Infosys’ $4B tax dispute could have larger ramifications for global outsourcing

A $4 billion tax dispute faced by Infosys for involving an overseas team in a project delivered from India could have significant ramifications for the IT services delivered from India.

If upheld, this tax notice could lead to increased costs for companies like Infosys, potentially impacting their profitability and financial planning. Higher compliance costs and revised tax strategies could also result in higher service fees for clients, affecting the cost of IT outsourcing.

“Accelerating services exports is key to India’s ambition of Viksit Bharat (developed India) and attracting global tech investment to India,” said India’s premier IT body National Association of Software and Service Companies (Nasscom). “This requires a supportive policy environment and ease of doing business.”

Infosys is currently embroiled in a significant tax dispute with the Indian state of Karnataka, facing a demand of nearly $4 billion. The controversy stems from expenses incurred by the company’s overseas branches, which Karnataka authorities believe should be subject to Indian sales tax. On Wednesday, Infosys disclosed the matter through a filing with the Bombay Stock Exchange, detailing the tax demand.

For perspective, the tax demand is nearly equal to Infosys’ Q1 revenue of $4.7 billion.

Infosys, however, disputes this claim, arguing that “GST is not applicable on these expenses.” The company cites a government circular that clarifies the valuation of imported services, asserting that it is “fully in compliance with the central and state regulations on this matter.” The circular, while not a new policy, provides a clarification on the treatment of imported services under India’s Goods and Services Tax (GST) regime, implemented in 2017.

The IT association said the government circulars issued based on recommendations of the GST Council must be honored in enforcement mechanisms so that notices do not create uncertainty and negatively impact perceptions of India’s ease of doing business.

“It is crucial that compliance obligations are not subject to multiple interpretations,” Nasscom added.

According to Indian media reports, the dispute involves a global client. Infosys serviced this client with workers both within India and internationally, and the expenses from its offshore entities were included in invoices sent from India.

Karnataka authorities contend that these invoices should attract Indian sales tax.

“This GST demand of over Rs 320 billion ($4 bn) reflects a lack of understanding of the industry’s operating model,” said India’s IT body National Association of Software and Service Companies (Nasscom). “This is an industry-wide issue, and multiple companies are facing avoidable litigation, uncertainty, and concerns from investors and customers.”

Infosys runs its operations across 274 locations in 56 countries.

Potential repercussions

If the tax demand stands, it could set a precedent affecting how expenses incurred by overseas branches are treated under Indian tax law. The potential ramifications could be far-reaching.

Multinational companies may face higher compliance costs as they navigate the complexities of India’s tax regulations. They might need to reassess their invoicing practices and ensure that expenses incurred overseas are accounted for in a way that aligns with Indian tax requirements.

A spokesperson from a rival IT sourcing company, wishing to remain anonymous, stated, “Multinational companies may have to revise their tax strategies, potentially leading to higher tax liabilities. This could impact their profitability and financial planning, particularly for firms with significant overseas operations.”

According to Nasscom, the issue involves the applicability of GST through the reverse charge mechanism (RCM). “The GST enforcement authorities have been issuing notices for remittance by the Indian head office to its foreign branches for cases where there is no service between the head office and the foreign branch for this RCM, ignoring that this is not a case of ‘import of service’ by the head office from the branch,” the IT association added.

Need for clearer guidelines

The increased tax burden could influence business decisions, such as the location of operations and the structuring of international projects. Companies might become more cautious in their international dealings to avoid hefty tax demands.

Furthermore, the case underscores the need for clearer guidelines and streamlined processes in India’s tax administration. Prolonged legal battles and administrative hurdles could complicate the business environment for not just Indian IT services firms but even the likes of Accenture, Cognizant, and IBM, which have a large part of their development teams based in India.

“The Karnataka High Court has stayed a show cause notice in a similar case for a large IT company in the past,” Nasscom said. The IT association further stated that it had earlier requested the Ministry of Finance to issue a circular to clarify the position so that the industry could avoid this litigation risk.

“The Government and the GST Council have been supportive and as a result, less than two months ago, a circular was issued exactly to address this issue,” it said. “This Circular No. 210/4/2024, dated June 26, 2024, states that for the import of services, the deemed open market value of such transactions will be NIL if full input tax credit is available.”

The $4 billion tax demand on Infosys highlights significant issues in the interpretation and application of India’s GST regulations for multinational companies.

The outcome of this case will be closely watched by industry stakeholders and could prompt calls for more comprehensive and transparent tax guidelines in India.