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Indian Business Connection - You may have to pay tax !!!
By Mansih Shah & Nishit Parikh Sudit K. Parekh & Co.

India has emerged as one of fastest growing economies in the world. Over the years India has witnessed tremendous increase in cross border transactions. Also with influx of technology in various businesses and Indian government’s push on digital India, India has also witnessed various e-commerce business flourishing.

Over a period of time the traditional tax systems were becoming inefficient as they were modelled keeping in mind the brick and mortar business.  In order to collect taxes efficiently from Multinational Companies operating in multiple countries, there was a need to update tax laws to ensure that fair share of tax revenues are collected by source country as well.

Recently, India has signed Multilateral Instrument (‘MLI’) under Base Erosion Profit Shifting (BEPS) Action Plan which has resulted in amendment of more than 3000 tax treaties. BEPS action plan was formulated to counter the aggressive tax planning/evasion measure adopted by multinational corporations. India has been frontrunner in implementing BEPS proposal under the Indian local laws. Indian has already introduced provisions of equalisation levy, Country by Country Reporting, limiting interest deduction, etc.

In line with the MLI proposals, India in Budget 2018 has proposed to expand the definition of Business Connection to widen the scope of Dependent Agency Permanent Establishment (DAPE) and also introduce the concept of significant economic presence.

Dependent Agency PE

Post the expansion of definition of DAPE under MLI, the provisions of Indian local laws had become more beneficial as compared to Tax Treaties. Accordingly, the Indian Government has proposed to expand the definition of DAPE to align the same with definition provided under MLI.

Existing Indian tax laws provides that a Foreign Enterprise would have a business connection in India:

if business activity of such foreign enterprise is carried out through person in India who is acting on behalf of such foreign enterprise and

  • Habitually exercises the authority to conclude contract
  • Habitually maintains stock of goods in India;
  • Habitually secures order in India“

The revised definition would now be as follows:

“Where the person in India on behalf of non-resident principal

a)      Has and habitually exercises in India, an authority to  conclude contracts on behalf of the non-resident or habitually concludes contracts or habitually plays the principal role leading to the conclusion of contracts by the non-resident principal and the contracts are:

i)      in the name of the non-resident, or

ii)    for the transfer of the ownership of, or for the granting of the right to use, property owned by that non-resident or that non-resident has the right to use, or

iii)  for the provision of services by the non-resident.”

b)      Habitually maintains stock of goods in India;

c)       Habitually secures order in India“

Typically, many agency arrangement in India are structured in such a manner that the entire sales function is performed by the agent in India and merely the ultimate contract is signed by the foreign principal. Based on the earlier definition, such situations were not brought under tax net as contracts were concluded outside India. This issue was highly litigated by the Indian Tax Authorities.

In order to capture such situations, the revised definition provides that a DAPE would be established even in cases where the agent plays a principal role in concluding contracts. The term principal role has not been defined and it would be interesting to see how the tax authorities as well as taxpayers interpret this term. In common parlance, principal role would mean playing an important role in concluding the transaction and not merely acting as a co-ordinator. Commentary to BEPS Action Plan 7 provides some guidance on what may be considered as ‘’playing a principal role’’. It specifically mentions following situation which would qualify as ‘’principal role’’:

  • Conclusion of contracts directly results from actions of Indian Agents; or
  • Cases where agent convinces the customers to sign the contract.  

However, given that the term is not specifically defined, this may result in litigation.

Further, it also appears that the revised definition would also capture cases where contracts (including service contract) are in the name of Indian party but the majority of the obligations of the contract are to be fulfilled by the foreign company. 

Significant Economic Presence

Budget 2018, has also introduced the concept of ‘Significant Economic Presence’. It appears that that this move is mainly to target companies having digital presence in India but are not covered under the tax next as per the exiting Business Connection/PE definition. Budget 2018 defines the term significant economic presence as follows:

 “significant economic presence of a non-resident in India shall constitute “business connection” in India and “significant economic presence” for this purpose, shall mean––

(a) transaction in respect of any goods, services or property carried out by a non-resident in India including provision of download of data or software in India, if the aggregate of payments arising from such transaction or transactions during the previous year exceeds such amount as may be prescribed; or

(b) systematic and continuous soliciting of business activities or engaging in interaction with such number of users as may be prescribed, in India through digital means:

 

Provided that the transactions or activities shall constitute significant economic presence in India, whether or not the non-resident has a residence or place of business in India or renders services in India:

Provided that the transactions or activities shall constitute significant economic presence in India, whether or not the non-resident has a residence or place of business in India or renders services in India:

Provided further that only so much of income as is attributable to the transactions or activities referred to in clause (a) or clause (b) shall be deemed to accrue or arise in India.”

As per the budget memorandum, it appears that the abovementioned provision is introduced to tax the digital economy. However, based on the plain reading of the provisions, it appears that many other unintended business transactions (even non-digital transaction) may also get covered in the definition of significant economic presence. It is expected that the Indian Government would take note of this unintended drafting error and provide suitable clarifications.

Also the threshold limit for the above transaction would be prescribed shortly. Hopefully Indian Government would take a pragmatic approach and keep the threshold limits on higher side so that small/medium taxpayers are not affected.

This provision may not be effective as such as Indian tax treaties do not have the concept of significant economic presence. Accordingly, these provisions may become academic for most of the taxpayers unless the tax treaties are amended. Indian Government has also indicated that they would look at renegotiating the tax treaties.

However, for now companies from countries which do not have a tax treaty with India or companies which are unable to claim tax treaty benefits, may be significantly impacted from this amendment. It would become imperative for these companies to evaluate the way they are conducting their business affairs in India.  

The above amendments shows that India is taking each and every measure to keep pace with the changing environment and ensure appropriate taxes are collected. It remains to be seen as to how effectively this provisions are implemented.


Authors:

Manish Shah - Partner, Sudit K. Parekh & Co.

Nishit Parikh - Principal, Sudit K. Parekh & Co.


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