Proposed US tax reforms to hurt investments in IT

US President Barack Obama?s proposed framework for business tax reforms, pushing for a new minimum tax on foreign earnings, coupled with tax credits for protecting jobs locally, is likely to encourage top American companies to go slow on India, experts feel. The joint report tabled by The White House and the department of treasury last week, if implemented, will affect future investment by US multinationals.

The proposal, forcing American companies to pay more tax on their overseas profits and rewarding companies by giving a 20% tax credit for bringing operations back home, is part of a larger tax reform in a sluggish US economy.

?Our current corporate tax system is outdated, unfair and inefficient. It provides tax breaks for moving jobs and profits overseas and hits companies that choose to stay in America with one of the highest tax rates in the world… It?s not right, and it needs to change,? Obama said in a statement last week. ?It is time to stop rewarding businesses that ship jobs overseas, and start rewarding companies that create jobs right here in America,? he noted.

Until now, large outsourcing players had been using tax incentives and other transfer pricing methods to keep their earnings from Indian operations out of the purview of the US tax department. But they will now have to pay a tax on these earnings if the proposal is implemented.

?This will lead some companies to think twice about whether some operations are worth being moved to India, and other outsourcing locations,? said Pradeep Udhas, head, IT practice, KPMG.

According to a research report by Dataquest last year, American technology majors? Indian operations posted impressive revenue growth during fiscal 2011. In the list of top five Indian IT companies, HP India was ranked fourth after TCS, Infosys and Wipro in terms of revenue growth. During fiscal 2011, HP India generated revenue of R23, 227 crore, up 30% from R17,831 crore in fiscal 2010.

Among other top US players, IBM?s Indian operation posted a revenue of R14, 132 crore, followed by Cisco at R8,157 crore, and Oracle at R7,934 crore. During the same period, PC major Dell posted revenue of R7,666 crore from its Indian business, while Intel had revenue of R6,108 crore, Accenture R5,672 crore and Microsoft India at R4,711 crore during the period, says the report.

?For a lot of these US companies, profits are retained abroad because of the dividend repatriation tax on earnings from foreign subsidiaries. So if this tax proposal gets implemented, it will definitely impact MNCs operating out of India,? noted V Balakrishnan, CFO, Infosys, adding that some of the top companies hold 40-45% cash outside the US, which is a huge disincentive for the US economy. Multinational companies like IBM did not want their views expressed on this story.

Experts also pointed out that the proposed 17% tax credit on R&D to US companies would affect some of the high-end research and development work that is being shifted to India. ?If R&D credit is introduced in the US, just like in Canada, American companies will seriously start looking at the kind of work that goes out to India as cost differentials get reduced,? said Udhas.

Companies like Google, Intel, Yahoo and Microsoft invest heavily into hiring and expand their R&D centres, which plays a key role in their global operations. Many multinationals are trying to ship more work to India. In the last few years, Yahoo?s Indian centre has transformed from being an inward looking R&D centre to a market-centric innovation hub. The Bangalore centre?s output in terms of intellectual property is increasing at a rate of 50-60% every year. Yahoo has over 2,000 employees in India, the second-largest centre outside its California headquarters.

Similarly, the Indian arm of US chipmaker Intel is gearing up for a greater share of the company?s R&D work into key areas such as tablets and phones, having increased its headcount by nearly a third over the past year.

With technological and revenue generating products like Google Finance and Map Maker born in its labs here, Google India has come to be recognised as a global development hub. The total advertisement spend online in India is about $200 million, of which Google is estimated to make about $100 million. In terms of its products, India is a major market for the internet giant. YouTube has grown over 20% in India, which is the third largest subscriber base after US and China.

But analysts feel the outsourcing industry, on the whole, will adapt quickly to these changes and factor-in the variables that get thrown into the mix as outsourcing, essentially, is not tax driven.