Multinational Corporates (‘MNCs’) have been alleged to have adopted strategies like tax inversions (moving operations) or migrating of intangibles in order to shift their profits to low / no-tax locations. This is known as Base Erosion and Profit Shifting (‘BEPS’). The Organization for Economic Cooperation and Development (‘OECD’) has taken an initiative to tackle such strategies which exploit disparities in tax provisions. The OECD has brought in “Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting” (‘MLI’) to facilitate jurisdictions to close gaps by updating their existing framework of bilateral tax treaties from OECD/G20 BEPS Project and to reduce opportunities of tax avoidance.

OECD BEPS initiative

India is actively participating in implementing the Action Items proposed by the OECD. Out of 15 Action Items; BEPS Action Plan 7, in particular, recommends anti-fragmentation rule, widening of agency PE rule, etc. to update the definition of Permanent Establishment (‘PE’) and to prevent situations where MNCs are artificially avoiding the PE Status.

It has been proposed that the rule for creation of agency PE shall include not only a person who habitually concludes contracts on behalf of a non-resident, but also a person who habitually plays the principal role leading to the conclusion of contracts without material modification. Action Plan 7 also recommended introduction of an anti-fragmentation rule to prevent the tax payer from availing benefit of exemption under paragraph 4 of Article 5 of Tax treaties by fragmentation of functions.

Indian domestic tax laws

The concept of “Business connection” under the domestic tax laws is akin to concept of PE in international parlance. The term ‘business connection’ includes activities carried on by non-resident through its dependent agents. Presently, a person acting on the behalf of the non-resident by negotiating and concluding contracts, maintaining stock of goods in India or habitually securing orders in India mainly or wholly for the non-resident would constitute its dependant agent in India.

It has been observed in several cases negotiation of contracts is carried out by a person in India acting on behalf of the non-resident principal, mere execution of contracts is performed by the principal himself and currently, such cases do not result in creation of PE in India.

It has been observed that the conditions resulting to agency PE under the domestic law is narrower in scope and it will be more beneficial than the tax treaties once MLI is enforced. In such a scenario, the tax payers would be benefited by the domestic laws making the MLI and BEPS Action Plan incapable of its application.

Proposed amendment

As a step forward, the Indian government, vide Finance Bill 2018, has proposed to widen the definition of ‘business connection’ to align it with the provisions in the tax treaties as modified by MLI.  The proposed definition of ‘business connection’ shall include activities of a person who habitually plays the principle role leading to conclusion of contracts by the non-resident principal. The contract is required to be in the name of the principal and for the transfer of right to use / ownership of property of the non-resident (owned or licensed). An exclusion for activities limited to purchase of goods or merchandise which was present under the present agency rule has been removed.

The amendment is wide enough to cover the following activities leading to execution of contract by non-resident:

  • non-binding investment advisory services (for identifying investment opportunities in India);
  • convincing prospective customers leading to receiving orders by non-resident ;
  • forwarding orders to the warehouse for delivery.

However, activities such as a pure advertising, marketing and promotion of goods and services which does not directly lead to conclusion of contracts should not be covered.

In light of this proposal, the following arrangements with non-resident principals needs to be revisited:

Franchise arrangement

Situations wherein the Indian franchisee is actively involved in negotiating contracts on behalf of the non-resident franchise owner shall be considered to constitute a dependant agent in India. Further, dependant agency would also cover Indian parties which arrange for launch of prospective franchisees and negotiate the terms of arrangement.

Distributor contracts / Commissionaire arrangements

MNCs having a distributing entity, a limited-risk distributing entity or a commissionaire in the customer jurisdiction may be brought to tax with the above amendment. In a typical commissionaire arrangement, a person (the agent) concludes contracts for the sale of products in a certain jurisdiction in its own name. However, the sale is made on behalf of an overseas principal that also owns the products and fulfils the contract.

The actions of the enterprise’s sales force of convincing a third party to enter into a contract with the enterprise (soliciting and receiving but not finalising) shall trigger a business connection. On the contrary, mere marketing / promoting of the goods, resulting in increase in sales, does not directly result in conclusion of contracts and is thus outside the purview of the above amendment.

Liaison offices (‘LO’) structures

Under foreign exchange control regulations, LOs are allowed to perform limited functions which are of preparatory or auxiliary nature. In practice, it is observed that, LOs go beyond their role and negotiate contracts with prospective customers leading to conclusion of contracts by the head office.

In the light of this amendment, there is a need to review the functions performed by the LOs because most likely, the LO may be playing a principal role in conclusion of contracts or leading to purchase and sale for non-resident. Under modified PE rule, such situations may be viewed as a dependant agent of the principal in India.

Non-binding investment advisory arrangements

Advisory services provided by Indian companies to its Associated Enterprise (‘AEs’) needs to be relooked in the light of this arrangement. This is primarily because the Indian AEs will be involved in evaluation of potential investment opportunities, credibility of the investee, holding meeting and providing presentations to negotiate the commercials ultimately leading to formalisation of the deal. Such foreign AEs could now be construed to have a business connection in India. 


The amendment to the domestic laws brings in a mirror image of the agency PE rules under MLI provisions. There is paradigm shift whereby a taxing right is proposed to be given to a jurisdiction where the value is created than in a jurisdiction where merely a legal authority has been exercised.

Practically, this modified PE rule will be effective only to non-treaty jurisdictions (like Hong Kong, Cayman Island etc) till entry into effect of MLI. Post MLI applicability to treaty jurisdictions, it shall depend on the extent to which the respective tax treaty is modified. By placing this agency PE rule under domestic law, the government will be able to negotiate their existing treaties or future tax treaties for adoption of such standard. As a result of formation of agency PE in India, the net profits attributable to such ‘business connection’ in India shall be taxed at 40% in the hands of the non-resident. The attribution will depend on the functions, assets and risks performed by such agent in India. MNC’s are now obligated to revisit their existing structures and are left with limited scope of tax planning and mitigation strategies.

Mansi Mehta, Senior Manager and Miloni Mehta, Deputy Manager with Deloitte Haskins & Sells LLPMansi Mehta and Miloni Mehta

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January 2021