Accounting admittedly isn't our strong suit, but we can see why American companies will welcome a recent decision by India's Supreme Court that will remove the financial burden of paying taxes on global income generated by captive units in India.
The key criteria for avoiding such taxation, according to recent Forbes article, is for American firms to pay an "arm's length" price (with a definition that sounds a lot like "fair market value" to us) for services from their subsidiaries.
Tax hits can erode labor arbitrage advantages -- which is why the Indian outsourcing industry earlier this year fought for a continuation of incentives that relieved firms from paying a minimum alternate tax of 11.33 percent on revenue from offshore services.
A possible glitch related to the Supreme Court ruling, says a KPMG partner interviewed in the Forbes article, lies in determining if deals meet arm's length criteria. Because India lacks an advance mechanism to allow companies to establish such a price in advance, companies may not know if their transactions meet the arm's length criteria until they are already in the midst of an outsourcing contract.
To spur continued foreign investment in India, KPMG is encouraging the government to introduce an advance mechanism.
A Mumbai-based accountant interviewed by Hindu Business Line India says a transactional net method, which was approved by the court in the case upon which its decision was based, should be appropriate in many instances.
The court's decision should also help clarify in which instances captives can be considered "permanent establishments" of parent companies -- and thus responsible for added taxes, notes the accountant.
Though captive operations have been popular -- especially with large financial services firms like Morgan Stanley, the company involved in the Supreme Court case -- some companies such as Citigroup are reportedly considering selling their captives.