Explained: Why Infosys received a Rs 32,000-cr tax demand, and why it may not need to make provisions

Infosys

India’s second-largest software exporter, Infosys, could face a potentially large tax liability as the Directorate General of GST Intelligence (DGGI) has issued a demand for alleged tax evasion amounting to over Rs 32,000 crore.

Based on intelligence gathered by DGGI officers, the report reveals non-payment of Integrated Goods and Services Tax (IGST) on services received from the company's overseas branches between July 2017 and 2021-22.

What does the demand note say? 

According to a document reviewed by Moneycontrol, the DGGI alleges that Infosys paid consideration to its overseas branch offices in the form of overseas branch expenses. Consequently, Infosys might have to pay IGST under the Reverse Charge Mechanism (RCM) on these supplies.

What is reverse charge mechanism? 

Typically, the RCM in GST states that the recipient of goods or services is responsible for paying the tax instead of the supplier. The DGGI contends that Infosys included the expenses incurred towards overseas branches as part of their export invoice from India, and based on these export values, computed the eligible refund. However, this process resulted in a significant underpayment of IGST by the Bengaluru-based IT firm, according to the DGGI.

Infosys hits back 

In response to the allegations, the IT major has firmly denied any wrongdoing. In an exchange filing, the company said that it has paid all its GST dues and is in full compliance with both central and state regulations. "The company believes that as per regulations, GST is not applicable on these expenses. Additionally, as per a recent circular… issued by the Central Board of Indirect Taxes and Customs on the recommendations of the GST Council, services provided by the overseas branches to Indian entity are not subject to GST," Infosys said in the filing.

Reacting sharply to the development, Infosys’ former Chief Financial Officer Mohandas Pai labelled it as 'tax terrorism' at its worst. "The Finance Ministry should immediately intervene. Such tax terrorism impacts investment into India in a big way," Pai, who is also the Chairman of Aarin Capital, told Moneycontrol.

Pai's comments reflect the broader concerns within the business community about the potential implications of such high-profile tax demands on investor confidence and business operations in India, and for a company that is widely known for its robust compliance framework and strong governance standards.

In September 2023, Infosys received a demand for GST totaling Rs 37.75 lakh, which it also contested.

Infosys and GSTN

The controversy assumes significance given that Infosys is the one that played a prominent role in developing India’s GST and income tax platform.

The company was awarded the contract to design and maintain the GST Technology Network for five years in 2015 and later developed the income tax e-filing portal in 2021. However, both projects have faced public criticism due to technical glitches.

The backstory

The tax department document mentions in detail about the company’s operations and compliance practices and how Infosys allegedly tried to evade taxes, and revolves around the classification of services provided by Infosys' overseas branches.

According to the report, Infosys established branches outside India to comply with local laws and ensure efficient project execution. These overseas branches house sales and marketing offices, delivery teams, and implement projects awarded to Infosys by clients.

They are also responsible for the smooth running of business operations, better delivery of services, and effective coordination between clients and the company's main office in India.

DGGI's take

The DGGI's interpretation of the IGST Act, 2017, specifically Section 8, classifies these overseas branches as distinct establishments. Roughly, this section also implies that transactions between Infosys and its branches should be treated as between distinct persons, thus classifying the services provided by the branches as imports under Section 2(11) of the IGST Act.

Thus, Infosys is liable to pay IGST under the Reverse Charge Mechanism (RCM) for services received from these branches.

“In lieu of receipt of supplies from overseas branch offices, the Company has paid consideration to the branch offices in the form of overseas branch expense. Hence, M/s Infosys Ltd, Bengaluru is liable to pay IGST under reverse charge mechanism on supplies received from branches located outside India to the tune of Rs 32,403.46 crore for the period 2017-18 (July 2017 onwards) to 2021-22,” the document read.

Further, the document shows that Infosys entered into a "Global Master Services Agreement" with clients located outside India. After securing projects, Infosys assembled teams with the necessary skills, executing these projects through centre’s both within and outside India. The overseas branches played an important role in service delivery and maintaining coordination between customers and the company's main office.

However, Infosys included the expenses incurred by these overseas branches as part of their export invoices from India and computed eligible refunds based on these export values. The DGGI argues that by doing so, Infosys effectively avoided paying IGST on the import of services.

GST Intelligence says that all expenses incurred by the overseas branches should be treated as import of services by Infosys, and thus subject to IGST under the RCM, according to the document.

The DGGI investigation, which is still ongoing, may lead to a more detailed case report, potentially involving further demands for information.

The outcome of this investigation could significantly impact how tax regulations are interpreted and enforced in relation to services provided by overseas branches of Indian IT companies, for whom most of the clients are based overseas.

What happens next and will Infosys have to set aside money?

Many experts believe Infosys may not have to make any provisions in its earnings for now as this is a 'pre-show cause notice.' It is in the process of replying to the same.

To be sure, the tax demand is Rs 32,000 crore compared to the over Rs 24,000 crore free cash flow that Infosys has on its books, till the end of FY24.

Precedents

Even as Infosys came under the scanner for the mammoth amount of tax evasion, what went mostly unnoticed was a relatively small amount of penalty slapped by authorities against IT behemoth Tata Consultancy Services (TCS) due to non-collection of export proceeds along with interest under certain sections of the GST Act.

On July 31, the Assistant Commissioner of Commercial Tax, Bengaluru, levied a penalty of Rs 55,607 and Rs 1.06 lakh for 2019-20 and 2020-21, respectively.

TCS, in an exchange filing, said it is taking necessary steps to appeal against the order before the appropriate authority.

Will Nasscom step in?

Industry body Nasscom on August 1 said it has sought clarity from the finance ministry, a day after Infosys received the pre-show cause notice on evasion of GST demand.

Nasscom has requested the Ministry of Finance to issue a circular to clarify the position so that the industry can avoid this litigation risk, it said in a statement. Adding that this is not a new problem and courts have been ruling in favour of the industry in such cases.

"The Karnataka High Court has stayed a show cause notice in a similar case for a large IT company," Nasscom added.

Meanwhile, the outcome of this case could set a significant precedent for how tax regulations are interpreted and enforced in relation to services provided by overseas branches of Indian companies.

“The IT industry is one of the few industries which is more transparent than many other industries in India, some of them are listed/invested in US, so they are used to a lot more routine than some of the other firms,” said Yugal Joshi, leader - technology services research, at management consulting firm Everest Group.

Also read: Infosys share price falls 1% even as IT major disputes Rs 32,000 crore GST evasion notice