Outsourcing in India Requires Dealing in the Local Realities

American businesses are usually very price sensitive. Compared to firms elsewhere in the world, American companies tend to pay close attention to performance numbers. Valuing this kind of metric often comes as a surprise to offshore service providers, particularly in cultures where personal connections may be more important than consistently meeting performance goals.

Even without new tax regimes being implemented, India in general and Bangalore in particular are quickly pricing themselves out of the market for lower-level outsourcing services. The actions of India’s Central Board of Direct Taxes (CBDT) — to create taxes on foreign companies that outsource to India — are accelerating that process.

This acceleration could be aided by new sales tax and value-added-tax schemes that are also being developed by Indian authorities. At the time of this writing, scant information had been released by the federal government in Delhi on what would be covered by sales and VAT taxes, or on their potential impacts on offshoring work and software sales in India.

Local Consultants

Foreigners doing business in India are advised to have a consultant familiar with banking issues and commercial licenses. These consultants can supplement advice provided by an accounting firm. They also can provide expediting and assistance with permitting that might be outside the scope of what accountants are usually expected to do.

Western executives who take a direct role in negotiating with Indian government officials for permits and with private individuals for vendor services might find that their status as Westerners makes the entire process slow down and instantly become more expensive. Commercial consultants can save Western firms substantial amounts of time and money in this regard. In some matters, they can enable discussions over key issues, such as price, to proceed while the identity of the purchaser is cloaked.

Commercial consultants can have backgrounds representing foreign firms seeking to set up operations in India, or they could be retired bank officials.

The Reserve Bank of India (RBI) has to approve transfers of hard currencies out of India. Commercial consultants can take the lead in dealing with the RBI and might consequently be referred to as RBI consultants, even though the scope of their services extends beyond RBI issues.

There is a nominal 20 percent withholding required to be deposited with the RBI for foreign earnings in India that will be transferred outside of the country. RBI consultants can be used to help resolve questions about these withholdings and other tax matters. Given the case-by-case process of determining tax liabilities, a well-selected RBI consultant might be able to reduce that liability.

Macroeconomic Conditions

Tax and tariff issues abroad can be confusing in any country. They can be unusually confusing in countries that do not have unified internal markets, unified civil codes, ready access to court systems for the real-time resolution of commercial disputes, and where governments and government-owned corporations have a dominant role in their nation’s economy.

India’s tax strategies have greater significance for firms that have chosen a go-it-alone approach and have built their own facilities in India. Firms operating under contractual arrangements face less risk, are in a better position to use their contractors as a buffer with the tax authorities and may be able to quickly shift work to countries with more favorable business climates.

The overriding issue driving India to tax Western clients of outsourcing facilities is India’s need for revenue. No large country in the world is engaged in more economic cross-subsidization than India. Prices and price signals are distorted throughout the economy, whereby India’s financial position could easily deteriorate even under conditions of continued growth.

Economic Reform Needed

The World Bank has traditionally loaned more money to India than any other country in the world. The Bank’s efforts, largely underwritten by the United States and a small number of other developed nations, have attempted to engage India in modest macroeconomic reforms, including paring down the dominant role of government-owned firms in key sectors of the economy. These attempts at reform by India’s creditors, trading partners and multilateral agencies acting on their behalf have been marked by failure.

Massive loans from the World Bank have not been accompanied by the political leverage required to institute much-needed economic reforms. Instead, the role of the World Bank and many foreign aid agencies has been to effectively prop up a structurally flawed semisocialist economic system, thereby enabling that system to draw scarce resources away from genuinely productive areas of that economy.

The United States has taken a lead role in enabling India’s structural inequalities and economic backwardness to continue. The consequences of both countries’ policies might gain some attention in the West now that India is moving to tax the global incomes of U.S. firms sending business to that country.

As India becomes more integrated with the world economy, it is becoming critical for other participants in the world economy that India institute fundamental economic reforms, reforms that will reduce pressures on India to find and collect new tax revenues from outside its borders.

International Dialogue

Modernizing the justice system in India, improving the efficiency of public agencies and dramatically reducing government corruption, particularly at the state and local level, are also gaining increased importance for the global economy and consumers everywhere.

The costs of delaying India’s economic and structural reforms are escalating as each day passes. Now that American outsourcing clients and software developers are being asked to directly share in those costs, Americans have a greater role to play in helping India emerge from its socialist malaise.

India’s macroeconomic and structural problems can only be addressed through a broad political and international dialog. Once American outsourcing clients and software developers begin receiving their long-overdue tax notices, that dialog might begin in earnest.

This story was originally published on August 17, 2004, and is brought to you today as part of our Best of ECT News series.

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