India has been an active advocate of the initiative by Organisation for Economic Co-operation and Development and the G20 on the Base Erosion and Profit Shifting (BEPS) project. The outcome of the project, in the form of 15 action plans, addresses various issues of tax avoidance contemporaneous with the current digitalized business environment. The final report provided its recommendations pertaining to various domestic and tax treaty provisions. Considering the colossal number of such tax treaties, the Action Plan 15 recommended creation of a multilateral instrument (MLI) wherein one document containing all the amendments could be applicable to all the tax treaties. The MLI has had 78 countries and counting, to being a signatory to the convention, including India.
As a part of the Budget proposals, the government aims to toughen the existing ‘Business Connection’ (treaty equivalent of the term ‘Permanent Establishment’) regime by adopting the more stringent definition of Dependent Agent Permanent Establishment (DAPE) as has been provided by the OECD under BEPS Action Plan 7 and the MLI.
Since India is a signatory to the multilateral instrument, the DAPE provisions of India’s tax treaties, as modified by MLI, shall become wider in scope than the current provisions contained in the Income-tax Act, 1961 (the Act), and as a result of this non-residents would have an option to choose the provisions of the Act that are beneficial to them.
By virtue of this proposed amendment, the definition of the DAPE as per the Act is being amended to be at par with the definition contained in the MLI.
The proposed amendment is in two parts:
As per existing provisions, in order to constitute a taxable presence (that is, a business connection) in India, inter alia, any person acting on behalf of the non-resident must have had an authority to conclude contracts on behalf of such non-resident. By merely taking away such authority, certain taxpayers would take the benefit of the loophole in the law and avoid payment of taxes in India.
Under the revised definition proposed in the Finance Bill 2018, an agent would include not only a person who habitually concludes contracts on behalf of the non-resident, but also a person who habitually plays a principal role leading to the conclusion of contracts.
It would be relevant to note that though the provisions of the MLI have not yet come into force, if the proposed amendments are passed by the Parliament, these would be effective from 1 April 2018. While this would not affect treaty partners, non-residents from countries with which India does not have a tax treaty and which are operating in India through agents, would be impacted.
Significant Economic Presence
As per BEPS Action Plan 1, OECD analysed three ways to tax digital transactions undertaken by the non-residents without having any physical presence in a country: (i) a new nexus in the form of a significant economic presence, (ii) withholding tax on certain types of digital transactions, and (iii) an equalization levy. OECD left it to individual countries to adopt any of these three measures in their domestic law as additional safeguards against BEPS.
India has already introduced the concept of equalisation levy as a separate code by Finance Act, 2016, in order to tax certain digital transactions.
However, it seems that the government is of the opinion that the equalization levy is not a one-stop solution and the memorandum to the Finance Bill, 2018 specifically addresses this issue of tax avoidance in a digital economy.
A non-resident enterprise interacts with customers in another country without having any physical presence in that country resulting in avoidance of taxation in the source country. Therefore, going a step further, the Finance Bill, 2018, now proposes to tax digital transactions on the basis of ‘significant economic presence’ vis-à-vis ‘physical presence’ by making amendments to the definition of the term ‘business connection’ as provided under the Act.
A non-resident enterprise that generates significant revenues from in-country customers by targeting them through digital means and without any physical presence would be a substantial economic presence.
The proposed amendment would only make an impact if India is able to negotiate its treaties to include ‘significant economic presence’ in the definition of Permanent Establishment.
It appears that India is adopting a two-pronged approach to tax e-commerce trade to demand its share of taxes.
K.R. Sekar is partner with Deloitte India