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Provisions regarding taxation of Business process outsourcing are not contained in Income Tax Act 1961 but a circular was issued no. 5/2004 dated 28.09.2004 issued by CBDT. Before understanding Taxation aspect of Business process outsourcing we have to get understand the term “Permanent Establishment”.

Concept of permanent establishment is used in DTAA. In order to determine taxability of a Foreign enterprise we have to determine whether it is having a permanent establishment in India or not. Article 5(1) of DTAA prescribed that “Permanent Establishment “means a fixed place of business through which the business of an enterprise is wholly or partly carried on. Article 5(2) gives certain instances of PE like a factory, a workshop, a retail outlet, a branch or a place of management, etc.

Taxability of Business Process Outsourcing can be understood in two ways:-

  1. Let us suppose there is a Non-resident entity which outsources its services to a resident entity and such resident entity is not a permanent establishment of Non-resident entity then such resident entity would be assessed under income tax act as a separate entity and importantly such non-resident entity would not be assessed under the act.
  2. Now it could be possible that such resident entity would be a permanent establishment of non-resident entity then in such case such non-resident entity would be assessable under tax but to the extent of profit attributable to resident entity.

Attributable profit will be calculated on the basis of “Arm’s length Principle”.

What is “Arm’s Length Principle”?

While calculating profit of resident entity we shall deduct every expense (whether administrative or general) that are incurred by such entity plus all transactions with head office (Non-resident entity) would be valued in such a way that if made with an entirely separate enterprise under conditions and at prices prevailing in the ordinary market. This is called “Arm’s length principle”



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