The finance ministry has in recent weeks confronted many overseas digital firms drawing significant business income in India, without paying any or due tax in the country, by deftly circumventing the permanent establishment (PE) rule.
The ministry has invoked the principle of source-based taxation under the Income Tax Act, to question the “organisational structures” built by them to avoid paying taxes on the income earned from operations here, official sources said, on condition of anonymity.
Some of these companies are found to have created marketing-support-services (MSS) arms in India — rather than marketing arms — to facilitate sales, and held these don’t qualify as PE as the services were rendered from abroad. Tax laws don’t permit authorities to tax a virtual service provider until it establishes a “service PE” or physical presence of its employees for periods longer than specified thresholds.
The companies tracked down by the tax department had been taking recourse to the norm that a mere presence of a subsidiary company in India does not automatically make it a PE of the parent company abroad. According to the rule, for a subsidiary to be PE, the parent company’s operations must be conducted “through it”.
“Without having any territorial access, a foreign entity can still have business in India. Most of these entities are registered in Ireland and the Netherlands. Of course, such arrangements aren’t much durable… it’s easier said than done to operate a business in India without having a presence,” an official said. “These entities need marketing people, which is why they create subsidiaries for providing marketing support services. The MSS units are actively involved in marketing the product in India, and hence the income they earn is taxable,” the official explained.
The companies that have recently been asked to cough up taxes include India-incorporated MSS entities namely SanDisk India Device Design Centre, Sumitomo Corporation India and Nortel Networks. E-mails sent to these companies did not elicit any response.
In the case of SanDisk India Device Design Centre, for instance, its Shanghai unit manufactures the products, sells them to the Singapore unit, which in turn sells these to a wholesaler in India, who takes a 0.5-0.6% cut. To effect the sales in India, the MSS player actively pushes the wholesalers and retailers mostly via people stationed in Singapore. “These entities engage in aggressive tax planning, and when the government takes actions against them under the transfer pricing rules, they don’t accept, and go for litigation,” the official said.
Currently, under the domestic taxation laws, digital transactions carried out by non-residents are typically evaluated from ‘Significant Economic Presence’ (SEP) and ‘Equalisation Levy’ perspectives primarily for levy of taxes, say experts.
SEP brings the non-resident entities — whether or not such entities have a residence or place of business in India or render services in India — within the tax net provided certain customer base thresholds are met. “However, under certain cases, where the non-resident entities do not have PE in India and are eligible to the benefit under the (double taxation avoidance) treaties, then they could be out of the tax net under SEP provisions contained under the Income Tax Act, 1961,” explained Dipesh Jain, partner at Economic Laws Practice.
In a recent case concerning Clifford Chance, the Income Tax Appellate Tribunal, Delhi, dealt with the issue of creation of a “virtual PE” in India. On the interpretation of Article 5(6)(a) of the India-Singapore DTAA, the tribunal held that to constitute a ‘Service PE’ in India, actual performance of services in India is essential. Thus, a service PE is constituted only if the employees are physically present in India. Accordingly, it was concluded that that the taxpayer did not constitute a service PE/virtual PE in India and the revenue earned by the taxpayer from Indian clients is in the nature of business profits, not taxable in India.
Rajarshi Dasgupta, executive director, AQUILAW, says: “The law is evolving when it comes to addressing the tax challenges associated with the digital economy. Until the time no specific provision is agreed upon and inbuilt into the law, a taxpayer cannot be taxed.”
‘Equalisation levy’, on the other hand, requires an Indian entity carrying out business or profession in India to deduct tax on the specified services (above a certain threshold) from the amounts paid to non-resident service providers. Non-payment of such amounts attracts interest or penalty exposures for such Indian entities.
Equalisation levy was introduced by India in 2016 to tax the digital economy. Initially, it was levied at 6% of the gross consideration on online advertisements and digital advertising space. Later, its scope was widened in 2020. It is also levied at 2% on the consideration amount paid to non-residents who own, operate or manage an e-commerce facility or platform.
However, once India adopts the OECD’s base erosion and profit shifting (BEPS) rules, or the Pillar 1 and Pillar 2 rules, the country will have to remove the equalisation levy. BEPS rules aim to make sure that, regardless of where they operate from, big, multinational digital businesses pay more taxes in the nations where they have users or customers. The convention requires all countries (138 signatory) to remove all ‘Digital Services Taxes’ and other relevant similar measures with respect to all companies, and to commit not to introduce such measures in the future. As per the BEPS agreement, the Global Digital Tax would only apply to businesses with revenues of €20 billion or more and a profit margin more than 10%.
According to the I-T Act, if a foreign company’s income is received or deemed to be received in India, or is accrued/ arisen or deemed to have accrued/ arisen in India, the country can tax such income under source-based taxation. If a foreign company has a long-term presence (PE) in India for the purpose of conducting business, the revenue received by such company, to the extent that it is due to the India presence, is taxable in India