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President Barack Obamas statement on May 4 about his proposed changes in US
tax rules has once again brought his stance on the issue to limelight. The
question is: what is the issue? He said he intends to change the tax rule that
says you should pay lower taxes if you create a job in Bangalore, India than
you create one in Buffalo, New York.
Expectedly, the Indian IT industry as well as all the outsourcing community
in general (the buyers of such services as well as the huge community of
sourcing advisers, brokers, tax and legal advisers) have reacted to it, though
some are more direct in their criticism and some are being optimistic on the
interpretation of what he meant.
Let us, address the question at different levels.
First and foremost among the questions to ask is: what was Obama trying to
address? In that speech, it was clearly tax maximization and not job creation.
The rule in question was the tax referral rule. American tax rules allows
US-headquartered multinational companies to deduct expenses for overseas
operations, but defer paying income tax on the profits from those operations.
That gets paid if and when companies bring that money back to the US. The
companies sometimes use that as a loophole to reinvest in businesses in one
geography directly from the profits of another geography and do not get that
money back to the US, thus saving taxes on those profit. President Obama wants
to change that. Even before we get into the actual debate of whether it is
enforceable, whether it will make US companies less competitive, and whether it
is some form of trade barriersthe real issueswe must make one thing clear.
An American company can make profit overseas by doing any business, not just
by offshoring. So, the first thing to clarify is that this is not about
offshoring. So, why has it been so widely interpreted that way? It is obviously
because of the Bangalore reference.
But why did he refer to Bangalore? Because it sounds nicer to a large section
of people. Job creation is a populist issue, tax collection or any fiscal
measures are not. And Mr Obama, at the end of the day, is a politician, in a
democracy.
The second question to ask is: will it impact those companies that do
offshoring? To an extent, yes. Based on our understanding, if the policy change
is implemented, it will impact US-headquartered companies that have captive
operations in India such as Ford, Delphi, etc, as well as US-headquartered
outsourcing service providers (IBM, HP, CSC, et al). Today, the profit earned in
Indiatheir cost-plus margincan be retained in India and even be moved to other
destinations for investment, without taking it back to the US, and thus avoiding
US taxes. If the rules are changed, companies will be forced to take it back to
the US and pay taxes on that.
So, will it impact offshoring per se? Not really, as few do offshoring
primarily for saving taxes. Even without those extra profits, offshoring is
still hugely profitable. Add to that the availability of talent. And these small
changes may not affect offshoring much.
The next question to ask is: will it make US companies uncompetitive. I feel
it is only the service providers based out of US that may become a little
uncompetitive. The enterprises that offshore may just change from a captive
model to an outsourcing model and it will no longer be considered profit in
India. While the expenditure will remain, it would be on buying a service. This
may actually result in more companies looking at outsourcing rather than running
a captive.
The big question, however, is: Is it good for America? Anything that creates
artificial barriers is never good in the long run. There is no logic to show
that it will save jobs. That reduces the question to: whether he can collect
some more taxes in the short run at least? Even if he can, it is still a
worthwhile tactical move in these bad times. But that is a question I am not
qualified to comment on.
But before that, a question remains: can he actually get it done? My guess is
as good as yours.
Shyamanuja Das
The author is Editor of Dataquest. shyamanujad@cybermedia.co.in
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