Potential American investors and US companies that outsource a lot of work to India are disturbed over India's decision to levy fringe benefit tax on firms.

The US-India Business Council, which represents over a 100 big companies doing business in India, has written to Finance Minister P Chidambaram saying that the proposed tax will have 'significant ramifications on businesses operating from India.'

Companies that outsource a huge amount of work to take advantage of the cost benefits that India offers will now have to rethink their strategy as the levying of FBT makes India an expensive place now.

The USIBC letter said that the 'tax will reduce cost competitiveness and add to litigation at a time when companies operating from India are seeking to build a competitive position in the export sector, and global business interest in India is rising.'

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The letter -- a copy of which was made available to rediff.com -- added that FBT will, over time, lead to a misalignment between benefits enjoyed by employees and taxes borne by them, as employers seek to pass on the FBT costs equivalently among employees.

Although the finance minister had earlier indicated that he would seek to tax only fringe benefits, the proposed tax in its current form seeks to do much more than that.

The tax, USIBC said, will send wrong signals to potential investors -- who are increasingly interested in India as an investment destination -- and might scare them away.

The USIBC letter went on to say that it was not clear if the fringe benefit tax would apply to companies operating in India or also companies that may depute an employee on a short-term project to India.

USIBC members operating in India are concerned about the dual impact this tax would have on them. They said that since this tax (FBT) is not an income tax, it would not be eligible for claiming US tax benefits under the Double Taxation Avoidance Agreement signed between New Delhi and Washington.

This would amount to double taxation, they complained.

The USIBC letter added that expenses borne by India companies on employees who are not taxable in India under the provisions of tax treaties are indirectly captured under this provision, defeating the spirit of tax treaties.

Ron Somers, USIBC president, told rediff.com: "The timing is not correct because it's sending confusing signals into the marketplace."

"This is not a cheap tax net -- it's about 30 per cent. Thus, for many American companies that were looking for that competitive advantage from a pricing standpoint, this is a huge shock."

"In other words, you set up operations over in India and you are having all this wonderful efficiency and this wonderful advantage and now some of that is being eroded, and no more is India such a cheap place to be – it's a costly place to be," he added.