India has been an active participant among the G20 countries and committed to the Base Erosion and Profit Shifting [BEPS] project. India’s Finance Minister on 7 June 2017 signed off the Multilateral Convention to implement Tax Treaty Related Measures [Multilateral Instrument / MLI] at Paris. The Indian Government is gradually aligning its international tax provisions with the BEPS recommendations. Equalisation levy, interest deductibility limits, Country-by-Country Reporting norms are some of the BEPS induced measures by the Indian Government. As a step forward, the Government, vide Finance Bill 2018, has proposed certain key amendments under the deeming fiction rules to tax non-residents in India, essentially to bring within its taxing fold, foreign companies without any physical business presence in India and defining India economic nexus for the purpose of taxation.
Widening the dependent agency PE scope under ‘business connection’
The Finance Bill 2018 proposes to widen the definition of “business connection” and align the same with the BEPS Action plan 7 and MLI.
Currently, Explanation 2 to section 9(1)(i) defines “business connection” to include business activities carried on by non-resident through dependent agents. As per the provisions of the Act and the most of the tax treaties which India has entered into with other countries, a dependent agent shall be the one who acts on behalf of the non-resident principle either to negotiate and conclude the contract or maintain stock of goods in India or habitually secure orders in India mainly or wholly for the non-resident.
BEPS Action 7 ‘Preventing the Artificial Avoidance of Permanent Establishment Status’ has recommended following changes for strengthening the existing international standards:
(i) Extending the applicability of ‘preparatory and auxiliary’ to all activities in Article 5(4)
(ii) Anti-fragmentation rule
(iii) Widening the ambit of agency PE rule
(iv) Measure to counter splitting-up of contracts in the context of Article 5(3)
BEPS Action Plan 7 proposes to amend criteria for qualifying as a dependent agent so as to include not only a person who habitually concludes contracts but also a person who habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise. Similarly, Action Plan 7 also recommended introduction of an anti-fragmentation rule as to prevent the taxpayer from resorting to fragmentation of functions which are otherwise a whole activity in order to avail the benefit of exemption under paragraph 4 of Article 5 of the tax treaties. The recommendations made under BEPS Action Plan 7 are included in Article 12 of MLI.
The Memorandum states that in light of the proposed amendments in BEPS and MLI, and once the same become effective in various tax treaties, the provisions under the tax treaty shall become wider than the provisions under the Act. Thus, the implementation of the global reforms in such a scenario would be a challenge. Accordingly, the law makers vide Finance Bill 2018, proposed to amend the provisions of section 9 of the Act to align them with the provisions as per the BEPS and MLI.
The proposed amendment provides that “business connection” shall also include any business activity 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.
It is further proposed that the contracts should be:-
a) in the name of the non-resident; or
b) for the transfer of the ownership of, or for the granting of the right to use, property owned by that non-resident or that the non-resident has the right to use; or
c) for the provision of services by that non-resident
In light of the BEPS provisions being gradually incorporated in the Act and the MLI being signed by the Finance Minister last year, the said amendment being incorporated in the Act was a matter of time. Considering that the scope of “business connection” under the Act has always been significantly wider than the scope of permanent establishment under the tax treaty, the said amendment may not have any major impact.
Business Connection to include “Significant Economic Presence”
Another amendment proposed to section 9(1)(i) of the Act is to include a criterion of “significant economic presence” of a non-resident in India as constituting business connection. Currently, taxation of income based on the economic dependence / activity is subject matter of debate even though it carries high weightage in the global tax regulations.
Generally, business profit of an enterprise is taxable in the country in which the taxpayer is a resident. However, if the tax payer has presence in other countries also then such other country also gets the right to tax the business profits attributable to the ‘Permanent Establishment’ in that country. The term Permanent Establishment’ means a ‘place of business’ through which the business of an enterprise is wholly or partly carried out. However, in the rapidly evolving business environment where technology changes every day, the need for physical presence is not required in order to carry out any business activity.
BEPS Action Plan 1 deals with the tax challenges of the Digital Economy. As per the Action Plan 1, a non-resident enterprise would create a taxable presence in a country if it has a significant economic presence in that country through a purposeful and sustained interaction with the economy by use of the technology. Foreign enterprise may have a PE in another State, where businesses in the digital economy is derived from a country without a physical presence. Further, revenue earned remotely through digital transactions should be a key factor coupled with a revenue threshold to be determined based on the size of the country’s market etc.
Under the current provisions of section 9(1)(i) of the Act, income of a non-resident is taxable in India if it has business connection in India. Business connection shall include a fixed place of business through which the business of the enterprise is wholly or partly carried on. However, business through digital economy does not require physical presence in India.
In view of the above, Finance Bill 2018 has proposed to amend the provisions of section 9(1)(i) of the Act to provide that ‘significant economic presence’ in India shall also constitute ‘business connection’.
The term ‘significant economic presence’ shall mean
a) any 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 the amount as may be prescribed; or
b) systematic and continuous soliciting of its business activities or engaging in interaction with such number of users as may be prescribed, in India through digital means.
It is further proposed to provide that income which is attributable to such transactions or activities should only be deemed to accrue or arise in India. The proposed amendment in the domestic law will enable India to negotiate inclusion of the new nexus rule in the form of ‘significant economic presence’ in the tax treaties as well.
It may be reiterated that Finance Act 2016 had introduced equalisation levy on certain digital payments to non-residents in order to tackle the tax leakage induced by the use of digital platform for carrying out business in India. The equalization levy had a very limited application to only such companies which are in the business of online advertising. The interplay between the equalisation levy and the proposed amendment in section 9 of the Act would be worthy to decode in future. Moreover, the amendment as regards the widening of the ambit of dependent agency PE concept would imperatively necessitate review of cross border operations under franchise models and liaison offices for possible revamp of business models.
Information for the editor for reference purposes only
Zainab Bookwala is a Manager and Paras Modi is a Deputy Manager with Deloitte Haskins & Sells LLP. The views expressed herein are personal and not that of the firm.