Objective

Author in this article discusses proposed taxation regime by CBDT on Profit attribution to a permanent establishment (PE)  in India and recommendations thereon.

It is definitely a welcome step as it will reduce the quantum of litigation.

Today as I hand down my article, NDA has come to power again with clean majority. Now it is possible for Ministry of Finance to bring in the changes in coming July 2019 by way of Finance Act, 2019.

Citation of the Enactment

CBDT has published a “Report on Profit Attribution to Permanent Establishments” on 18-April-2019 and has called for comments within 30 days. Strictly speaking by the time this article is published, the window would have stood closed.

Entering the subject

In today’s era, the whole world has become a village and various activities of business are being conducted from varying states / jurisdictions. Refer para 52

52. Often, a need is emphasized for allocating taxing rights to the jurisdiction where value is created. However, the concept of value is often not clearly elaborated to show how it is related to the different tax bases. For instance, in value added tax or VAT, where the tax base is value addition, it would be more logical to tax the transaction where value is created, and accordingly the adoption of destination based rule reaffirms the principle elaborated in the example of California oranges referred above. However, the tax base in income tax or corporate tax is not value addition, but business profits, and accordingly sales and supply both need to be taken into account as contributors to this tax base.  

There is a need to bring harmony in the mechanism of attribution of profit to each of the activity.

Take away points 

The committee broadly recognised three approaches;

(i) supply approach allocates profits exclusively to the jurisdiction where supply chain and activities are located;

(ii) demand approach allocates profits exclusively to the market jurisdiction where sales take place;

(iii) mixed approach allocates profits partly to the jurisdiction where the consumers are located and partly to the jurisdiction where supply activities are undertaken.

The committee has taken into consideration

  • Concept of significant economic presence within the definition of “business connection” in view of digital development
  • the practical difficulties of getting worldwide information about an entity

 The committee has rejected exclusive reliance on FAR [functions, Assets and Risks] analysis

Finally in para 193, the committee found an acceptable approach – namely Fractional Apportionment

Before going into the characteristics of Fractional Apportionment, there is one specific provision for enterprises having global loss or EBIDTA less than 2%.

There will be a deeming profit of 2% of turnover or revenue derived from India

Fractional Apportionment

It is based on

1. apportionment of profits derived from India

2. information related to Indian operations.

The measurement is cumulative weighted average of following three factors.

1. Sales

2. manpower

3. assets

Formula for computing the profit attributable to Indian activities

Basic criteria to be fulfilled

An assessee who is not a resident of India,  has a business connection in India and derives sales revenue from India by a business all the operations of which are not carried out in India,

Method of computation of income

General Rule

Profits attributable to operations in India =

Profits derived from India  x [SI/3xST + (NI/6xNT) +(WI/6xWT) + (AI/3xAT)]

Where,

SI = sales revenue derived by Indian operations from sales in India

ST = total sales revenue derived by Indian operations from sales in India and outside India

NI =number of employees employed with respect to Indian operations and located in India

NT = total number of employees employed with respect to Indian operations and located in India and outside India

WI= wages paid to employees employed with respect to Indian operations and located in India

WT = total wages paid to employees employed with respect to Indian operations and located in India and outside India

AI = assets deployed for Indian operations and located in India

AT = total assets deployed for Indian operations and located in India and outside India

‘profits derived from Indian operations = amount higher of the following amounts:

a. The amount arrived at by multiplying the revenue derived from India x Global operational profit margin, or

b. Two percent of the revenue derived from India

Profits derived from India” = Revenue derived from India x Global operational profit margin as referred in paragraph 159.

159. The profits derived from India would need to be defined for the purpose of clarity. In the absence of separate accounts of Indian operations, an option that is also frequently practiced and sustained by the Courts in several cases as discussed earlier, could be to determine such  profits by applying the global profit margin[82] on the Revenue generated from customers within India, as under: 

Profits derived from India = Revenue derived from India[83] x Global operational profit margin[84]

[82] As discussed in Section 4, the marginal profits and average profit of an enterprise is different in the presence of sunk costs. The average profit which forms the tax base in the corporate tax regimes, is constituted by the surplus of total revenue over the sum of all the costs i.e. Marginal cost + corresponding portion of the sunk cost. In case of a PE which is not owning R&D or assets ideally no rent should be attributed to R&D or to assets in the form of depreciation. Thus, the operating margin valuation should exclude depreciation, interest and R&D costs. However, for simplification the Committee was of the view that the global profit margin should be taken as EBITDA margin as this figure is a known number and easy to calculate. EBITDA excludes depreciation and interest costs.

[83]Revenue derived from India includes all receipts arising or accruing or is deemed to accrue or arise from India which are chargeable under the head Profits and gains of business or profession.

[84] As discussed above EBITDA margin (Earnings before interest, taxes, depreciation and amortization) of a company is to be taken as the global operational profit margin.

Exception 1 to the General Rule

Basic criteria to be fulfilled

Business Connection is primarily constituted by the existence of users

beyond the prescribed threshold, or

users in excess of such prescribed threshold exist in India.

Method of computation

profits derived from India on the basis of four factors of

1. sales,

2. employees (manpower & wages),

3. assets and

4. users.

The formula will remain same but the weights will be different

Particulars sales Employ yees (man power & wages), Assets Users. Profits attributable to operations in India =

 

low and medium user intensity 30 30 30 10 Profits derived from India’ x [0.3 x SI/ST + (0.15 x NI/NT) +(0.15 x WI/WT) + (0.3 x AI/3xAT)] + 0.1]
high user intensity 30 25 25 20 Profits derived from India’ x [0.3 x SI/ST + (0.125 x NI/NT) +(0.125 x WI/WT) + (0.25 AI/3xAT)] + 0.2]

Exception 2 to the General Rule

Basic criteria to be fulfilled

Business Connection is primarily constituted by the activities of an associate enterprise that is resident in India

Facts the enterprise does not receive any payments on accounts of

sales or services from any person who is resident in India [or such payments do not exceed an amount of Rs. 10,00,000]

and

the activities of that associated enterprise have been fully remunerated by the enterprise by an arm’s length price,

the payments received by that enterprise on account of sales or services from persons resident in India exceeds the amount of Rs. 10,00,000

For this purpose, the employees and assets of the associated enterprise will deemed to be employed or deployed in the Indian operations and located in India.

Profit attribution no further profits will be attributable to the operation of that enterprise in India. Profit as computed above

Recommendations

Law related

The amendment may be drafted by using plain language and preferably inserting a separate section 9B in the Income Tax Act, 1961.

The committee should clarify its position regarding

Particulars
profit attribution vis-a-vis DTAA Clarification in terms of Advance Pricing Arrangement, Force of Attraction principle, Limitation of Benefit clause.
profit attribution vis-a-vis GAAR It directly hits any arrangement / system which has character of colourable device.
profit attribution vis-a-vis source based taxation. Equalisation levy, section 115A, section 44BB etc. IT is so because for example a company availing some specific services of say google may not know whether Google has a PE for that service or not.
profit attribution vis-a-vis MAT / AMC In this case, the assessee may be a company or may not be a company

Functional recommendations

Run a simulation without disclosing the names of the entities and compute the tax inflow. Publish the figures.

It will give the audience a perspective so that more quality input may flow in before the enactment is made.

Section 3 Evolution of the Three Different Standards of Article 7 in Model Tax Conventions& its Implications

3.4 Committee’s Observations

48. The Committee observes that at present three standard versions of Article 7 exist in tax treaties and model tax conventions, the two versions that existed in the OECD model convention before and after 2010 and the one that continues to be a part of UN model convention. The Committee further observes that one of the primary implications of the revisions introduced in Article 7 of the OECD model tax convention, of necessitating reliance upon FAR for profit attribution and excluding the option of apportion, was that in cases where business profits could not be readily determined on the basis of accounts, the same were required to be determined by taking into account function, assets and risk, and completely ignoring the sales receipts derived from that tax jurisdiction. This was a major deviation from the generally applicable accounting standards for determining business profits, where business profits cannot be determined without taking sales into account.

Section 4 Economic Basis for Allocation of Taxing Rights in respect of Income from Business

4.4 Committee’s observations

60. The Committee observes that business profits are contributed by both demand and supply of the goods, and hence a jurisdiction that contributes towards demand by facilitating the economy and the ability of their resident to pay or by maintenance of markets that enable sales as well as the jurisdiction that contributes to the production or supply of goods, contribute towards the business profits of an enterprise. This gives rise to a valid justification of taxation by them of the profits to which their economies have contributed. Where, the economies of both Contracting States in a tax treaty contribute to the business profits, there exists sufficient economic justification for profits to be allocated among them in a manner that avoids double taxation.

Section 5 Different Approaches to Profit Attribution& International Practices

5.7 Committee’s Observations

81. The Committee observes that there are three possible approaches for profit attribution– (i) the purely supply approach that allocates all business profits exclusively to the jurisdiction where factors of production are deployed and supply side activities are undertaken; (ii) the purely demand side approach that allocates all business profits exclusively to the jurisdiction where the consumer is located; and (iii) a mixed or a balanced approach that allocates profits between the jurisdiction where the consumers are located and the jurisdiction where factors or production are located and where supply side activities are undertaken. The analysis of international practices shows that among these the mixed approach is most commonly adopted, though there are also instances of purely demand approach, especially in certain US states. The purely supply side approach does not appear to be practiced within any of these countries.

82. The Committee also observes that the revision of Article 7 by OECD in 2010 amounted to a shift from a broader approach that permitted either of the three approaches followed under the domestic law of a Contracting State, to a purely supply approach, by seeking to determine profits exclusively with reference to functions, assets and risks, and thereby completely excluded the role of demand. This approach taken by the OECD is, however, not observed in international practices even among the OECD countries and regions, which either opt for a mixed approach or a purely demand approach.

Section 6 Views of Academicians & Experts on Profit Attribution

6.4 Committee’s Observations

92. The Committee observes that there is a wide acceptance among academicians and experts that demand side factors, as represented by sales can be a valid ground for attribution of profits. On the question whether OECD approach for profit attribution (AOA) can be considered appropriate, there appear to be no agreement among experts and a number of international authors completely disagree with it, and have been critical of it. The Committee further notes that the OECD approach of revising Article 7 by adopting the purely supply approach of profit attribution and exclusion of sales as a contributing factor is neither supported by the views of renowned experts, nor has it been able to generate a theoretical basis that is supported by contemporary academicians and experts till date.

Section 7 Position of India on Inadequacies of Revised Article 7, AOA & FAR based Profit Attribution

7.5 Committee’s Observations

109. The Committee observes that the AOA approach restricts the taxing rights of the jurisdiction that contributes to business profits by facilitating demand, and thereby has the potential to break the virtuous cycle of taxation that benefits all stakeholders in the global economy. Instead, it can set a vicious cycle in place that is destined to lead to losses for all stakeholders. Thus, while AOA approach may be favorable to the interests of certain countries that are net exporters of capital and technology, it is likely to have a very significant adverse impact on all other stakeholders, especially the developing economies like India, which are primarily importers of capital and technology.

110. The Committee also observes that India has documented its disagreement with the revised Article 7 by not only reserving its right not to include it in its tax treaties, but also documented the rejection of the approach inherent in it. Further, India has consistently communicated and shared its view that since business profits are dependent on sale revenue and costs, and since sale revenue depends on both demand and supply, it is not appropriate to attribute profits exclusively on the basis of function, assets and risks (FAR) alone. Lastly, since the revised Article 7 recommended by OECD since 2010 onwards has not been incorporated in any of the Indian tax treaties, the question of applying AOA for attribution of profits does not arise.

111. The Committee takes into account the fact that the additional guidance issued by OECD with reference to AOA in respect of the changes in Article 5 introduced by the Action 7 of the BEPS project on Artificial Avoidance of Profit Attribution, cannot apply to Indian tax treaties, since they do not incorporate the revised Article 7 of OECD model tax convention in respect of which AOA has been developed as a guidance. Though this position of India has been clearly communicated to the OECD, the Committee considers that there may be a need for bringing further clarity on how the profits will be attributed to the PEs under the Indian tax treaties, especially in consequence to the changes introduced as a result of Action 7.

Section 8 Court Decisions on Profit Attribution in India

8.4 Committee’s Observations

133. The Committee observes from the above discussion that the Courts have repeatedly endorsed the right of the Assessing Officer to attribute profits under rule 10 of the Rules, even in cases where tax treaties were applicable, thereby confirming that application of rule 10 is permissible for attribution of profits in such cases. The Committee also observes that in several of these cases, the Courts have also upheld the right of India to attribute profits by apportionment, as permissible under Indian tax treaties.

134. The Committee notes with concern that very diverse methodologies seem to have been adopted in different cases in attributing profits to the PEs. In the view of the Committee, this may be a result of the wide scope of discretion accorded under rule 10 in terms of methodology for attribution of profits. Since lack of a universal rule can create  uncertainties for taxpayers as well as result in more tax disputes, there appears to be a case for providing a simple and universally applicable rule to bring in greater certainty and predictability among the stakeholders and prevent avoidable tax litigation on this account.

Section 9 Need for Clarity in India’s Approach on PE Attribution: Various Options for a More Specific rules

9.7 Summary of Committee’s Observations

164. After taking into account the preceding details and the analysis of methods for profit attribution, the Committee unanimously agreed that there is a need to consider possible options that can be adopted as a uniform method of profits attribution by apportionment under rule 10, in accordance with India’s position and views. Accordingly, the Committee considered the possible options.

165. Regarding the option of Formulary Apportionment, the Committee was of the view that since it requires an apportionment of consolidated profits of the enterprise derived from different jurisdictions, it may not be feasible due to practical constraints in obtaining details related to operations in other jurisdictions.

166. The Committee considered the option of Fractional Apportionment based on apportionment of profits derived from India and observed that such an approach is permissible under paragraph 4 of Article 7 of Indian tax treaties as well as rule 10 of the Rules and being based largely on information related to Indian operations, is also practicable. For this purpose, the Committee found considerable merit in a three factor method based on equal weight accorded to sales, representing demand, and manpower and assets, which represent supply including marketing activities.

167. In view of the principle laid down by the Hon’ble Supreme Court in the case of DIT Vs Morgan Stanley, as well as the need to avoid double taxation of such profits in the hands of a PE as well as an Indian subsidiary participating in the integrated business, the Committee arrived at a view that profits derived from Indian operations that have  already been subjected to tax in India should be deducted from the apportioned profits. The Committee observed that in a case where no sales takes place in India, and the profits that can be apportioned to the supply activities have already been taxed in the hands of an Indian subsidiary, no further taxes would need to be paid by the PE. The Committee observes that the profits derived from India need to be defined objectively, and considers that the same can be arrived at by multiplying the revenue derived from India with the global operational profit margin. However, acknowledging the contribution of market jurisdictions, where the enterprise is having global losses or where its  global operational profit margin is less than 2%, the same can be arrived at by deeming the global operational profit margin to be 2%.

Section 10 Profit Attribution in Significant Economic Presence Nexus

10.3 Committee’s Observations

176. The Committee, after detailed deliberation, considered the various aspects of users’ contribution in the digital economy and also the fact that the role of user has blurred the traditional demand and supply functions. Taking these factors into consideration, the Committee arrived at a unanimous view that user contribution can be a substitute to either assets or employees, and supplement their role in contributing to profits of the enterprise. However, putting users together with either manpower or assets can pose significant challenges in distributing their respective shares within the assigned weight for their category (i.e. 33% for manpower or 33% for assets). Accordingly, the Committee found it reasonable that for business models in which users contribute significantly to the profits of the enterprise, they should also be taken into account for the purpose of attribution of profits, as the fourth factor for apportionment, in addition to the other three factors of sales, manpower and assets.

177. The Committee also noted that in its recent amendment of the 2016 proposal for CCCTB90,  the European Commission has now proposed a new four factor formula, that includes users as the fourth factor, in addition to sales, manpower/wages and assets and is given equal weight of 25% as given to other factors.

178. The Committee considered the option of following the approach of the EU in CCCTB and assigning users the same weight as other three. However, the Committee also considered that different weights are to be ascribed to different categories of digital businesses depending upon the level of user intensity. The Committee decided to assign a lower weight of 10% to the users for those business models involving low or medium user intensity and assigning a weightage of 20% to users in those business models involving high user intensity. The Committee also decided that since the users carry out the work of employees and are also assets to the company, the relative weightage of employees and assets will be adjusted downwards, keeping the weightage of sales fixed at 30% in both the cases.

Section 11 Conclusions &Recommendations of the Committee

11.1 Summary of Committee’s Observations & Conclusions

180. The business profits of a non resident enterprise is subjected to the income-tax in India only if it satisfies the threshold condition of having a business connection in India, in which case, profits that are derived from India from its various operations including production and sales are taxable in India, either on the basis of the accounts of its business in India or where they cannot be accurately derived from its accounts, by application of rule 10, which provides a wide discretion to the Assessing Officer. Where a tax treaty entered by the Central government is applicable, its provisions also need to be satisfied for such taxation. As per Article 7 of UN model tax convention (which is usually followed in most Indian tax treaties, sometimes with variations), only those profits of an enterprise can be subjected to tax in India, which are attributed to its PE in India, and would include profits that the PE would be expected to make as a separate and independent entity. Under the force of attraction rules, when applicable, it would include profits from sales of same goods as those sold by the PE that that are derived from India without participation of PE. Profits attributable to PE can be computed either by a direct accounting method provided in paragraph 2 or by an indirect apportionment method provided in paragraph 4 of Article 7.

181 An analysis of Article 7 and its legal history shows that there are three standard versions. The Article 7 which exists in UN model tax convention is similar to the Article 7 as it existed in the OECD model convention prior to 2010, except that the UN model tax convention allows the application of force of attraction rules and restricts deduction of certain expenses payable to head office by the PE. This Article in the OECD model convention was revised in Under the revised article the profits attributable to the PE are required to be determined taking into account the functions, assets and risk, and the option of determining them by way of apportionment has been excluded.

182. One of the primary implications of the 2010 revision of Article 7 by OECD was that in cases where business profits could not be readily determined on the basis of accounts, the same were required to be determined by taking into account function, assets and risk, completely ignoring the sales receipts derived from that tax jurisdiction. This amounts to a major deviation, not only from the rules universally accepted till then, but also from the generally applicable accounting standards for determining business profits, where business profits cannot be determined without taking sales into account.

183. Economic analysis of factors that affect and contribute to business profits makes it apparent that profits are contributed by both demand and supply of the goods. Accordingly, a jurisdiction that contributes to the profits of an enterprise either by facilitating the demand for goods or facilitating their supply would be reasonably justified in taxing such profits. The dangers of double taxation of such profits can be eliminated by tax treaties. If taxes collected facilitate economic growth in that jurisdiction, the demand for goods rises, which in turn also benefits the taxpaying enterprise, resulting in a virtuous cycle that benefits all stakeholders. On the contrary, if the jurisdiction is unable to collect tax from the nonresident suppliers, it would be forced to collect all the taxes required from the domestic taxpayers, which in turn would reduce the ability of consumers to pay, reduce their competitiveness, hurt economic growth and the aggregate demand, resulting in a vicious cycle, which will adversely affect all stakeholders including the foreign enterprises doing business therein.

184. Broadly, possible approaches for profit attribution can be summed in three categories– (i) supply approach allocates profits exclusively to the jurisdiction where supply chain and activities are located; (ii) demand approach allocates profits exclusively to the market jurisdiction where sales take place; (iii) mixed approach allocates profits partly to the jurisdiction where the consumers are located and partly to the jurisdiction where supply activities are undertaken.

185. The mixed approach appears to have been most commonly adopted in international practices, though in some cases, demand approach has also been favored. In contrast, supply side does not appear to have been adopted anywhere, except in 2010 revision of Article 7 of the OECD model convention, which requires determination of profits without taking sales into account. As a consequence, the contribution of demand to profits is completely ignored.

186. A purview of academic literature and views suggests a wide acceptance in theory that demand, as represented by sales can be a valid ground for attribution of profits. There also exists a diversity of views among academicians and experts on the validity of the revised OECD approach for profit attribution contained in the AOA. A number of international authors disagree with it, and many have been critical of this approach.

187. The AOA approach can have significant adverse consequences for developing economies like India, which are primarily importers of capital and technology. It restricts the taxing rights of the jurisdiction that contributes to business profits by facilitating demand, and thereby has the potential to break the virtuous cycle of taxation that benefits all stakeholders. Instead, it can set a vicious cycle in place that can harm all stakeholders.

188. The lack of sufficient justification or rationale and its potential adverse consequences fully justify India’s strongly worded position on revised Article 7 of OECD model convention, wherein India has not only found it unacceptable for adoption in Indian tax treaties, but also rejected the approach taken therein. This view of India, that since business profits are dependent on sale revenues and costs, and since sale revenues depends on both demand and supply, it is not appropriate to attribute profits exclusively on the basis of function, assets and risks (FAR) alone, has been communicated and shared with other countries consistently and on a regular basis.

189. Since, the revised Article 7 of OECD model tax convention has not been incorporated in any of the Indian tax treaties, the question of AOA being applicable on Indian treaties or profit attributed therein cannot arise. For the same reason, additional guidance issued by OECD with reference to AOA in respect of the changes in Article 5 introduced by the Action 7 of the BEPS project on Artificial Avoidance of PE Status, also does not have any relevance to Indian tax treaties. This, however, means that India cannot depend on OECD guidance and gives rise to a need for India to consider ways and means for bringing greater clarity and objectivity in profit attribution under its tax treaties and domestic laws, especially in consequence to the changes introduced as a result of Action 7.

190. An analysis of case laws indicates that the courts have upheld the application of rule 10 for attribution of profits under Indian tax treaties. In several such cases, the right of India to attribute profits by apportionment, as permissible under Indian tax treaties, has also been upheld by the courts. The judicial authorities do not appear to have insisted on a universal and consistent method. They have also upheld the wide discretion in the hands of Assessing Officer under rule 10 of the Rules, but corrected or modified his approach for the purpose of ensuring justice in particular cases. Thus diverse methods of attributing profits by apportionment under rule 10 of the Rules are in existence. In view of the Committee, the lack of a universal rule can give rise to tax uncertainty and unpredictability, as well as tax disputes. Thus, there seems to be a case for providing a uniform rule for apportionment of profits to bring in greater certainty and predictability among taxpayers and avoid resultant tax litigation.

191. A detailed analysis of methods adopted by tax authorities for attributing profits in recent years also highlight similar diversity in the methods adopted by assessing officers for attribution of profits, which reaffirms the need to consider possible options that can be consistently adopted as an objective method of profits attribution under rule 10 of the Rules, and bring greater clarity, predictability and objectivity in this exercise. Any options considered for this purpose, must be in accordance with India’s official position and views and must address its concerns.

192. Accordingly, the Committee considered some options based on the mixed or balanced approach that allocates profits between the jurisdiction where sales take place and the jurisdiction where supply is undertaken. The Committee did not find the option of formulary apportionment method apportioning consolidated global profits feasible, in view of the practical constraints in obtaining information related to jurisdictions outside India. Thus, Committee considers that it may be preferable to adopt a method that focuses on Indian operations primarily and derives profits applying the global profitability, with necessary safeguards to prevent excessive attribution on one hand and protect the interests of Indian revenue on the other.

193. The Committee found the option of Fractional Apportionment based on apportionment of profits derived from India permissible under Indian tax treaties as well as rule 10, and relatively feasible as it is based largely on information related to Indian operations. Out of various possible options of apportioning profits by a mixed approach, Committee found considerable merit in the three factor method based on equal weight accorded to sales (representing demand) and manpower and assets (represent supply including marketing activities).

194. After taking into account the principle laid down by the Hon’ble Supreme Court in the case of DIT Vs Morgan Stanley, and the need to avoid double taxation of profits from Indian operations in the hands of a PE, which is primarily brought into existence either by the presence of an Indian subsidiary carrying on parts of an integrated business, whose profits are separately taxed in its hands in India, the Committee found it justifiable that the profits derived from Indian operations that have already been subjected to tax in India in the hands of a subsidiary should be deducted from the apportioned profits. The Committee observed that in a case where no sales takes place in India, and the profits that can be apportioned to the supply activities are already taxed in the hands of an Indian subsidiary, there may be no further taxes payable by the enterprise.

195. In this option, in order to ensure objectivity and certainty, profits derived from India need to be defined objectively. The Committee considers that the same can be arrived at by multiplying the revenue derived from India with global operational profit margin91. However, the Committee also noted the need to protect India’s revenue interests in cases where an 91 In order to avoid any doubt the global operational profit margin is the EBITDA margin (Earnings before interest, taxes, depreciation and amortization) of a company enterprise having global losses or a global profit margin of less than 2%, continues with the Indian operations, which could be more profitable than its operations elsewhere. In view of Committee, the continuation of Indian operations justifies the presumption of higher profitability of Indian operations, and in such cases, a deeming provision that deems profits of Indian operations at 2% of revenue or turnover derived from India should be introduced.

196. After taking into account the developments in taxation of digital economy and the new Explanation 2A, inserted by the Finance Act, 2018, explicitly including significant economic presence within the definition of business connection, the Committee considered it necessary to take into account the role and relevance of users in contributing to the business profits of multidimensional business enterprises. Users can be a substitute to either assets or employees, and supplement their role in contributing to profits of the enterprise.

197. After considering various aspects of users’ contribution the Committee came to the conclusion that user data and activities contribute to the profits of the multidimensional enterprises, and there is a strong case of taking them into account, per se, as a factor in apportionment of profits derived from India by enterprises conducting business through multidimensional business models where users are considered crucial to the business. The Committee concluded that for such enterprises, users should also be taken into account for the purpose of attribution of profits, as the fourth factor for apportionment, in addition to the other three factors of sales, manpower and assets.

198. Although a recent amendment of the 2016 proposal for CCCTB has proposed assigning a weight to the users that is equal to other three factors of sales, manpower and assets, the Committee found it preferable to assign a relatively lower weight of 10% to users in low and medium user intensity models and 20% in high user intensity models at this stage, with the corresponding reduction in the weightage of employee and assets except for sales being assigned 30% weight in apportionment in both the fact patterns. Given the rapid expansion of digital economy and the ongoing developments related to rules governing its taxation, it may be necessary to monitor the role of users and their contribution to profits in future and accordingly assess the need for considering a review of the weight assigned to users in subsequent years.

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