Obama tax move may hit DTAA

The decision by President Barack Obama to plug loopholes in the tax regime for US multinational companies is likely to impact their Indian operations as well. Indian subsidiaries of US firms may no longer be able to claim benefits under the Indo-US double-tax avoidance agreement (DTAA).

Current US laws allow businesses to claim credit against their US tax bill on taxes paid abroad on overseas profits. Obama is planning to close such foreign tax credits, and hopes to net $43 billion. "Article 25 of the Indo-US DTAA provides relief from double taxation, subject to US domestic laws. This may now be open for a reinterpretation," pointed out KPMG head of taxation Uday Ved.

Obama's Monday announcement comes close on the heels of moves by the current administration in Washington to further restrict H-1B visas, which will not only have a direct bearing on Indian IT companies, but also on US firms that depend on overseas talent to remain competitive.

The US president has proposed outlawing three offshore tax-saving strategies commonly used by US multinationals, and is expected to generate $210 billion over the next decade. Companies like General Electric, PandG and Citigroup were being seen as among those likely to be affected. All three have a significant presence in India.

The immediate impact, reckon experts, is that Indian subsidiaries of US firms such as Pfizer, Microsoft, IBM and Oracle could see their tax bills rise significantly once lawmakers pass the measures. Deloitte tax analysts estimate that the Obama changes could boost overall US corporate taxes on average by 8%.

The new tax proposals would be effected by removing relaxations that currently allow businesses to deduct expenses on their overseas operations while paying taxes in the US and by closing foreign tax credit loopholes.

By disallowing business expenses, US multinationals working out of India or any other low-cost outsourcing hub may no longer be able to deduct costs such as employee wages while filing tax returns in the US, thereby increasing their tax liability. Corporate income attracts a 35% tax in the US.

Reacting to the tax credit proposal, Nasscom in a statement, said: "Global companies that earn profits in India are subject to a tax rate of 33.9% (including surcharge and cess) and the impact of the proposed reforms on them would be marginal." However, until the exact details of the Obama tax proposals are available, the jury is still out on their precise impact.

Analysts said Indian subsidiaries of US firms that are export-oriented units are almost certain to be hit. At present, such companies only pay an 11% minimum alternate tax and a 15% dividend distribution tax in India and claim a tax credit on these in the US. But with the planned amendment, they could end up paying a 35% tax in the US on their entire income from operations in India.

What's more, with the proposed changes, analysts said the US may no longer be suitable for setting up holding companies for non-US entities. "Even traditionally, the US has not been a favoured jurisdiction for holding non-US entities. The direction of this policy only confirms this view. More companies will reorganise their non-US businesses away from a US holding company," said Ernst and Young partner Srinavas Rao.

The Indian outsourcing industry, though, is likely to remain insulated from Obama's move. Nevertheless, in a related development, the $40-billion domestic IT industry could see significant new restrictions if the H-1B and L-1 Visa Reform Act introduced by senators Dick Durbin and Chuck Grassley is passed as it would require employers to pay H-1B and L-1 workers the highest local prevailing wage for the job.

Nasscom president Som Mittal, in an interaction with the US-India Business Council on Monday, described the legislation as "draconian". "It will have an extremely adverse impact on Indian and US companies. While Nasscom does support measures to reduce fraud and abuse of the H-1B visa programme, the provisions of this Bill deliberately targets US and Indian companies," he added.

Though H-1B employees must be paid according to the US prevailing wage structure, there is no such provision for L-1 workers. But, says KPMG India director-IT advisory services Viral Thakkar: "Wages paid to H-1B visa-holders is market dependent and usually less than what a local employee would get." Industry insiders say employers typically pay H-1B employees between $45,000 to 60,000 a year.

The Act is set to increase the cost of IT companies who now bank on low wages paid to the Indians for onsite projects. At the moment, the wage bill works out to 15-20% of sales for onsite employees for larger companies. With the proposed legislation, operating margins that were already tumbling on account of pricing pressure could narrow further.

"This provision is basically to curb the misuse of bringing employees on H-1B and paying them less than the mandatory wage. But the larger issue is there is a lack of available skills in the US and these restrictions could become a concern," said Zensar Technologies global CEO Ganesh Natarajan.

Also, employers would be prohibited from displacing a US worker with an H-1B worker in the period beginning 180 days before and after the filing of an H-1B or L-1 petition, increased from 90 days under existing law. This is expected to have an impact on project implementation, and thereby collections.