:: Nitish Sengupta

Pak, offshoring: Obama neither fair, nor friendly

Nitish Sengupta

May.22 : As US President Barack Obama settles in his presidency, the pro-India hype amongst his supporters seems to be evaporating. A US congressional committee on Thursday approved legislation that would provide Pakistan an annual grant of $1.5 billion for five years. To further prop up Pakistan Prime Minister Asif Ali Zardari’s tottering government, the Obama administration bowed to Islamabad’s sensitivities and dropped the demand for access to nuclear smuggler A.Q. Khan and the India-specific clause in the Pakistan Enduring Assistance and Cooperation Enhancement Act (HR1886 or Peace Act).

Mr Obama has also come up with tax proposals that are intended to plug loopholes in taxing American multinational companies (MNCs) operating in India. The proposed measures are likely to hit not only the Indian subsidiaries of US firms because they may not be able to claim benefits under the Indo-US Double Taxation Avoidance Agreement, but also Indian companies engaged in business outsourcing from the US. Mr Obama has proposed ruling out three offshore tax-saving strategies used by American companies like General Electric, Citi Corps and Procter & Gamble Co. The proposal is expected to generate $210 billion of additional revenue in the next 10 years.

Mr Obama has said that American companies must stop outsourcing and creating jobs in Bengaluru rather than in Buffalo, otherwise all tax concessions for outsourcing companies will be stopped. This announcement has come in the wake of another move by the Obama administration to further restrict H-1B visas which will not only affect Indian IT companies but also US firms that depend on overseas talent to remain competitive. By disallowing business expenses, American MNCs working out of India may no longer be able to deduct costs such as employee wages while filing tax returns in the US. This will increase their tax liability amounting to around 35 per cent of the total corporate income-tax in the US. However, there is a view that the proposal rests on tax rate differential between the US and other countries. And as the differential in case of India is only 1.1 per cent, US-based MNCs could easily avoid paying taxes on the profits they earn abroad until they bring the money back to the US. From this point of view, we cannot support the opinion of the National Association of Software and Services Companies (Nasscom) that the impact of the proposed reforms on such companies will be marginal. However, we have to reserve our final judgment until we know the details of the tax proposals.

There is no doubt about the safeguard offered by Article 25 of the Indo-US Double Taxation Avoidance Agreement. But this is subject to US domestic laws. We are unaware of the existing US domestic laws and how they will impinge on this issue. The corporate tax rate in the US is higher than India’s (35 per cent vis-a-vis 33.9 per cent). If Indian subsidiaries of US firms are no longer allowed to deduct expenses on their Indian operation while filing tax returns in the US, their tax liability in the US might increase substantially.

In a way, Mr Obama is only translating into action a deep-seated prejudice against business outsourcing evident during the presidential campaign, especially among the Democrats. As a candidate, Mr Obama had promised to come down on outsourcing if he was elected President. Now he is fulfilling that promise and only Congress’ approval stands in his way. But Mr Obama’s current tax proposals go against the essential compulsion that in a globalised economy, US companies must necessarily do cost-cutting by taking advantage of cheaper manpower overseas. If protectionist instincts win, as in Mr Obama’s tax proposals that are bound to make US goods and services costlier, it will eventually hurt the US economy in the long run.

Some of the well-known beneficiaries of outsourcing are companies like General Electric, Hewlett-Packard and Microsoft. They will have to pay a heavy price if they are denied the benefits of cost-cutting through outsourcing. But we have to wait for some time to understand the full impact of these tax proposals for US subsidiaries and for Indian companies in business with India through outsourcing. Barack Obama the politician will have to be given precedence over Barack Obama the economic practitioner.

From this point of view we should be ready to expect some more hiccups from orthodox Democrats’ policy prescriptions. A few days ago, at a lecture in New Delhi by Robert Blackwill, former US ambassador to India, at a Confederation of Indian Industry (CII) event, Mr Blackwill warned India that the Obama administration would force India to take up the Kashmir issue with Pakistan and sign the Comprehensive Test-Ban Treaty (CTBT). Does this mean we would go back to the early days of George W. Bush as President, or even back to the days of Richard Nixon and Henry Kissinger? Hopefully Mr Blackwill’s words will not reflect Mr Obama’s thinking either on the Kashmir dispute or on CTBT.

Surely, American policy should appreciate that Pakistan’s claim on Jammu and Kashmir suffered a serious blow after 1971 when Bangladesh emerged as a larger Muslim country in the subcontinent. Pakistan has no claim to be the "godfather" of Muslims in this subcontinent when the number of Indian Muslims is double the number of Muslims in Pakistan. On CTBT, Mr Bush tried to bypass the entire controversy by formulating the Indo-US nuclear deal. There is no way by which Mr Obama can bring back the Jammu and Kashmir issue or the CTBT issue.

Nitish Sengupta, an academic and an author, is a former Member of Parliament and a former secretary to the Government of India