All material subject to strictly enforced copyright laws. © 2022 ITR is part of the Euromoney Institutional Investor PLC group.

India seeks to codify rules on attribution of profits to a permanent establishment

Sponsored by

India seeks to codify rules on attribution of profits to a permanent establishment

On April 18 2019, the Central Board of Direct Taxes (CBDT) issued a public consultation report, laying down its proposal for attribution of profits to a permanent establishment (PE) in India. The report is India's first attempt to codify rules on attribution of profits to a PE.

Revisions to the definition of a PE in BEPS Action Plan 7, the introduction of unique business models, and inconsistency in domestic tax laws relating to model tax treaties are catalysts for revisiting the domestic tax laws relating to attribution of profits to a PE in India.

The reports interpretation

The report summarises the committee's interpretation of Article 7 under the UN's Model Tax Convention (MTC) and the OECD's MTC in pre- and post-2010 amendment form.

According to the committee, the approach on attribution of profits to a PE could be segregated into:

  1. Supply approach (allocates profits where supply chain and activities are located);

  2. Demand approach (allocates profits where sales takes place); and

  3. Mixed approach (allocates profits considering both supply and demand).

The report also deliberates on the economic basis for allocation of taxing rights, the practice followed in some jurisdictions, the views of certain experts and academics, and the Indian courts' positions on attribution of profits to a PE.

It is important to note that the committee holds that provisions of Article 7 of the revised OECD MTC (post 2010) which advocates attribution of profits following the arm's-length principle (ALP) is absent in the OECD MTC (pre 2010), UN MTC and the India treaties.

The committee finally holds that Article 7 of the UN MTC, OECD MTC (pre-2010), and Indian model tax treaties prescribed a "mixed approach" towards attribution of profits to a PE which can be achieved through the formulary method, with proper safeguards through weights relating to several factors such as assets and wages. These are coined by the committee as "fractional apportionment" under the overall canopy of the formulary method.

The committee also recommends attributing 2% of revenues derived from India to the PE in cases where the enterprise is incurring a loss.

Arm's-length principle

The attribution of profits to a PE, taking it into account a distinct and separate enterprises engaged in the same or similar activities of which it was a PE (OECD pre-2010), is nothing but the application of the ALP.

UN MTC on Article 7 resembles the OECD's pre-2010 approach (ALP) with two additional stipulations, i.e. (1) the 'force of attraction' rule, and (2) 'limitation on expense deductions' for a PE. Indian tax treaties follow the UN MTC and also resemble the pre-2010 OECD MTC.

Simply concluding that the application of the ALP for allocating profit is a "supply approach (OECD post-2010)" fails to appreciate that an ALP analysis also mandates the adoption of the profit split method (PSM) under special circumstances, namely where both PE and head office (HO) contribute to unique/non-routine intangibles, resulting in the appropriate attribution of profits to the market place.

In fact, unlike the past, greater focus on value creation analysis and application of the development, enhancement, maintenance, protection and exploitation (DEMPE) functions under the ALP will also lead to appropriate attribution of profits to the PE if the PE is involved in any activities pertaining to key value drivers or intangibles in the business.

The ALP approach will help to achieve the objective of the mixed approach, without resorting to application of the formulary approach, which fails to recognise key factors like industry nuances, business models, and the possibility of double taxation.

One needs to appreciate that the application of the ALP for attribution of profits to a PE has always been the recommended approach as per the UN MTC, OECD MTC (pre-2010) and Indian Income Tax Act 1961, though the OECD MTC (post-2010) has been more explicit.

more across site & bottom lb ros

More from across our site

This week Switzerland opens consultation on draft legislation to implement the OECD’s global minimum tax rate, while Germany cuts VAT amid the highest inflation rate in decades.
ITR looks into the biggest transfer pricing cases in 2022 including multinational companies McDonald’s, BlackRock, and Rio Tinto.
TP technical leader at ‘big four’ firm KPMG Philip Roper talks to senior reporter Leanna Reeves about how businesses can mitigate the transfer pricing impact of higher interest rates in the UK.
Vikas Garg talks to reporter Siqalane Taho about how regulation, technology and the goods and services tax has affected the manufacturing company.
A major shift is underway in tax as the profession transitions from a mostly accounting and finance sector to a hybrid industry that requires significant IT skills, say tax experts.
The Biden administration is about to give $80 billion to the Internal Revenue Service to enhance the tax authority’s enforcement processes and IT systems.
Audi, Porsche, and Kia say their US clients will face higher prices under the Inflation Reduction Act after the legislation axes an important tax credit for electric vehicle production.
This week Brazil’s former President Luiz Inacio Lula da Silva came out in support of uniting Brazil’s consumption taxes into one VAT regime, while the US Senate approved a corporate minimum tax rate.
The Dutch TP decree marks a turn in the Netherlands as the country aligns its tax policies with OECD standards over claims it is a tax haven.
Gorka Echevarria talks to reporter Siqalane Taho about how inflation, e-invoicing and technology are affecting the laser printing firm in a post-COVID world.
We use cookies to provide a personalized site experience.
By continuing to use & browse the site you agree to our Privacy Policy.
I agree