Generally speaking, Branch Profit Tax is a tax imposed on effectively connected earnings / income of a branch (or entity) in a contracting state (country, in common parlance) of a foreign entity when those earnings are repatriated, or deemed repatriated, to the home country of such foreign entity.
Currently, there is no concept of additional Branch Profits Tax in India, as the permanent establishments of foreign entities are taxed at a higher rate as compared to domestic companies. It may, however, relevant to note that the concept was proposed in the Direct Taxes Code, 2010 but the same was not implemented.
It is worthwhile to mention that some of treaties (including certain treaties signed by India) provide for a right of the source state to levy a tax – Branch Profit Tax. Such tax, however, relates only to Permanent Establishment and not to a fixed base. This tax is explained as under:
Suppose, there is subsidiary of a foreign entity (say, Entity A) in a Country X earning a similar profits as the Permanent Establishment or branch (say, Entity B) of such foreign entity in Country X.
Entity A & Entity B will pay tax on the profit / income generated by them in Country X. Further, if Entity A distributed these profits as dividend, an additional tax would be levied on these dividends in accordance with normal Income-tax provisions of Country X or under article 10(2) – Dividends of Double Taxation Avoidance Agreement [DTAA], in case of shareholder being a non-resident (the provisions of DTAA are applicable in case they are beneficial than the normal Income-tax provisions of Country X).
However, no such additional tax would be levied / paid in case such distribution is being made by Entity B.
Therefore, in order to bring in parity between two entities operating in India, certain countries has incorporated the concept of Branch Profit Tax in their domestic laws as well as DTAA entered into by them. It is in this background (along with other benefits) the entities prefers Branch over a subsidiary since these branches are treated as permanent establishment under DTAA and thus benefit from:
(a) repatriation of profits at reduced rates and various tax exemptions available in the parent company’s home country;
(b) Tax credits in order to avoid the payment of a similar tax in both countries signing the agreement.
On the contrary, the commentaries on Model Tax Convention issued by Organisation for Economic Co-operation and Developments [OECD] & United Nations provides that Branch Profit tax will be contrary to the principles of DTAA and requires urgent amendments in the relevant DTAA, in which such tax is present. The relevant extract are reproduced as under:
“…….where such tax is simply expressed as an additional tax payable on the profits payable on the profits of the activities of the permanent establishment itself and not as a tax on the enterprise in its capacity as owner of the permanent establishment. Such a tax would therefore be contrary to paragraph 3….”
Typically, the relevant clause dealing with Branch Profit Tax is placed under Article 10 – Dividends and is phrased as follows:
“……..profits of a company carrying on a business in the other contracting state through a permanent establishment situated therein may, after having been taxed under Article 7, be taxed on the remaining amount in the contracting state in which the permanent establishment is situated at a rate that does not exceed the rate set forth in paragraph 2 of this article.”
In the absence of any specific article / paragraph or sub-paragraph, the provisions provided under the Article of Other Income would apply, and, therefore in such a scenario, the right to tax is taken away by the residence state.