The MLI makes three key changes to the PE rules in India that will impact foreign companies:
- Amending when a foreign enterprise constitutes an agency PE in India;
- Amending the provisions on commissionaire arrangements; and
- Changing the specific activity exemptions that will significantly impact foreign companies carrying out preparatory or auxiliary activities in India.
Rakesh Nangia, chairman of Nangia Andersen Consulting, said these amendments are detailed in Articles 12, 13 and 14 of the MLI, which will change the way companies do business in India because it broadens the PE definition.
Part IV of the MLI targets the avoidance of the PE status. In brief:
- Article 12 covers commissionaire arrangements and similar strategies, including the dependent agent permanent establishment (DAPE) and independent agent rules;
- Article 13 covers specific activities, which would be listed under covered tax agreements. This most often relates to the preparatory or auxiliary activities of a foreign enterprise;
- Article 14 covers the splitting up of contracts. This refers to scenarios when a foreign enterprise reduces the time period of a contract to benefit from treaty benefits, but in reality the contracted activities are taking place over a longer period of time; and
- Article 15 cover the definition of a person closely related to an enterprise.
“All the marketing companies, all the support companies, all the companies working on cost-plus model may be threatened,” warned Nangia. “You need to see that if you are performing these functions, and you are being taxed on a cost-plus model, will this model survive?”
Several provisions in the MLI reference a business connection, but the Indian government has gone one step further than just amending its treaties on this matter with regards to Article 12. It has amended domestic law by changing the definition of ‘business connection’. This means that the MLI provisions will affect companies from treaty-partner countries, while those outside of this network get caught by the domestic law instead.
“There's a complete 360 degree attack on commissioning agents,” said Nangia.
However, there is one flaw in Article 12 because it is not a minimum standard in the MLI. “It will only apply when the other countries have accepted it. If the other country does not accept it, then this clause fails,” explained Nangia.
Nevertheless, tax directors have questioned the legal position of when the Indian entity has already been compensated at arm’s length for the work it carries out for a foreign enterprise under any of the four provisions.
“Is there anything left to be taxed in the hands of a PE, if even if there is one?” asked Amit Gupta, tax director at Dell Global.
Gupta pointed out that in cases such as Morgan Stanley (Mumbai v. Morgan Stanley and Co), if the Indian agent is already compensated at arm's length, with all functions taken into account, there's nothing more to be done.
“You can file a nil return, even if you admit that there is a PE, because there's nothing left to be attributed,” said Gupta.
He recommended that companies will have to look at its functions, but be aware of the expanded thresholds and note the language now states that negotiating a contract is enough to justify a PE.
All preparatory or auxiliary activities caught it the net
The MLI offers several options to countries under Article 5 to eliminate double taxation with regards to the preparatory or auxiliary nature of the activities listed in a covered tax agreement – Option A, B or none.
Amit Maheshwari, partner at AKM Global, explained that India has chosen Option A, which broadly means that all activities have to be checked for their preparatory and auxiliary nature.
A part of the problem for companies is that the tax authority will deem any such activities as a PE, even if those activities are conducted at arm’s length.
Haroon Qureshi, vice president of taxes at Genpact, said that although the Indian tax authority has sought to apply PE rules wherever possible, whether rightly or wrongly, the difference now is that they have license to do so.
As a silver lining, however, Qureshi said that at least there is more clarity now and the risk of litigation is reduced.
Although, Vikas Aggarwal, head of tax at Home Credit, explained that if an Indian company buys stock from a related foreign company, proving that the transactions are arm’s length will not be enough to avoid PE exposure.
Create a legal entity and avoid the risk
Gupta’s advice to companies in a post-MLI world is to create a legal entity to reduce the risks they’re exposed to. For example, if there is any risk of a foreign company having PE exposure in India because of its activities, or because it has a liaison office, it would make sense to create a legal entity.
“A legal entity is taxed at 25% now, and dividends would depend on the treaty. Whereas a liaison office would be akin to a branch office from a taxability perspective,” Gupta said.
“If they [the tax authorities] say you have created a presence, which could mean 40% tax with no dividends because it’s a branch office, you're still better off being in a legal entity scenario,” he continued.
Gupta added that if procurement becomes a point of controversy, tax practitioners should remember that procurement itself does not generate profits.
“It could be a cost-plus remuneration for the activities that you're doing,” he said. “So, one has to look at the facts and then think about what you really want.”
APAs at risk
Besides settling the PE risks, advance pricing agreements (APAs) that straddle pre-MLI and post-MLI tax treaty benefits could be at threat. This may potentially expose taxpayers relying on such agreements to audits and reassessments.
Before the MLI entered into force in India on April 1, Nangia said that corporate business models would be taxed under the MLI measures once it enters into force, threatening APAs that are often done on a cost-plus basis. Nangia said taxpayers need check whether their APAs could be challenged.
“The APA covers the transfer pricing part [of a business model], but the MLI will hit your business income,” said Nangia, potentially impacting the whole business.
“Looking at the next five years, the APA remains the same, but the law has changed,” the chairman said.
There are no sunset clauses or grandfathering of rules once the MLI is in force, which means companies need to check their APAs against the post-MLI rules, or risk those agreements collapsing, warned Nangia.
Companies will need to maintain clear documentation to prove the APA is still in line with their business model. This documentation has to substantiate the roles of agents, employees, and wholly-owned subsidiary companies.
Gupta said companies should focus their functions, assets and risk (FAR) analysis of the Indian company. He argued this was the best approach to attribution. If the APA has been signed on a cost-plus basis, it “would boil down to the fact as to what’s mentioned in the FAR analysis”.
“If everything you believe has been already covered, I think that's a critical piece,” Gupta said. “If all aspects of a negotiation or anything, which leads to the conclusion of a contract, is already covered in the FAR analysis and the arm’s-length price has already been determined, there would be nothing left to be attributed further.”
It may be better for foreign enterprises to create legal entities in India to avoid unexpected PE exposures and ‘surprise’ tax assessments, as well as review their Indian APAs. However, companies need to carefully consider how they approach this.
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