After the Y2K scare of the late 1990s, software outsourcing from India surged, leveraging a large pool of affordable engineering talent for programming. Since the industry earned in dollars, it retained most of its profit, and New Delhi’s tax authorities couldn’t devise a way to heavily tax it.
However, the knives have now been sharpened. Infosys Ltd. recently received a notice alleging it evaded India’s goods and services tax (GST) by 324 billion rupees ($4 billion) over five years, equivalent to its annual operating profit. Infosys stated on Wednesday that it has paid all required taxes, and investors don’t believe the company needs to set aside funds for the alleged liability. Despite being the best performer on the benchmark Nifty 50 index over the past three months, Infosys shares fell 2.5% on the news.
On Thursday evening, Infosys announced that the pre-show-cause notice by the state authority had been withdrawn, and it was directed to submit a response to the GST intelligence directorate in New Delhi. By Saturday, Infosys reported that the notice for the financial year ending March 2018, covering 12% of the demand, was “closed.”
The federal authority’s claim suggests that Infosys imported services from its own global offices, which solicit business from large corporations. Although coding primarily occurs in India, foreign branches provide engineers onsite at clients’ locations, coordinating with Bengaluru. The department claims these units are distinct from the head office, making Infosys liable to pay GST on the services received from its overseas branches.
Infosys likely regrets securing the $200 million project from Prime Minister Narendra Modi’s government nine years ago to develop the GST software, India’s largest fiscal reform in decades. Businesses had long demanded a unified market of 1.4 billion people, free from sub-national taxes. However, the implemented GST was one of the world’s most complex, with five rates: 0%, 5%, 12%, 18%, and 28%, while petroleum products and alcohol remained separately taxed, creating a compliance nightmare for smaller firms.
The poorly structured, hastily implemented GST caused significant issues in the accounting community, with Infosys taking much of the blame for persistent glitches. The company’s reputation suffered further when it developed a clunky, error-prone web portal for income tax filing, frustrating the administration and leading to political criticism.
Three years ago, Panchjanya, a Hindi weekly aligned with the Rashtriya Swayamsevak Sangh, a right-wing cultural organization supporting the Modi government, criticized Infosys co-founder Narayana Murthy in an article titled “Reputation and a Grievous Harm,” alleging that Infosys management was trying to destabilize the Indian economy. However, Murthy, no longer in management, remains an influential figure due to his track record in wealth and job creation. Recently, he expressed skepticism about India’s ability to compete with China in manufacturing, a key strategy of the Modi government.
The political backdrop adds intrigue to the situation. Similar tax demands could be made of other IT services firms, according to a government source. Such moves could be poorly received, especially as the ruling party has lost its parliamentary majority and the first budget of its third term has disappointed many of its middle-class supporters.
Billionaires, however, remain supportive of Modi, even on the eve of elections in April. Yet, imposing a sales tax on an industry facing lackluster demand and challenges from generative artificial intelligence raises questions about Modi’s pro-business stance.
If there’s a loophole in the GST code that makes services exported to global clients liable for a local Indian consumption tax, the code itself needs fixing—unless someone powerful in New Delhi wants to target Infosys or send a warning to India Inc.
