In recent times, the innovation in technology has helped to bring individuals and information together more than ever. However, it has also led to evolution of complex transactions which has encouraged tax avoidance practices. It has been widely reported that multinational corporations resort to base erosion and profit sharing (BEPS) techniques to shift their profit to tax havens or nations with lower tax incidence. For dealing with such challenges, the G20 nations at the 2012 Los Cabos summit tasked the Organisation for Economic Cooperation and Development (“OECD”) to develop the BEPS Action Plan.
The Action Plan 1 deals with tax challenges in a digital economy and Action Plan 7 deals with the definition of permanent establishment (“PE”) with a view to prevent avoidance of tax by circumventing the existing definition of PE.
Since it was impractical to renegotiate the existing tax treaties for incorporating the 14 BEPS Action Plans of OECD, a Multilateral Instrument (“MLI”) was created by way of Action Plan 15 for modifying the tax treaties simultaneously. Since India is a signatory to the MLI, it has resulted in modification of its tax treaties with other signatories to MLI. In order to align the Indian income tax provisions with tax treaties, two amendments have been proposed in the Union Budget 2018. The proposed amendments seek to bring enterprises having a digital presence in India within the tax net and widen the definition of dependent agency permanent establishment.
Significant Economic Presence
The BEPS Action Plan 1 focuses on solving the digital issue i.e. identifying appropriate tax rules for addressing the tax challenges presented by digital businesses. The final report on BEPS Action Plan recommended that nexus of an income should be established where a non-resident has a “significant economic presence” evidenced by factors such as revenue from remote transactions, local domain names, localized websites, local currency payment options, number of active users in a country, online contracting and data collection.
In the view of above, the government has proposed to amend the definition of business connection as defined in Section 9(1)(i) of the Income Tax Act, 1961 by inserting Explanation 2A to provide that “significant economic presence” in India shall constitute business connection in India.
“significant economic presence for this purpose shall mean-
(i) 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
(ii) 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.“
The income attributable to such transactions shall be deemed to accrue or arise in India. Further, it is pertinent to note that it would be irrelevant whether the non-resident has a place of residence in India or not. The threshold limit for such transactions has not been prescribed by the government. It is expected that the government would be careful in deciding such threshold limit so that other unintended digital transactions are not covered in the definition of “significant economic presence”, which would invite unnecessary litigation cost.
The provision of “significant economic presence” has not been incorporated in any tax treaty which India has entered, and thus would have a limited impact. The government may intend to accordingly renegotiate its tax treaties.
Dependent Agent Permanent Establishment
Under the existing Indian tax laws, a dependent agent would be deemed to constitute a PE of the non-resident enterprise if it habitually concludes contracts on behalf of the non-resident, or habitually maintains a stock on behalf of the non-resident out of which deliveries are made, or habitually secures contract for the behalf of non-resident.
In order to bridge the gap between agency PE as per tax treaties (after incorporating changes proposed in BEPS Action Plan 7) and Indian tax laws, the government has proposed to amend the definition of business connection. The clause (a) to Explanation 2 of Section 9(1)(i) has been amended to provide:
“business connection shall include any business activity carried out through a person who, acting on behalf of the non-resident,—
(a) has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident or habitually concludes contracts or habitually plays the principal role leading to conclusion of contracts by that non-resident and the contracts are––
(i) in the name of the non-resident; or
(ii) 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
(iii) for the provision of services by the non-resident”
The term ‘principal role leading to conclusion of contracts’ has not been defined under the Indian tax laws or BEPS Action Plan. Although, the commentary on BEPS Action Plan 7 provides that following situations may constitute ‘principal role leading to conclusion of contracts’:
The non-resident enterprises used to avoid the creation of a PE in India by signing the contract outside India, even though major sales activity was conducted by the agent in India. By way of this proposed amendment, the government seems to bring such transactions within the ambit of the Indian income tax laws. To avoid disputes, it is expected that government would issue clarifications to define cases where agent plays a principal role leading to conclusion of contracts.
It can be inferred from the above two amendments that the government intends to plug the loophole which enabled the non-resident enterprises to circumvent the provisions of agency PE without being subject to income tax and bring enterprises having a digital presence in India within the tax net.
With these amendments, the existing businesses operating through the agency model in India may need to reassess their business structure. The government needs to carefully consider the threshold limit for digital transactions so that unintended enterprises do not fall into the tax net. Moreover, the government would need to renegotiate its tax treaties to ensure that enterprises having significant economic presence in India to constitute a PE.
(Authored by – Akshit Gulati, Asst. Manager, Direct Tax at International Business Advisors)