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15 December 2017 India's positions on permanent establishment in OECD's 2017 Update to Model Tax Convention and Commentary On 21 November 2017, the Organisation for Economic Co-operation and Development (OECD) approved the contents of the 2017 Update to the OECD Model Tax Convention (MTC) and Commentary (the OECD Model).1 Like the previous updates, the 2017 Update contains the positions of OECD and non-OECD member countries, including those of India,2 on the OECD MTC and its Commentary. India's positions to the 2017 Update are mainly on Permanent Establishment (PE), Mutual Agreement Procedure (MAP) and on certain other miscellaneous provisions such as the tie-breaker rule for residence of non-individuals, and tax treaty eligibility for transparent entities, among others. The OECD's Base Erosion and Profit Shifting (BEPS) Action 1 Final Report, issued in October 2015, examining the tax challenges of the digital economy identifies, among others, a new nexus test in the form of "significant economic presence" as an additional option for determination of taxable presence in a state.3 This is, however, not a specific recommendation in the Final Report and the OECD's work on Action 1 is still in progress, with the final outcome expected in 2020. Further, as per the 2014 Model Commentary, a website which is a combination of software and electronic data, does not create a PE since the enterprise does not have a physical presence at a location that can constitute a "place of business." On this, India reserved a position that a website can create a PE in certain circumstances or by virtue of hosting a website on a server at a particular location.
The 2017 Update expands the scope of DAPE to cover a person who habitually plays the principal role in the conclusion of contracts that are routinely concluded without material modification by the enterprise. India has reserved a right on non-inclusion of the term "routinely." In other words, Agency PE can be created even if contracts are concluded without material modification by the enterprise on a non-routine basis. Person working exclusively for a foreign enterprise cannot be considered as independent, irrespective of its close relationship with the enterprise The 2017 Commentary provides that if a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent. India has reserved a right on non-inclusion of the term "to which it is closely related." Thus, according to India, if a person acts exclusively or almost exclusively on behalf of one or more enterprises, such person may not qualify as an independent agent, irrespective of whether such person is closely related to the enterprise or not. In the 2017 Update, a new anti-fragmentation rule has been introduced, which seeks to deny the PE exemption of preparatory/auxiliary activities if specific conditions are satisfied. The Commentary clarifies that unless the anti-fragmentation rule is applicable, the preparatory/auxiliary activity condition is of no relevance in a case where an enterprise maintains several fixed places of business to which other listed PE exemption clauses apply since, in such cases, each place of business has to be viewed separately and in isolation for determining whether a PE exists. India does not agree with the above interpretation. According to India, even when the anti-fragmentation provision does not apply, an enterprise cannot fragment a cohesive operating business into several small operations in order to argue that each is merely engaged in a preparatory or auxiliary activity. The 2017 Commentary states that a buy-sell distributor (irrespective of whether it is an associated enterprise or not) may not be considered as a DAPE since it is neither acting on behalf of a nonresident enterprise nor is it selling goods that are owned by such enterprise. The goods that are sold to the customers are owned by the distributor itself. This conclusion would apply even if the distributor acted as a "low-risk distributor." India does not agree with the above interpretation because it considers that distribution of goods owned by an enterprise (by an associated or related enterprise) may create PE, particularly in a case where the risks are not borne by such distributor. The 2017 Commentary provides that where an enterprise does not have a right to be present at a location and does not use that location itself, that location cannot be considered as being at the disposal of the enterprise. Further, with regard to home office as PE, the 2017 Commentary introduces an example of a cross-frontier worker who performs most of his work from his home situated in one state rather than from the office made available to him in the other state, in such case his home should not be considered as being at the disposal of the enterprise.
According to the OECD, a PE is deemed to exist only if there is certain degree of permanence in the source country. In general practice, this is satisfied if the place of business is maintained for a period of six months. An exception to this condition is a case where business activities are carried on exclusively in a country. In such case, even if the business exists for a shorter duration, due to the nature of the business activity, its connection with that country is stronger. This exception is illustrated in the following two circumstances:
India disagrees with the OECD's view in scenario 2. According to India, operation of catering facilities in scenario 2 also meets the time requirement for constituting a PE. Repair work on project subsequent to completion of construction work to be added to original construction period The 2017 Update states that a building site or construction or installation project constitutes a PE only if it lasts more than 12 months. It is clarified that work undertaken on a site after the construction work, pursuant to a guarantee that requires an enterprise to make repairs, would normally not be included in the original construction period. India does not agree with such interpretation. According to India, any work undertaken on a site shortly after the construction work has been completed, including repair works undertaken pursuant to a guarantee, may be taken into account as part of the original construction period. Collection of information on risks not preparatory or auxiliary, in the case of an insurance company According to the OECD, if a fixed place of business is used merely for collecting information for an enterprise, such place may not be treated as PE, provided such activity of information collection qualifies as preparatory or auxiliary for the enterprise. To illustrate this, if an insurance company sets up an office solely for the collection of information, such as statistics or for understanding risks in a particular market, such collection of information will be a preparatory activity. India does not agree with the above interpretation. Collection of data for the purpose of determination or quantification of risk by an enterprise in the business of managing risks, such as insurance, is not an activity of preparatory or auxiliary character. The 2017 Commentary states that treatment under VAT/GST is irrelevant for the purposes of the interpretation and application of the definition of PE. Hence, when evaluating PE status, one should not draw any inference from the treatment of a foreign enterprise (including registration) for VAT/GST purposes. India does not agree with the above. According to India, treatment under VAT/GST can be a relevant factor for determining PE status. Tax treaties generally provide that the business profits of a foreign enterprise are taxable in a State only to the extent that the enterprise has in that State a PE to which the profits are attributable. The definition of PE, and its interpretation, is therefore crucial in determining whether a nonresident enterprise must pay income tax in another State. Traditionally, India has sought to have greater source country taxation while allocating taxing rights under a tax treaty by seeking to have a broader definition of PE as compared to the OECD standard. Consistent with this objective, the positions stated by India in the 2017 Update reflect a broader application of some of the PE rules. India's positions serve as a guide to taxpayers on the likely approach of the Indian tax administration during audits, and also as a broad outline of India's tax treaty policy to countries seeking to negotiate a tax treaty with India. However, these positions are unilateral actions and may not be legally binding on taxpayers or on Courts while interpreting a tax treaty. Also, a preponderant judicial view in India has been that India's positions on the OECD MTC may be relevant, if at all, only while interpreting tax treaties which will be entered into by India after making these positions. Multinational enterprises should evaluate how these positions may impact their PE risk assessment in India and the potential for tax controversy if these positions are proposed by the Indian tax authority during PE audits. 1 See EY Global Tax Alert, OECD Council approves 2017 update to OECD Model Tax Convention, dated 1 December 2017. 2 India was granted the "Observer Status" in July 2006 and participates in the OECD's work under the enhanced engagement program. 3 See EY Global Alert, OECD releases final report on the tax challenges of the digital economy under Action 1, dated 23 October 2015. 4 2017 amendments to Article 5(5) and 5(6) of the OECD Model are based on the BEPS Action 7 Final Report. See EY Global Tax Alert, OECD releases final report on preventing the artificial avoidance of permanent establishment status under Action 7, dated 19 October 2015. Document ID: 2017-5038 |
