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Some Indian Tax Issues of Legal Process Outsourcing

Posted by William Byrnes on July 26, 2009


You must pay taxes.  But there’s no law that says you gotta leave a tip.  ~Morgan Stanley advertisement (according to quotegarden)

Attraction of Income Tax

An Indian resident’s total income includes their worldwide income “from whatever source derived.” Thus, a resident’s income need not be received in India to be subject to the income tax.  An Indian resident’s total income includes income received in India, income “accruing or arising in India,” and income “accruing or arising outside India.”[1]  The total income of a person who is not ordinarily resident in India does not include foreign source income unless the income is derived from an Indian company.[2]

The Indian government taxes some types of income based on the source of the income. Of particular importance to users of LPO services is the source-based taxation of income from a business connection in India.  A nonresident’s total income includes income received in India and income “accruing or arising” in India.[3]  Income is deemed to accrue or arise in India when it comes directly or indirectly from any business connection in India.[4]

Under Indian domestic tax law, some payments to nonresidents are subject to a non-final withholding tax. Income from sources other than royalties are subject to withholding at the current rates in force.[5]  Any person in India who has a business connection with a nonresident or from whom the nonresident receives income directly or indirectly is considered to be an agent of the nonresident.[6]

An agent is treated as a “representative assessee” of the nonresident and must deduct the tax at the source and pay that amount to the Government.[7]  However, India does not require withholding from remittances from a branch to a foreign parent.

Tax Treaty Protection

Under India’s Double Taxation Avoidance Agreements (DTAA), the business profits of a nonresident may only be taxed in India if the profits are attributable to a permanent establishment in India.  India’s DTAAs are more similar to the U.N. Model Double Taxation Convention rather than the OECD’s.

The definition of “permanent establishment” (PE) under India’s DTAAs is generally consistent with the definition found in the UN Model Convention. Included in the definition of PE is a person, other than an independent agent, who has the authority to, and does habitually conclude contracts in the name of the nonresident person.  Also included is a person authorized to, and who habitually does, keep a stock of goods for the nonresident and regularly delivers the goods on behalf of the nonresident.[8]

Business income is taxable in India if the income is attributable to a permanent establishment in India.  A nonresident person may be taxed in India even if the nonresident does not have a physical presence in India. For instance, the Income Tax Appellate Tribunal has held that nonresident companies operating reservation systems servicing Indian residents are subject to the income tax under Indian treaty law (and domestic law).[9]

India’s domestic tax law applies to nonresidents when the domestic tax law is more beneficial to the taxpayer.[10]

Recent Treaty Based Decision Impacting BPOs / Transfer Pricing Issue

In a landmark Supreme Court decision in summer of 2007 that impacted many captive LPO providers, the Court substantively agreed with the conclusion of the 2006 Authority for Advance Ruling’s determination that Morgan Stanley’s Indian BPO subsidiary constituted a permanent establishment, though the Court’s and Authority’s analysis diverged.[11]

The Court’s analysis of the permanent establishment issue focused on the oversight/quality control employees of Morgan Stanley deployed to its Indian subsidiary.  However, the inevitable question of determination of taxable income of the subsidiary whether in its own right or as a permanent establishment is answerable via a transfer pricing functional analysis.

The Court ruled that the Transaction Net Margin Method was an appropriate method for determining the arm’s length price between the associated parties.

Within the Fall Transfer Pricing course we will analyze the facts, reasoning, and criticisms of this case.

practical_guide_book

Lexis’ Practical Guide to U.S. Transfer Pricing, 28 chapters from 30 expert contributors led by international tax Professor William Byrnes,  is designed to help multinationals cope with the U.S. transfer pricing rules and procedures, taking into account the international norms established by the Organisation for Economic Co-operation and Development (OECD). It is also designed for use by tax administrators, both those belonging to the U.S. Internal Revenue Service and those belonging to the tax administrations of other countries, and tax professionals in and out of government, corporate executives, and their non-tax advisors, both American and foreign.  Fifty co-authors contribute subject matter expertise on technical issues faced by tax and risk management counsel.


[1] Income Tax Act § 5(1).

[2] Income Tax Act § 5(1) (flush language).

[3] Income Tax Act § 5(2).

[4] Income Tax Act § 9(1)(i).

[5] Income Tax Act § 195(1) and. § 194(J).

[6] Income Tax Act § 163(1)(b), (c).

[7] Income Tax Act §§ 161, 190.

[8] See e.g. Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, India-Austria, Nov. 8, 1999, India Income Tax Department, art. 5.

[9] Galileo International Inc. v. DCIT, ITA No. 1733/Del/2001; 2473 to 2475/Del/2000; 820 to 823/Del of 2005 (Nov. 30, 2007).

[10] Income Tax Act § 90(2).

[11] Civil Appeal No. 2914 of 2007 arising out of S.L.P. (C) No. 12907 of 2006, M/s DIT (International Taxation), Mumbai v. M/s Morgan Stanley & Co. Inc., with Civil Appeal No. 2915 of 2007 arising out of S.L.P. (C) No. 16163 of 2006, M/s Morgan Stanley & Co. Inc. vs. Director of Income Tax, Mumbai.  See Jefferson VanderWolk’s interesting commentary at 47 TNI AUGUST 13, 2007, P. 631.  Email me for copies of the decision and lecture notes thereto.

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Risk Management of Important Issues of LPO

Posted by William Byrnes on July 23, 2009


Quote for this blogticle: “First weigh the considerations, then take the risks.” Helmuth von Moltke

In my last blogticle I listed the types of LPO services undertaken with a link to over 100 providers of LPO services.  Hereunder I address several important considerations concerning avoiding the sinkholes in the road to outsourcing. 

Attorney Ethical Issues

In 2006 the New York City Bar Association published a formal opinion regarding the ethical considerations of overseas legal outsourcing of services.  The New York City Bar considered whether a New York lawyer may “ethically outsource legal support services overseas when the person providing those services is (a) a foreign lawyer not admitted to practice in New York or in any other U.S. jurisdiction or (b) a layperson?”[1]  That bar association concluded that a lawyer may do so, upon meeting the following conditions (quoted from its opinion)[2]:

(a) rigorously supervises the non-lawyer, so as to avoid aiding the non-lawyer in the unauthorized practice of law and to ensure that the non-lawyer’s work contributes to the lawyer’s competent representation of the client; (b) preserves the client’s confidences and secrets when outsourcing; (c) … avoids conflicts of interest when outsourcing; (d) bills for outsourcing appropriately; and (e) … obtains the client’s informed advance consent to outsourcing.

Early last year, the Florida Bar Association addressed the same issue and it found no distinction between hiring contract paralegals in the US and contract foreign (specifically Indian) attorneys outside the US, concluding that contractual legal services do not aid the unlicensed practice of law if the Florida law firm provides adequate supervision.[3]

Security

The legal and operational issues that perhaps attracts the most attention, and deservedly so, because of a few highly publicized cases, are privacy, confidentiality and the preservation of privilege.  These issues require a robust discussion of operational data security, institutional / LPO governance, and employee security as well as quality control for processes and compliance verification.

By example of addressing security concerns, outsourcing contracts mitigate the disclosure of documents by mandating the LPO employees’ computers have Internet access limited.[4]  Note that in India anyone with access to customer records is free to sell the data, or use it for direct marketing.  However, pending legislation (the Personal Data Protection Bill, 2006) will if passed protect data provided to the Government and private entities from being sold or used for direct marketing.

Professional Indemnity

By example of addressing professional indemnity and security liability concerns for which the US contracting source firm will inevitably be liable to its clients, LPO contracts may mandate professional liability coverage written by US based insurers, with a certificate of coverage provided annually.[5]  Naturally, heightened insurance and compliance/verification will increases the LPO firm’s operational costs, pressuring its margin and pricing.

Functional Equivalency & Education / Training

While India may have four times the amount of law graduates, are these graduates the functional equivalent of a US associate?  One of my colleagues poses the question that if the Indian graduate attorney was the functional equivalent, then why doesn’t his and other firms, like the technology industry, import Indian trained lawyers?  While it is not uncommon for United Kingdom trained solicitors to be employed by US firms, the same cannot be said of Indian graduates. 

Is the equivalency up to par with US paralegal training?  How can a US firm verify professionalism and level of expertise?  More importantly for the LPO industry, if components are missing in India’s legal education that impact functional equivalency, what are these components and can these be effectively transferred? 

By example, many India law graduates do attend one-year Master of Laws in the United States.  Is the LL.M. necessary to rectify any (perceived) differences?  Will staff’s passage of the penultimate multistate bar examination, by example in Washington DC, New York or California, provide Indian LPO firms competitive advantage to obtaining work, or disadvantage because the (now US) attorney may command a higher wage?

Some LPO providers state that as long as a Indian based U.S.-trained lawyer oversees the Indian staff, the work product will be of equivalent quality.  Because of the recent recession in USA legal services, the US has an ample supply of attorneys willing to relocate to India to oversee such operations.  May a US firm consider this supervision sufficient for certain contracted skill sets, such as document review?

As a counterpoint to this equivalency issue, some LPO marketers state that Indian law graduates are better, rather than equivalent, to their US associate counterparts, by example, because of the competitive motivation of the number of Indian graduates and fewer high paying attorney positions.

In my next blogticle, I will examine some tax issues associated with LPO with India.

Professor William H Byrnes, IV (www.llmprogram.org)


[1] The Association of the Bar of the City of New York Committee on Professional and Judicial Ethics, Formal Opinion 2006-3, August 2006.

[2] The Association of the Bar of the City of New York Committee on Professional and Judicial Ethics, Formal Opinion 2006-3, August 2006.

[3] Professional Ethics Of The Florida Bar (Opinion 07-2); January 18, 2008

[4] Legal Outsourcing to India Is Growing, but Still Confronts Fundamental Issues, Anthony Lin, New York Law Journal, January 23, 2008.

[5] Legal Outsourcing to India Is Growing, but Still Confronts Fundamental Issues, Anthony Lin, New York Law Journal, January 23, 2008.

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Types of Indian Legal Process Outsourcing (LPO)

Posted by William Byrnes on July 22, 2009


Quote for this blogticle: “Most people are other people. Their thoughts are someone else’s opinions, their lives a mimicry, their passions a quotation.” Oscar Wilde

In my last blogticle I looked at Conditioning Drivers for LPO Growth.  In this one, I turn to the types of LPO services undertaken and a link to a provider list.

Types of LPO Services

Examples of legal services currently outsourced with substantial fees to India include, non-exclusively:

(1) secretarial including presentations,

(2) legal transcription,

(3) legal publishing services,

(4) document review including e-discovery,

(5) legal research,

(6) business/market research,

(7) litigation support,

(8) contract drafting and review services,

(9) form completion and information population, such as tax forms

(10) intellectual property, such as patent application and compliance, and

(11) administrative such as accounting and billing.[1] 

Type of LPO Providers

The four categories of Indian outsource providers typically referred to are:

(1)     captive centers of corporate legal departments,

(2)     captive centers of large legal and audit firms,

(3)     third party niche providers, and

(4)     third party multiservice providers.[2]

LPO Expertise Legacy

Especially given the mass layoffs amongst large firms, the US law community is experiencing a high attrition among its US contract attorney staff, as well as its partners and associates.  On the contrary, India experiences a high retention, thus legacy experience, amongst its LPO providers. 

Moreover, LPO proponents state that Indian LPO multiservice providers may be leveraged by their US counterparts to (1) reduce fixed staffing costs of associates and paralegals, (2) mitigate the capital investment and IT operational costs necessary for purchasing, implementing, and keeping abreast of, legal technology for document review, and (3) cross-fertilization obtained form experience with multitudes of varying projects.[3]

List of LPO Providers

The website Prism Legal provides a vendor list of 111 firms providing outsourced legal service in India and elsewhere for the US and UK markets.[4]  

The Prism Legal list also includes corporations and law firms leveraging legal offshore services, such as Dell, American Express, Dupont, Puarolator Courier Inc., General Electric and Microsoft, as well as top law firms such as Clifford Chance, Allen & Overy, Millbank Tweed, Jones Day, Kirkland & Ellis, White & Case; and Chadbourne & Parke.[5]

In my next blogticle, I will turn to the Risk Management of Important Issues of LPO.  Look forward to your comments to any of my blogticles.  Professor William Byrnes (www.llmprogram.org)


[1] Offshoring Legal Services to India: an Update (Market Research Report), Valuenotes Database Pvt. Ltd., July 2007.  Also see Why and What Lawyers Should Consider Outsourcing, Ron Friedmann LLRX.com, Sept 1, 2008 (available at http://www.llrx.com/features/legaloutsourcingoptions.htm).

[2] Contract with India: Legal outsourcing, Jim Middlemiss, Financial Post (Canada), April 25, 2008.

[3] Why and What Lawyers Should Consider Outsourcing, Ron Friedmann LLRX.com, Sept 1, 2008 (available at http://www.llrx.com/features/legaloutsourcingoptions.htm).

[4] http://www.prismlegal.com/index.php?option=content&task=view&id=88&Itemid=70#Intro (last visited October 30, 2008).

[5] Also see Contract with India: Legal outsourcing, Jim Middlemiss, Financial Post (Canada), April 25, 2008; U.S. firms outsource legal services to India, Cynthia Cotts and Liane Kufchock, Bloomberg News, August 21, 2007; and India Lures Corporate Outsourcing, Jonathan Hill, Law Technology News, October 14, 2008.

Posted in Legal Process Outsourcing | 4 Comments »

Conditioning Drivers for Legal Process Outsourcing Growth

Posted by William Byrnes on July 21, 2009


Conditioning Drivers for LPO Growth

The previous blocticle post addressed the market for LPO and BPO in India relative to the USA.  Hereunder we shall address the cost structure that is driving the LPO market and its transfer of transactional based legal services to functional equivalent yet substantially lower cost practitioners.

Litigation Costs

For medium size businesses, legal fees as a percentage of income are growing.  In 2007 electronic data discovery expenditures increased 43% to $2.7 billion and are projected to reach $4.6 billion by 2010.[1]  A recent Fulbright & Jaworski client study found that approximately 10% of the clients responding reported legal fees represented about 5% of the company’s gross annual revenues.[2] 

The recession has greatly impacted legal services, in particular client’s willingness to pay substantial fees for traditional associate and paralegal level work.  This, firms have been driven, sometimes specifically by clients, to legal process outsourcing (LPO) in India.

Compliance Costs

The Regulatory Environment [3]

For the past several years, the US banking industry and its legal/audit counsel has focused on regulatory issues, such as the corporate governance provisions of the Sarbanes-Oxley Act (enacted in 2002) and the banking-related parts of the USA Patriot Act (enacted in 2001). These provisions are having a bottom line impact in terms of increasing expenditure resulting primarily from increased staffing and technology.  The provisions of the USA Patriot Act require increasing investments in technology (though many in the industry have questioned the effectiveness of these investments in preventing the funding of terrorist groups or activities) and staff hours that smaller community banks have contended impact them disproportionately.  

Increasing Compliance Costs

Senior banking management perceives rising and unpredictable compliance costs that undermine US global competitiveness as the most significant threats to the future growth of banking.[4]  The cost of AML compliance increased around 58% globally but 71% in North America between 2004 and 2007.[5]

A 2005 survey of Florida, in particular Miami, banks engaged in international banking estimated the staffing cost of AML compliance at nearly $25 million. The study concluded that compliance costs are not uniform across institutions, even after making adjustment for sizeLarger institutions (measured in terms of deposits) typically devote more resources and spend more on compliance than smaller ones, of course, but the compliance burden does not rise proportionately with size.  That is, survey data indicates that economies of scale in compliance are present, and that compliance costs per dollar of deposits is greater for smaller institutions than for larger ones.[6] Even after the dramatic increases in compliance costs and regulatory complexity since 2001, the regulatory environment is likely to become increasingly challenging in coming years.

In a 2006 Economist Intelligence Unit survey, international senior bank executives were asked about the costs of compliance with government regulation. When asked what changes they expected in the regulatory environment over the coming three to five year, over 91% stated that they expected regulations affecting their institution to grow in complexity and breadth, 88% stated that compliance with industry regulations will become more onerous, and 81% reported that they expect penalties for non-compliance to increase in severity.[7]

As a result, the international banking industry in Florida has been characterized by consolidation and contraction since 2000.  The number of foreign bank agencies operating in Florida fell from 38 in 2000 to 31 in 2005.[8]  There were 10 Edge Act banks operating in Florida in 2000, but only 7 in 2005.  The number of international banking employees (in foreign agencies, Edge Acts and the international divisions of domestic banks chartered in Florida) declined from 4,660 in 2000 to 3,027 in 2005.

Based on a survey of banks significantly engaged in international banking Florida International Bankers Association (FIBA) was able to estimate the Florida international bankers staffing cost for 271 full-time employees of anti-terrorism/anti-money laundering compliance at nearly $25 million in 2005. [9]  The average survey respondents indicated that it devoted 2.9 FTE employment positions to BSA/AML compliance in 2002 versus 6.8 FTE positions in 2005. The number of full-time employees devoted to compliance represented 9% of the workforce in 2005.  Staff resources devoted to compliance increased by 160% between 2002 and 2005.

Document Review & Customization Costs

In 2003, a legal forms publisher, Socrates Media, reduced the cost for a fifty state customized residential lease from approximately $400,000 to $45,000 via the Hyderabad company QuisLex.[10]

A company’s legal department can reduce its document review costs from $7 to $10 per page in the US to approximately $1 per page with Indian counsel.[11]  Whereas New York associates undertaking document review may earn a $160,000 base annually, similarly reviewing Indian associates earn less than $10,000.[11]  Contrast the annual increase of labor supply of 200,000 Indian law graduates (of a 1.2 billion population) versed in the Common law to that of the USA, being 50,000 for 300 million population.

 A US legal secretary’s average hourly cost is $63 under the realistic conditions of 80% annual time utilization ($50 if 100% hourly utilization) based upon an $85,000 annual employee cost including salary, benefits, and payroll tax.[13] That of the New York associate will be double. In 2003, University of California (Berkeley) reported that whereas US paralegals and legal assistants may average $18 hourly, the equivalent India positions earn between $6 and $8.[14]

In our next blogticle we will address areas best suited for legal process outsourcing.  You may follow new blogticle postings via Twitter (http://twitter.com/williambyrnes).  Feel free to comment.  Professor William Byrnes (www.llmprogram.org)


[1] India Lures Corporate Outsourcing, Jonathan Hill, Law Technology News, October 14, 2008.

[2] India Lures Corporate Outsourcing, Jonathan Hill, Law Technology News, October 14, 2008.

[3] Standard and Poor’s Industry Surveys: Banking (Dec. 6, 2007).

[4] The Washington Economics Group, The Economic Impacts of International Banking in Florida and Industry Survey: 2005.

[5] KPMG’s Global Anti-Money Laundering Survey 2007.

[6] The Washington Economics Group, The Economic Impacts of International Banking in Florida and Industry Survey: 2005.

[7] Economist Intelligence Unit, Bank Compliance: Controlling Risk and Improving Effectiveness (2006)

[8] In 2005, however, 7 of the 31 international banks had no deposits booked in Florida, while in 2000 only 2 of the 38 had zero deposits.

[9] Note that these cost estimates only include manpower or staffing costs, and do not include costs such as transaction monitoring software, possible IT investments and services, legal counsel and similar support.

[10] U.S. firms outsource legal services to India, Cynthia Cotts and Liane Kufchock, Bloomberg News, August 21, 2007.

[11] Offshoring Legal Services to India: an Update (Market Research Report), Valuenotes Database Pvt. Ltd., July 2007

[12] India Lures Corporate Outsourcing, Jonathan Hill, Law Technology News, October 14, 2008.

[13] Why and What Lawyers Should Consider Outsourcing, Ron Friedmann LLRX.com, Sept 1, 2008 (available at http://www.llrx.com/features/legaloutsourcingoptions.htm)

[14] Outsourcing the lawyers, Krysten Crawford, CNN/Money October 15, 2004; Outsourcing Legal Services Abroad, K. William Gibson, Law Practice Magazine Volume 34 Number 5 July/August 2008 Issue Page 47.

Posted in Legal Process Outsourcing | Leave a Comment »

Legal Process/Service Outsourcing Focus on India

Posted by William Byrnes on July 20, 2009


This week I will break from wealth management and turn to a series of blogticles on legal process / service outsourcing to India.  The blogticles will present an overview of issues relating to the discussion held in our Masters course (see www.llmprogram.org).  Whereas our course also addresses our groundbreaking technology and pedagogical developments for educating the Indian legal process outsourcing workforce, within this blog we will focus on basic outsourcing issues such as types of outsourcing, compliance, and two tax issues being (1) India source based taxation / permanent establishment considerations, and (2) transfer pricing considerations. 

I will provide citations to relevant sources that you may jump start your research for legal process outsourcing for India.  Please contact me if you require more detailed suggested resources to continue you research.

Economic Comparison: BPO and LPO Growth

Since 1994 I have observed, and participated in the rise of technnology, business, service, and finally legal process outsourcing.   Originally I leveraged South African accountants for service fullfillment for projects overseas, transferring information via the Internet.   Many South African accountants immigrated overseas, and India’s bandwidth grew stable and robust enough that its labor force could be effectively leveraged.  Fees in India generated from USA sourced legal services are estimated to increase to $640 million within the next two years, employing 32,000 legal staff (from $146 million employing 7,500 in 2006, and only $80 million in 2005).[1]  In the past three years, legal outsourcing revenue has grown approximately 60% annually.[2]  From just 2006 to 2007, growth of US companies outsourcing legal services to India increased from 37% to 51%.[3]  By 2015 Forrester Research projects $4 billion in legal services outsourced to India. 

By contrasting example, last year India’s IT outsourcing revenues reached $64 billion, growing 33%, and breached the two million employment level.[4]  As Indian has accomplished phenomenal growth since 1994 with its BPO information technology sector, so it is likely to in the BPO legal services sector though as a much faster pace.

My Background Relevant To Legal Process Outsourcing

In 1994-95, I was a senior consultant for a significant non-resident Indian acquisition of an India manufacturer, requiring leveraging of the Mauritius double tax agreement and working with Mauritius and Indian tax and exchange control authorities.  In 1996, I followed up that experience by outsourcing to India a substantial text capture project in agreement with Kluwer Law International for the creation of HTML hyperlinked online materials for our online law program.  Since 1995, I have spoken numerous times in India at conferences and trainings held by organizations such as the Bombay Management Association and for Bangalore’s charted accountants.  Last year the All India Federation of Tax Practitioner invited me to address its membership on legal education for Indian tax process outsourcing.  Recently I co-authored the Indian chapter for Oxford University Press’ treatise Global E-Business Law & Taxation (distributed electronically through www.ibls.com).

Prior to my tenured academic career I was a senior manager then associate director, international tax, Coopers and Lybrand (South Africa), which subsequently amalgamated into Price Waterhouse, whereby I sourced multinational structuring and investment projects, completing the work cost effectively for the clients via competently educated South African advisors. 

In the next blogticle, we turn to examine the issues of Litigation Cosst, Compliance Costs and Document Review & Customization Costs.

Prof. William H. Byrnes, IV (www.llmprogram.org)


[1] Offshoring Legal Services to India: an Update (Market Research Report), Valuenotes Database Pvt. Ltd., July 2007 and Legal Outsourcing to India is Growing, but Still Confronts Fundamental Challenges, Anthony Lin, New York Law Journal, January 2008. – see Mittal – NASSCOM

[2] U.S. Legal Work Booms in India, Rama Lakshmi, Washington Post Foreign Service, May 11, 2008.

[3] India Lures Corporate Outsourcing, Jonathan Hill, Law Technology News; October 14, 2008.

[4] Indian IT-BPO Industry Factsheet, NASSCOM, August 2008 (available at http://www.nasscom.in/Nasscom/templates/NormalPage.aspx?id=53615).

Posted in Legal Process Outsourcing | Tagged: , , | 3 Comments »

 
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