Infosys Explained: Is Another Controversy Brewing?

Did Narayana Murthy's 70-hour work-week mantra just backfire? 🙂‍

Karnataka's Goods and Services Tax (GST) authority really took Murthy's "the youth should work hard" remark to heart.

It turns out that Infosys, India's second-largest tech giant, might be a little behind in paying its tax dues, falling short of ₹32,403 crore! According to Karnataka's GST authority, Infosys evaded GST over services provided by its overseas branch from 2017 to 2022.

This accusation was made on 30 July 2024, and since then, the employees have been working 70 hours a week to prove it. I bet Narayana Murthy never thought his vision would be realised in such a way.

Infosys accused of tax evasion! It does not sound right, does it?

Well, let me tell you some details about what’s going on, with some insight into who Infosys is and how it came to be.

What's Happening with Infosys?

The simple fact is that Infosys is accused of evading GST. But there's more to it:

Allegedly, Infosys included the expenses its overseas branches incurred in its export invoices and did not pay Integrated Goods and Services Tax (IGST) on these services. The authorities claim that these services are subject to tax because, under the IGST Act, the parent company (in this case, Infosys) and its overseas branches are considered distinct entities.

The situation stirred up a cloud of controversy when Karnataka state GST authorities, a zonal body of the Directorate General of Goods and Services Tax Intelligence (DGGI), sent a pre-show cause notice to Infosys for evading ₹32,403 crore in IGST.

Soon after, Infosys got another pre-show cause notice on the same matter, this one from the central authority of DGGI.

Infosys made an announcement on 1 August 2024, stating that the Karnataka GST authorities had withdrawn the pre-show cause notice, and it was directed to respond to the DGGI's central authority. The allegations hit Infosys’ share price hard.

On 3 August 2024, Infosys announced that the DGGI had closed the pre-show cause notice proceedings for the FY 2017-18, the allegedly evaded tax for which amounted to ₹3,898 crore. It means that Infosys was found "not guilty" of evading ₹3,898 crore out of the total ₹32,403 crore.

Who's Really at Fault?

National Association of Software and Service Companies (NASSCOM), the IT industry trade association and advocacy group, rose in support of Infosys. It stated that the GST demand shows a misunderstanding of how the IT industry works.

Nasscom also pointed out that this GST issue is not an Infosys issue but an industry issue. Many other companies in the sector are facing similar avoidable litigations, giving way to market uncertainty and concerns from investors & customers.

In this context, the authorities believe that GST is applicable because of something called the Reverse Charge Mechanism (RCM). This mechanism makes sure that services provided by foreign branches to Indian head offices are tax compliant.
 
This way, the recipient of the service (head offices in India) becomes liable to pay GST for cross-country transactions that might otherwise escape taxation.

The GST enforcement authorities have been asking the Indian head offices to pay GST under RCM, ignoring the fact that this is not a case of 'import of service’ by the head office from the branch.

Nasscom raised concerns about this issue with the Central Board of Indirect Taxes and Customs (CBIC), which issued a circular on 26 June 2024. It clarified that if an Indian head office receives services from its related foreign entity, the value of the same is considered “nil” for GST applicability.

In light of this circular, Infosys can take a breath of relief.

Now that we are all caught up on what's going on, here is the story of how Infosys came to be as promised.

Infosys' Founding Story & Business Model

Infosys’ founding story is the story of how an IT star was born. It was founded in 1981 by Narayana Murthy and six of his friends with the support of Mrs Sudha Murthy (Narayana Murthy's wife) and an initial investment of ₹10,000.

Fast-forward to today: Infosys is one of the most successful companies in the IT industry. In the last 40 years (give or take a few), Infosys has turned its ₹10,000 initial investment into a market valuation of more than ₹7 lakh crore.

Even though Infosys is truly Narayan Murthy's brainchild, he wasn't the company’s first employee; no, he was fourth in line. Infosys' first employee was N. S. Raghavan (also a co-founder of Infosys).

Infosys is a shining star, leading the charge in making India a top global destination for finding software services talent. Infosys got its first computer in 1983, almost two years after its foundation, because Murthy could not afford to buy Data General 32-bit MV8000, an imported option he wanted.

In 1987, Infosys expanded to international markets, starting with Boston and the US, and soon after that, in 1993, it went public. The company achieved significant revenue milestones, crossing ₹512.7 crore and ₹1,00,000 crore in 1999 and 2021, respectively.

Later, it pioneered the Global Delivery System (GDS) and became the first IT company to be listed on the NASDAQ. Infosys’ latest achievement from 2024 is that it was recognised as the top 100 most valuable brands in the world by Kantar BrandZ.

Infosys sure has come a long way. And what a journey it has been!

Infosys' Business Model

Infosys offers a number of IT solutions, including:

• Application Development and Maintenance: It creates software solutions specific to the needs and preferences of its clients.
• Consulting Services: It helps optimise business operations and advises businesses during their journey of digital transformation.
• Outsourcing: It helps businesses efficiently and cost-effectively manage various business functions.
• Digital Transformation: Helps businesses become more tech-savvy, basically by helping them integrate the latest digital technologies.

Among the many industries Infosys caters to, the financial services industry is the top contributor to its revenue at 27.5%. The company also serves other industries like manufacturing, energy, utility, etc.

As we can see from the infographic above, Infosys' industry mix is varied, eliminating the possibility of over-dependence on any one sector. Its software products and platforms include proprietary solutions like Next Generation Integrated AI Platform or NIA for short, EdgeVerve Systems, and Finacle.

Even though Infosys has desi roots, India only contributes 4.4% to its revenue, as can be seen from the infographic above. Over 64.2% of its revenue comes from North America, and 16.8% of its revenue comes from Europe.

Infosys has a very diversified business model.

IT & Business Process Management (BPM) Industry Overview

The Indian economy has been greatly affected by the IT & BPM industry. In FY23, the sector contributed to 7.5% of the GDP and by 2025, the industry is expected to contribute 10% of the GDP.

Things did look a little down for the industry in FY24 due to various reasons:

• The client decision-making process has become slow.
• More and more companies are now focusing on immediate cost savings instead of digital transformation due to economic uncertainties.
• Consumers and businesses are reducing non-essential expenses due to global macroeconomic headwinds.
• The industry is facing margin pressures due to a rise in costs associated with hiring and retaining employees.

But now, the industry is set for a new era of growth. India has become the top choice for IT companies all over the world to outsource their work. It's not really a surprise because India has proven that it can provide top-notch services to its domestic and global clients.

India has one of the largest populations, and its internet rates are some of the cheapest in the world, at just ₹10 per GB ($0.12/GB). Thanks to such low-priced data plans, 76 crore (760 million) Indians now have access to the internet.

In the Union Budget 2023-24, the Indian government has allocated over ₹10,300 crore (approximately $1.2 billion) to the IndiaAI Mission. This investment is to help the growth of India's Artificial Intelligence (AI) ecosystem.

The Indian IT companies earn the majority of their revenue from developed markets. Instead of serving domestic clients, they export their services because usually, the services are too expensive for domestic clients. This brings in foreign exchange money, helping the country’s financial position.

The IT sector relies heavily on its software services. As can be seen from the above infographic, in FY23, IT software and services formed the majority of total IT exports at over 60%, whereas BPO and other services, including hardware, contributed to less than 40% of the total IT exports.

Infosys' Financials

Infosys’ revenue has risen consistently over the past 5 years, with a 13% Compound Annual Growth Rate (CAGR).  

In 2024, its revenue growth went down to 4.7% in terms of rupee (1.4% in constant currency) from over 21% in 2022 and 2023.

Not to worry though, as the global economy mends and companies start spending on non-essential IT services again, Infosys' revenue will pick up.

There is an increasing demand for software solutions that help optimise costs, which is the key revenue catalyst for Infosys.

The company's profits have performed well over the past 5 years, with an impressive 11% CAGR as is clear from the infographics above.

However, the fact that its profit growth has been lower than its sales growth, might be an indication of poor operating efficiency. It might be a cause for concern when combined with intensifying competition in the industry thanks to the global slowdown in IT spending and the decline in contact value that followed.

As a result, software exports fell from 11.3% in previous years to 3.3%.

Challenging business conditions surround Infosys, as we read earlier, but the company might be able to protect its profits. It is focusing on improving its capabilities in areas such as digital services and consulting, which have higher profit margins. Additionally, it is also trying to enhance its core technologies with the use of automation.

Peer Comparison

Comparing Infosys to its peers, we see that it is India's second-largest IT company, close behind TCS.
If you want to read about the Fundamental analysis between Infosys and TCS, then click on the link

As can be seen in the infographic above, over the last 5 years, Infosys and HCL have shown the highest sales growth among peers.

Infosys’ profits, on the other hand, have shown the fastest growth in the past 5 years.
 
In the IT industry, companies use revenue per employee to track performance because they do not spend much on setting up large factories, plants, machinery, etc.; instead, the majority of their costs are their employees.

The higher the revenue and profit per employee, the better the company’s performance.

Infosys's revenue and profits per employee are the highest among its peers (maybe because Infosys employees work 70 hours a week).

Over the last few years, the attrition rate for the IT industry has reduced, which is a good thing because the IT sector is notorious for mass layoffs. Infosys’ attrition rate stands at 12.6%, just under the industry standard. Although Wipro's attrition rate is at 14%, which is higher compared to the industry average.

The Bottom Line

Infosys got in some trouble for evading GST (supposedly). The whole debacle is still going on. The company is only off the hook for not paying GST for FY2017-2018.

From what we can see, it might be an issue over GST applicability and the whole IT industry is suffering from similar issues.

This one might not be Infosys’ fault. However, this is not the first time it has done something to anger the GST authorities. In April 2024, the company had to pay a penalty of ₹1.46 lakh to the Odisha GST Authority because it had availed an input tax credit it wasn't eligible for.

In light of the current GST allegations, many other controversies related to Infosys have come up, especially the income tax portal glitch back in 2021. Ironically, Narayana Murthy is a big advocate of hard work and work ethics, but the ethics of the business he runs are now being questioned.

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