The significance of DCGI dropping the Infosys tax case

It signals the government’s acceptance of the fact that business processes by software companies need not necessarily be organized in a way that is convenient for the tax administration, according to two people familiar with the development.

The closure of the case, based on a clarification issued by the Central Board of Indirect Taxes and Customs (CBIC) last June and verification of Infosys’ transactions for the past five years, is significant as it changes the way GST authorities will examine the transactions of software companies.

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It allows officials to look at Indian tech businesses making use of offshore branches for exporting services from India at the broadest level and conclude that the offshore branches’ services to the parent are not taxable because the parent can claim credit for any tax paid on it or claim a refund for it, explained one of the persons quoted above. 

Credits claimed for the taxes paid on import of service can be utilized for settling any domestic tax liability of the IT company. Credit or refund is offered for these taxes because, the value of the service imported from the offshore branch is included in the total software services exported from India. 

Most countries refund indirect taxes like GST on goods or services used in exported products or services in order to keep exports competitive.

For India, this is a big departure from the practice followed till now, which requires software exporters like Infosys, which operate through foreign branches, to first raise an invoice on itself for the services rendered by the overseas branch which contributes to the overall export value from India, pay Integrated GST (IGST) on it, and then either claim a refund or tax credits which can be used to set off the parent’s domestic GST liability, added the person. 

Other large software exporters in India have been doing meticulous paperwork to ensure that they either get tax credit or a refund, making the exports tax exempt. Hence other large software exporters did not encounter the tax complication Infosys ran into, explained the person. 

However, the new approach benefits them too, said the person. If any of these firms following this model of exporting software using services of overseas branches, have any inadvertent problems in their paperwork, the 26 June 2024 circular—on the basis of which the Infosys case has been resolved—will have them covered too, explained the person. 

The clarification had said that in such cases, the value of services ‘imported’ by the Indian parent for its overall exports, will be deemed as zero.

The DGGI decision closing the tax proceedings on Infosys Ltd. is a welcome move, said M.S. Mani, partner indirect taxes, Deloitte India. 

“Ensuring that field staff do not initiate tax proceedings without a sound basis and resolving any pending disputes quickly where clarifications are issued by the government are crucial for fostering investor confidence,” said Mani.

Does this clarification cover smaller exporters?

In order to have an export business and have overseas branch operations, the exporter typically needs to be at least the size of a medium enterprise. If they follow this model of using foreign branches for exports, the CBIC circular will benefit them as well. However, this does not apply when the overseas operations are organized as a subsidiary of the Indian parent, rather than a branch office.

Why Infosys encountered the tax notice

The way some of the wordings in GST provisions are enacted by Parliament requires field officers to strictly look at specific transactions in certain cases and does not afford a bird’s eye view, and this at times comes in the way of implementing the spirit of the law, said the person.

Read more: Small businesses bleed cash as GST kicks in before payments

To resolve the case, DGGI was required to verify the company’s transactions for the preceding five years, a process that started towards the end of last year and took a few months to complete. The pre-tax notice was issued to the company to keep the case alive till it was resolved.

Mint had reported on 3 August last year that, in a move that could bring early closure to a potentially damaging tax litigation, the Central government was likely to accept Infosys’ plea that GST does not apply to the services it avails from its offshore branch offices.

Why paperwork poses a problem

For company to raise an invoice to itself for the services of overseas branches, pay tax on it and claim credit or refund, certain timelines have to be met. This adds to additional compliance obligations.

Technology and IT services industry body Nasscom said in response to a query from Mint that the government has been proactively engaged on this issue, with a clear intent to enable ease of doing business and provide greater tax certainty. The industry body’s observations are purely from an industry perspective, and not company specific.

“A fundamental design of the GST regime is that exports are zero-rated, treating a head office and its branch as distinct persons has introduced avoidable complexity,” said Ashish Aggarwal, vice president, Government Policy and Engagements.

While this distinction may serve domestic revenue-sharing between states, its extension to international transactions has spawned litigation, as authorities scrutinize every flow involving an Indian-headquartered IT company, its overseas branch, and the foreign client, Aggarwal said.

In all cases, the Indian company has a master agreement with the overseas client and export earnings are realized in foreign exchange in accordance with RBI’s Foreign Exchange Management Act regulations,” Aggarwal added.

“IT-ITES companies have adopted various operational structures and billing methodologies to optimize service delivery abroad, but the substance and economic reality remain unchanged. Whether billing directly to the client or via a branch office, the underlying service, value creation and economic benefit are identical; taxability must therefore follow substance, not form, to honour legislative intent and ease business. We have engaged constructively with government—presenting prevalent billing models—and urged a holistic resolution to end both past and future disputes,” said Aggarwal.

Read more: Govt relaxes rules to boost GST registration among small businesses

While the Infosys case has been closed early, tax experts said that, in general, if businesses proactively challenge the tax issues they face, it will help to bring legal clarity. 

Abhishek A. Rastogi, founder of Rastogi Chambers, Tax and constitutional expert said, “When a manifestly arbitrary tax notice is issued, irrespective of the amount involved, its absurdity should be challenged in court so that the correct procedure is established and the industry at large will benefit.”

Queries emailed on Monday to the finance ministry and to Infosys seeking comments for the story remained unanswered at the time of publishing.