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India, amongst various countries, participated in the signing of the Multilateral Instrument (MLI) on 7 June 2017, to implement tax treaty related measures as a part of the various Base Erosion and Profit Shifting (BEPS) related Action Plans. Even prior to the signing of the MLI, India has progressively modified its domestic tax law provisions to align them with the principles laid down under BEPS. The key amendments introduced vide Finance Act 2016 and 2017 in line with BEPS included:

  • Introduction of a concessional tax regime for royalty on patents
  • Equalization levy
  • Country-by-Country reporting
  • Limiting the deduction of interest payments to non-resident Associated Enterprises

The Union Budget 2018 presented on 1 February 2018, has inter-alia proposed to broaden the scope of the term ‘business connection’ under section 9 of the Income-tax Act, 1961 (the Act) thereby aligning it with the modified scope of Dependent Agent PE under the MLI  in line with BEPS Action Plan 7.

Existing provisions under the Act and tax treaties: 

Under the existing provisions of section 9(1)(i) of the Act, ‘business connection’ includes business activities carried on by a non-resident through dependent agents. The provision is akin to the ‘dependant agent PE’ as laid down under the tax treaties entered into by India with various countries. As per the ’dependent agent PE’ clause contained in various tax treaties, if any person acts on behalf of the non-resident and is habitually authorized to conclude contracts for the non-resident in India, then such agent would constitute a PE of the non-resident in India and consequently the profits attributable to such PE are taxable in India.

However, the provisions under the tax treaties did not address certain types of agency arrangements. Further, in many situations, contracts though substantially negotiated in India were finalized /signed /authorized abroad, thereby mitigating PE exposure in India. The domestic tax law also did not fully address the issue.

In order to overcome such scenarios, the scope of agency PE was amended under BEPS Action Plan 7 to include an agent having authority to conclude contracts or plays a principal role leading to conclusion of contracts. Further, Article 12 of the MLI (which has inter-alia been signed by India) also incorporates the above modification suggested under BEPS Action Plan 7. Accordingly, the amended provisions w.r.t. dependent agent would be automatically subsumed in the bilateral tax treaties signed by India covered by MLI.

Proposed amendment:

Accordingly, the Finance Bill 2018 proposes to amend the provision of section 9 of the Act with effect from 1 April 2019 i.e. applicable from assessment year 2019-2020, to provide that the term ‘business connection’ shall also include any business activities carried through a person who, acting on behalf of the non-resident, habitually concludes contracts or habitually plays the principal role leading to conclusion of contracts by the non-resident and the contracts are:

  • in the name of the non-resident; or
  • 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
  • for the provision of services by the non-resident.

In view of the above amendment, the scope of business connection under the Act would now be extended to include scenarios where the agent in substance negotiates / plays a principal role in concluding the contracts in India on behalf of the non-resident and transfer of property of an undisclosed principal.

Key issues / considerations: 

  • Section 90 of the Act provides an assessee to opt for the provisions of the Act or the tax treaty, whichever is more beneficial. The scope of dependent agency PE would become narrower under the tax treaties vis-à-vis the scope laid down under the Act in cases where unlike India, the other treaty partner has not signed the MLI or not included the said clause in MLI signed by it. In such cases, the existing beneficial provisions under the tax treaty would continue to prevail thereby avoiding PE exposure.
  • In view of the above proposed amendment, amongst other issues, various liaison offices of foreign companies in India would be required to be more cautious of the activities being undertaken by them in India to ensure that the activities do not fall under the purview of ‘business connection’ and trigger taxability in India for the foreign companies.
  • Further, under the current provisions of the Act, activities that are confined to purchase of goods or merchandise is considered as an exclusion. However, on account of the proposed removal of such exclusion, the benefit now gets restricted to purchase of goods in India for the purpose of export.
  • The term ‘principal role’ has not been defined or examples relating to what in substance would tantamount to ‘playing a principal role in conclusion of contracts’ have not been listed.

To conclude: 

The proposed amendment in the Finance Bill 2018 in the scope of ‘business connection’ under the provisions of the Act, firmly evidence India’s convergence with BEPS project and is a significant move towards India’s willingness to align the domestic tax laws with the internationally accepted practices. The amendment proposed noticeably demonstrates the government’s perennial intention to widen the tax ambit for non-resident taxpayers and consequently boost the tax revenue collections of the government.

On the other hand, it would be now all the more imperative for non-resident taxpayers to be more vigilant with such arrangements in India vis-à-vis triggering of PE exposure in India.

Author Deepa Bakhru is Senior Manager with Deloitte Haskins & Sells LLP and Kripa Ray is Deputy Manager with Deloitte Haskins & Sells LLP.

Deepa Bakhru and Kripa Ray

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June 2024