Two amendments have been proposed to Section 9. The first proposed amendment is substitution of clause (a) in the Explanation 2 to Section 9(1)(i) which defines the meaning of ‘business connection’. Such amendment is proposed in view of recommendation of Action Plan 7 of BEPS report. This Action Plan proposes measure to curb the practice of multi-national companies of artificially avoiding the PE in source state through commissionaire arrangements. The loopholes in existing provision and rationale behind such amendment are explained below.
Commissionaire Arrangements:A ‘Commissionaire Arrangement’ is defined as an arrangement through which a person sells products in a given State in its own name but on behalf of a foreign enterprise who is the owner of the products. Through such an arrangement, a foreign enterprise is able to sell its products in a State without having a PE to which such sales may be attributed to for tax purposes. Since the person that concludes the sales does not own the products, he cannot be taxed on the profits derived from such sales and may only be taxed on the remuneration that he receives for the services (usually a commission).
Loophole in Para 5 of Article 5 of India’s DTAA’s: Para 5 of Article 5 of India’s DTAAs which talk about the constitution of PE viadependent agent provides that an enterprise is deemed to have agency PE only if a person acting in its behalf habitually exercises authority to conclude contracts in name of enterprise. It is clear that to constitute an agency PE, contract must be concluded in the name of the enterprise.To take benefit of this loophole, enterprise enters into a ‘commissionaire arrangements’ with the intermediaries who sell products in a given State in their own name instead of its actual owner (i.e., the foreign enterprise) which eventually erodes the taxable base of the State where sale takes place.Further, in many cases the person acting on the behalf of the non-resident, negotiates the contract but does not conclude the contract
BEPS recommendation to address the above loophole: The OECD under BEPS Action Plan 7 reviewed the definition of ‘PE’ with a view to prevent the avoidance of payment of tax by circumventing the existing PE definition by way of commissionaire arrangements. The BEPS Action plan 7 recommended modifications to para (5) of Article 5 to provide that 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:
in the name of the enterprise; or
for the transfer of the ownership of, or for the granting of the right to use property owned by that enterprise or that the enterprise has the right to use; or
for the provision of services by that enterprise
India’s action on BEPS recommendations: The recommendations under BEPS Action Plan 7 have been included in Article 12 of Multilateral Convention to Implement Tax Treaty Related Measures (herein referred to as ‘MLI’), to which India is also a signatory. Consequently, these provisions will automatically modify India’s bilateral tax treaties covered by MLI, where treaty partner has also opted for Article 12. As a result, the Article 5(5) of India’s tax treaties, as modified by MLI, shall become wider in scope than the current provisions of the Explanation 2 to Section 9(1)(i) of the Income-tax Act.
Corresponding amendment proposed to section 9: Since in the instant situations, the provisions of the domestic law are narrower in scope and are more beneficial than the provisions in the DTAAs. It is proposed to amend the provision of section 9 of the Act so as to align them with the provisions in the DTAA as modified by MLI so as to make effective the provisions of treaties. Accordingly, Section 9(1)(i) has been proposed to be amended to provide that ‘business connection’ shall also include any 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 that non-resident and the contracts are:
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.
Taxability of digital transactions on principles of Significant Economic Presence
[Section 9 – Applicable from Assessment Year 2019-20]
Two amendments have been proposed to Section 9. The second proposed amendment is insertion of a new Explanation 2A to Section 9(1) (i) which would expand the scope of meaning of ‘business connection’. As per new the Explanation, the Significant Economic Presence of non-resident entities in India shall be deemed as business connection in India. Such insertion of a new Explanation would enable the Govt. to levy tax on dot com companies who have digital presence in India without any physical presence. Such amendment would also make it possible for the Govt. to renegotiate the provisions of treaty so as to include the similar provisions in the bilateral treaties on line’s of recommendation’s of Action Plan 1 of BEPS report.
Tax on Business Profits of non-residents: As per the allocation of taxing rules under Article 7 of DTAAs, business profit of an enterprise is taxable in the country in which the taxpayer is a resident. If an enterprise carries on its business in another country through a PE situated therein, such other country may also tax the business profits attributable to the PE.
Meaning of ‘Permanent Establishment’: It means a ‘fixed place of business’ through which the business of an enterprise is wholly or partly carried out provided that the business activities are not of preparatory or auxiliary nature and such business activities are not carried out by a dependent agent.
Is definition of PE outdated: For a long time, nexus based on physical presence was used as a proxy to regular economic allegiance of a non-resident. With advancement in information and communication technology, new business models operating remotely through digital medium have emerged, wherein the non-resident enterprises interact with customers in another country without having any physical presence in that country. Therefore, the existing nexus rule based on physical presence does not hold good anymore for taxation of business profits in source country. As a result, the right of the source country to tax business profits that are derived from its economy is unfairly and unreasonably eroded.
Definition of Business Connection is outdated: Explanation 2 to Section 9(1)(i) which defines the term ‘business connection’ is narrow in its scope as it limits the taxability of certain activities or transactions of non-resident to those carried out through a dependent agent. Therefore, emerging business models such as digitized businesses, which do not require physical presence of itself or any agent in India, is not covered within the scope of Section 9(1)(i).
What BEPS Action Plan 1 suggests: OECD in its BEPS Action Plan 1 addressed the tax challenges in a digital economy wherein it has discussed several options to tackle the direct tax challenges arising in digital businesses. One such option is a new nexus rule based on “significant economic presence”. As per the Action Plan 1, a non-resident enterprise would create a taxable presence in a country if it has a significant economic presence in that country on the basis of factors that have a purposeful and sustained interaction with the economy by the aid of technology and other automated tools. It is further recommended that revenue factor may be used in combination with the aforesaid factors to determine ‘significant economic presence’.
What is the proposed amendment: It is proposed that ‘significant economic presence’ in India shall also constitute ‘business connection’. Significant Economic Presence shall mean:
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
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.
It is also proposed that only so much of income as is attributable to such transactions or activities shall be deemed to accrue or arise in India.
It is further proposed that the transactions or activities shall constitute significant economic presence in India, whether or not the non-resident has a residence or place of business in India or renders services in India.
It is clarified that unless corresponding modifications to PE rules are made in the DTAAs, the cross border business profits will continue to be taxed as per the existing treaty rules.