India's 2018 Budget seals progress towards BEPS Project recommendations
Union Budget includes major BEPS related proposals on the digital economy, the country's permanent establishment rules and CbCR.
"Recent amendments to India’s direct tax laws show the willingness of India’s tax authorities to adopt the BEPS Project recommendations, with changes in the context of permanent establishment being the latest step in India’s BEPS journey."
Pankaj Dave, BMC Support & Accounting Services
India’s Government took a big step towards implementation of tax laws aligned with the recommendations in the OECD’s Base Erosion & Profit Shifting (BEPS) Project when the country’s Finance Minister presented the Union Budget 2018 in parliament on 1 February 2018. As a member of the G20, India has been a leader in adopting the BEPS Project recommendations. Pankaj Dave, Partner, explains more.
Some of the announced proposals are aligned with India’s plan to implement the various recommendations (actions) of the BEPS project in a phased manner.
For example, India has demonstrated its intention to create a feasible structure for bringing digital entities into the tax bracket. This applies to entities which sell to Indian consumers but don’t have a significant physical presence in India.
The Budget includes major proposals on:
i) Permanent Establishment
ii) Digital Permanent Establishment
iii) Country by Country Reporting (CbCR).
Permanent Establishment (PE)
The Indian Income Tax Act and other tax treaties signed with various countries have carefully incorporated the rules used to determine the permanent establishment (‘PE’) status of foreign entities which have a direct or indirect business connection to India. These rules have been defined and drafted in a largely similar manner.
Whether a company has a business connection to India is the main criteria for determining a foreign entity’s PE status and is given impetus in the Income Tax Act and Rules. These explain that if an employee who is working on behalf of a foreign entity is authorised to negotiate and execute contracts on the company’s behalf, then this constitutes a business connection to India, and therefore the existence of a PE.
To incorporate the recommendations under BEPS Action 7 (prevention of the artificial avoidance of PE status), the Budget included amendments to India’s direct tax laws which widen the scope of this ‘business connection’ by suggesting amendments which would treat a foreign entity as having a business connection to India if a person acting on behalf of the foreign entity:
(i) Has executed and/or routinely exercises the authority to conclude contracts
(ii) Routinely concludes contracts or
(iii) Routinely plays the leading role leading in concluding contracts on behalf of the foreign entity in India, and the contracts are:
• In the name of the foreign entity
• For the transfer of the ownership of, or the granting of the right to use, property owned by the foreign entity or which the foreign entity has the right to use, or
• For the provision of services by the foreign entity.
Digital Permanent Establishment
The second proposal to incorporate the existence of a digital PE in India represents another bold step towards implementation of BEPS Action 1 which relates to measures to cope with the challenges presented by the digital economy.
The proposal considers a foreign entity as having a business connection to India if it has a substantial economic presence in India. A substantial economic presence could be in the form of a business connection through a digital PE in India.
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Significant economic presence
To test the existence of this significant economic presence and to tax the business profit of the foreign entity in India, the Budget proposed that various domestic tax laws be amended under the Indian Income Tax Act.
Under the existing provisions of section 9(1)(i), an income is deemed to accrue or arise in India if it accrues or arises, directly or indirectly, through or from any ‘business connection’ to India. Explanation 2 of that section defines ‘business connection’ as including business activities carried out through a person who, acting on behalf of the non-resident, routinely exercises an authority to conclude contracts in India, or routinely maintains a stock of goods or merchandise in India, or routinely secures orders in India for the non-resident.
The Budget proposes to widen the scope of the current business connection threshold stipulated in section 9(1)(i) of the Income Tax Act and recommends taxing the profits of the foreign entity in India from April 2019 if it has a ‘significant economic presence’ in India. This is subject to the benefit of PE as per the respective tax treaties i.e. if a bilateral agreement has been entered into with a foreign country, then the PE has an option either to be taxed as per the Double Taxation Avoidance Agreement or as per the normal provisions in India’s Income Tax Act 1961, whichever is more favourable to the Assessee.
The benefit is given to PE under tax treaties to allow them to opt for the most favourable option as the tax treaties override the provisions stipulated in domestic laws.
Under traditional rules, the source state has the right to tax the business profits of a foreign entity only if the entity carries on business activities in the source state through a PE which requires a physical or representative presence. As companies which operate in the digital environment do not necessarily need to be physically present in the source state, governments around the world have spent much time discussing whether the traditional definition of PE needs to be looked at in order to ensure it applies to entities with a virtual or digital economic presence.
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Determination of significant economic presence
The BEPS Action 1 explanatory memorandum states that a non-resident enterprise creates a taxable presence in a country if it has a ‘significant economic presence’ in that country based on factors which have a purposeful and sustained interaction with the economy through the use of technology and other automated tools. Furthermore, it recommends that the revenue factor may be combined with the aforesaid factors to determine ‘significance economic presence’.
Aligned with the above recommendation, India’s Finance Bill 2018 states that a foreign company shall be said to have a significant economic presence in the country if: (a) the aggregate of payments arising from a transaction carried out by a non-resident during the financial year exceeds a yet-to-be prescribed amount; or (b) there is systematic and continuous soliciting of business activities or engaging in interaction with a yet-to-be prescribed number of Indian consumers through digital means.
For a foreign entity, a ‘significant economic presence’ in India means:
- One or more transactions in respect of any goods, services or property carried out by a foreign enterprise in India (including downloads of data or software in India) if the aggregate payments arising from such transactions during the year exceed a prescribed threshold; or
- A systematic and continuous soliciting of an entity’s business activities, or engaging in interaction with a number of consumers (as may be prescribed) in India through digital means
Whether the foreign entity has a place of business/service in India or not becomes irrelevant in the above circumstances.
The business connection rules defined in India’s direct tax laws determine the eligibility for taxation of the share of a foreign entity’s profit which can be reasonably attributed to operations carried out in India. However, after the implementation of Digital PE and testing for a significant economic presence, the portion of income attributable to the transactions or activities described above would also be liable to tax in India.
No existing Indian tax treaty (nor the MLI) incorporates the concept of digital PE or significant economic presence. This will impact taxpayers who are tax residents in a jurisdiction which does not have a tax treaty with India. However, India’s government has clarified that the proposed amendments to its domestic laws will enable India to negotiate the inclusion of a new nexus rule in its tax treaties in the form of rules to determine significant economic presence.
Country by Country Reporting in India
India’s Finance Minister also gave preference to implementation of CbCR reporting in the Budget with proposals consisting of clarifications intended to align India with the recommendation in BEPS Action 13.
A positive approach to implementing the BEPS Project recommendations
Recent amendments to India’s direct tax laws show the willingness of India’s tax authorities to adopt the BEPS Project recommendations, with changes in the context of permanent establishment being the latest step in India’s BEPS journey.
For more information
Contact Pankaj Dave at BMC Support & Accounting Services who have offices across India.