The COVID-19 pandemic has exposed catastrophic outcomes upon the entire world and India is no exception. The limited experience of handling such a crisis in India has already revealed its overbearing effect on business and industry, while the tax landscape has also faced significant transformation as a consequence.
In an interconnected world, some of the issues that have arisen in the context of cross-border taxation have created concern for businesses and taxpayers, with the potential of leading to far-reaching implications. Some of these issues are considered in further detail in this article.
Determining the residential status of an individual
The pandemic has forced the governments of many jurisdictions to impose partial or complete lockdowns, coupled with travel restrictions, in an attempt to decelerate the spread of the virus. These measures have rendered movement across country borders difficult, forcing residents and nationals of different countries to be stationed in other geographies. Furthermore, there are also tax residents of other jurisdictions, who have visited their home countries to take care of their families and have had to extend their stay there due to reasons beyond their control.
These extended periods of stay can result in persons becoming resident in: (a) multiple tax jurisdictions; (b) a jurisdiction where they would not have been a resident otherwise, but for the travel constraints imposed as a result of the pandemic.
Addressing the concerns faced by taxpayers, the Central Board of Direct Taxes (CBDT) clarified for the financial year (FY) 2019-20, that where individuals had come on a visit to India before March 22 2020, or were quarantined on or after March 1 2020, the period from March 22 2020 or onset of quarantine till March 31 2020 or the date of departure (whichever is earlier) shall be excluded in determining residential status. It was also clarified that for individuals who have been quarantined on or after March 1 2020, the period of stay from the onset of quarantine till March 31 2020 or date of departure whichever is earlier shall be excluded.
Addressing the concerns raised by stakeholders for FY 2020-21, the CBDT issued another clarification wherein it was opined that a short stay in India is not likely to render a person qualifying themselves as a tax resident in India. Furthermore, it was stated that the presence of a tie breaker clause and the division of taxing rights on employment income contained in tax treaties, would sufficiently take care of scenarios of dual residency and income being taxed in India. The CBDT requested individuals who may have specific concerns to furnish necessary information in a specific form by March 31 2021, so that general or specific relaxation to residency rules may be issued.
While one awaits any relief that may be granted by the CBDT taking note of specific difficulties, the following circumstances would certainly require some reliefs:
- Where an individual qualifies as a resident and an ordinarily resident of India solely because of his stay in the country for 182 days or more, due to circumstances caused by the pandemic and his ordinary jurisdiction of tax residence is elsewhere where he may be subject to a lesser tax rate; and
- Cases where there are no tax treaties between jurisdictions to address issues of dual residency
Determining permanent establishment
There are concerns that the presence of employees in other jurisdictions, other than the one from where they have ordinarily been working from, could result in a permanent establishment (PE) being created in such other jurisdictions.
Home office PE
Generally, temporary domicile of an employee in another country as a result of COVID-19 should not result in the creation of a PE of the employer. Such a 'home office' usually does not meet the permanency test or disposal test. In the case that such modalities of working continue even after the restoration of normalcy, it may beg a question as to the existence or otherwise of a PE. Temporary geographical dislocations solely because of the pandemic should not result in PE exposure, if the entity did not otherwise have a PE exposure in the other countries.
The OECD in its 'Updated guidance on tax treaties and the impact of the COVID-19 pandemic' (OECD guidance) suggests that individuals teleworking from home as a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved to prevent the spread of the COVID-19 virus, should not create a PE.
Home office and GST implications
Under goods and services tax (GST) law, a supplier is required to register the premises from where they make the supply of goods or services, if such a premise constitutes a 'fixed establishment'.
“Temporary domicile of an employee in another country as a result of COVID-19 should not result in the creation of a PE of the employer.”
A fixed establishment is a place which is characterised by a sufficient degree of permanence and suitable structure in terms of human and technical resources to supply services. Based on this definition, can the house of an employee from where they work be considered a fixed establishment?
A house is unmistakably characterised by a degree of permanence and has suitable structure in terms of human and technical resources to supply services – even if the resources in question consist of nothing more than an employee and their laptop. Therefore, if an employee were to provide technical support to a client from their house, it would follow that the house ought to be registered by the employer-company as a fixed establishment under GST law. Furthermore, if the employee were to change addresses, the employer-company would also be required to track and register the new address as a fixed establishment under GST law.
The chaos which would ensue from the above interpretation can be averted relatively expediently. All that is necessary, is for the government to issue a clarification to specify that the house of an employee shall not be considered to be a fixed establishment under GST.
Agency and construction PE
Agency PE under the tax treaties gets triggered when the agent habitually exercises his authority in his temporary domicile to conclude contracts on behalf of an enterprise. Whether the authority exercised by the agent is 'habitual' or not would depend on the facts and circumstances of each case. However, the OECD guidance suggests that the agent's activity should not be regarded as 'habitual' if they have exceptionally begun working from another jurisdiction as a public health measure imposed by either or both of the jurisdictions involved.
Construction activities in a jurisdiction can also result in the creation of PE depending on the provisions of the tax treaties and the number of months for which such activities are carried on. Temporary disruptions are generally not excluded in calculating the time period to determine existence of a PE. The OECD guidance suggests that in light of the extraordinary circumstances of the COVID-19 pandemic – and based on the facts and circumstances – that certain periods where operations are prevented as a public health measure imposed or recommended by the government, may be considered a type of interruption that should be excluded from the calculation of time thresholds for construction site PEs.
If an entity is determined to have a PE in India, then the entity is liable to pay taxes on profits attributed to the PE at the highest basic rate of 40%. Furthermore, other entities that are availing services of the non-resident entity, which is determined to have a PE in India, can also face implications for non-deduction of tax at source on payments made.
Detailed guidance from the tax department on determining PE status for the pandemic period would go a long way in alleviating the hardships that can arise for non-residents.
Transfer pricing implications arising from the disruptions caused to economic activities are a huge concern for many taxpayers who are subject to these specific anti-avoidance provisions in India.
A crucial step for any TP analysis is the selection of comparables and the determination of arm's-length pricing or margin (ALP or ALM). Commonly used methods used to determine ALP include the transactional net margin method (TNMM) or cost plus method (CPM), which use averaged data from past years to determine the ALP. However, that may not be the correct approach to determine the ALP, considering that the pandemic years would need to necessarily be considered extraordinary, considering the effects that it may have caused to capacity utilisation and sales.
Another area where potential issues can arise concerns determining the costs for the purpose of carrying out TP analysis. Such an exceptional one-time cost could include compensation paid to suppliers/contractors, welfare measures granted to employees, and expenditures incurred to facilitate 'work from home' of employees. Depending on the facts and circumstances, such costs need exclusion especially if these are not incurred as a replacement of other costs. Costs incurred to ensure uninterrupted internet connectivity to employees may be seen as an alternative to rents and electricity for instance and exclusion may not be justified in such a circumstance.
Yet another issue surrounds advance pricing arrangements (APAs), which may have been negotiated by multinational enterprises so as to obtain certainty in TP assessments. The situation caused by the pandemic may potentially result in upsetting the critical assumptions that have been considered in these APAs, causing an event of breach. Permitting re-negotiation of APAs in such circumstances could act as a solution in these cases.
It may be welcome that the CBDT issues detailed guidance on peculiarities that may arise in TP issues, some of which have been highlighted above.
The need for guidance
The pandemic is continuing to cause havoc in the lives of people and businesses. As nations continue to fight the virus and also ensure that economic disruptions do not take a toll on livelihood of the masses, it is important that the tax administrations provide necessary guidance or reliefs wherever required to ensure that the tax disputes and litigations do not add to the sufferings caused by COVID-19.
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S Vasudevan heads the direct tax practice of Lakshmikumaran & Sridharan in New Delhi. He has more than 16 years of experience across multiple tax verticals. Apart from advising clients on complex tax issues, he regularly appears before various courts and tribunals in India.
Vasudevan has rich exposure to issues of manufacturers, traders and service providers particularly in the telecommunication, finance, energy and IT sectors, which enable him to provide practical and holistic solutions, which are tax efficient. He assists clients with advisory on mergers and acquisitions, international taxation, transfer pricing, and compliance of withholding obligations, among other matters. He also represents them before various quasi-judicial and judicial bodies including advance ruling authorities, settlement commissions, high courts and the Supreme Court.
Vasudevan is a chartered accountant and holds graduation in law and commerce from the University of Delhi. He regularly delivers lectures on various topics relating to direct and indirect taxes.
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Raghavan Ramabadran is an executive partner at Lakshmikumaran & Sridharan, where he heads the Chennai branch of the firm. He has over 16 years of experience in tax advisory and litigation at the firm.
Raghavan has broad experience in both direct and indirect taxes. He is highly experienced in tax litigation and has handled matters before various high courts and tribunals. He often counsels Fortune 500 companies on complex tax issues. His area of expertise also extends to corporate litigation and arbitration.
Raghavan is a chartered accountant and holds a bachelor's degree in law from the University of Delhi. He is also a regular speaker at various conferences on tax-related topics.
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Bharathi Krishnaprasad is a principal associate at Lakshmikumaran & Sridharan, having joined the firm in 2015. She has previously worked as a corporate banker with a leading private sector bank in India.
Bharathi focuses on direct taxes and foreign exchange laws. She advises clients on a broad range of issues relating to domestic and international taxation. She also handles compliances and litigation upto the stage of tribunals.
Bharathi is a chartered accountant and holds a bachelor's degree in commerce from the University of Madras.
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Sahana Rajkumar is a principal associate at Lakshmikumaran & Sridharan. She has five years of experience in the indirect tax practice.
Sahana focuses on advising clients from diverse sectors such as real estate, automobile, and information technology. Her primary area of expertise is GST. She has handheld several clients in transitioning into the GST regime through counsel on key issues and interactions with enterprise resource planning (ERP) implementation partners.
Sahana is graduate of arts and law from the National University of Juridical Sciences, Kolkata.
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