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On February 1, 2018, India’s Finance Minister, Arun Jaitley, issued the country’s 2018 Budget, which introduces a new permanent establishment (PE) nexus based on virtual economic presence to tax business profits of foreign enterprises.
Jaitley’s Budget seeks to amend section 9(1)(i) of the Income Tax (IT) Act to provide that a “significant economic presence” in India shall constitute “business connection” of a foreign company in India. According to the Finance Bill, 2018, “significant economic presence” will exist where the aggregate of payments arising from a transaction during the previous year exceeds a certain prescribed amount.
Systematic and continuous soliciting of business or engaging with a prescribed number of Indian users in India through digital means will also give rise to a “business connection” in India.
In its Report on base erosion and profit shifting (BEPS) Action 1, the OECD discussed several options to tackle the direct tax challenges posed by digital economy, including the introduction of a new PE nexus based on “significant economic presence.” The proposal was subsequently dropped from the Final Report on BEPS Action 1, which was published in October 2015.
An Explanatory Memorandum published alongside Budget 2018 explains: “For a long time, nexus based on physical presence was used as a proxy to regular economic allegiance of a non-resident. However, with the advancement in information and communication technology in the last few decades, new business models operating remotely through digital medium have emerged.”
“Under these new business models, the non-resident enterprises interact with customers in another country without having any physical presence in that country resulting in avoidance of taxation in the source country. Therefore, the existing nexus rule based on physical presence do not hold good anymore for taxation of business profits in source country.”
The changes to the definition of “business connection” will apply from April 1, 2019. The Finance Minister has clarified that business profits of foreign companies will continue to be taxed in India as per the existing rule based on a physical or representative presence, pending corresponding modifications to PE rule in tax treaties.
Changes to dependent agent PE rule
Next, the Budget broadens the scope of “business connection” contained in Explanation 2 to section 9(1)(i) of the IT Act in line with the PE rule stipulated in the BEPS Multilateral Instrument. Under the new definition, “business connection” shall include business activities 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.
The Budget proposes that the contracts should be in the name of the non-resident, or 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 for the provision of services by that non-resident.
The amendment would bring the definition of “business connection” in line with BEPS Action 7, which sought to prevent tax avoidance by circumventing the PE definition through commissionaire arrangements and fragmentation of business activities.
CbC reporting requirement
Finally, the Budget seeks to rationalize the provisions relating to filing of country-by-country reports as contained in section 286 of the IT Act. The time allowed for furnishing CbC reports in the case of parent entity or alternative reporting entity, resident in India, is proposed to be extended to 12 months from the end of the “reporting accounting year.”
Additionally, constituent entity resident in India, having a non-resident parent, shall furnish a CbC report in case its parent entity outside India has no obligation to file the report in its country.
The amendments will take retrospective effect from April 1, 2017, and will apply from the 2017-18 assessment year.