempt under the provisions of the Act.

The tax office should also re-evaluate an appropriate arm’s-length markup for Indian captive ITES companies, providing services only to their foreign affiliates (“associated enterprises”). The Indian affiliates are primarily low-risk captive service providers and do not assume entrepreneurial risks borne by independent ITES companies. Therefore, a comparable set comprising of full-risk entrepreneurial companies should not be used by the tax office (without applying an appropriate risk adjustment) to benchmark the financial results of Indian captive ITES players from an arm’s-length perspective; since this approach results in an inappropriate (high) benchmark and leads to transfer pricing adjustment to the results of the tax payer.