Recently, OECD released an update to the OECD model convention and commentary (“2017 update”). The 2017 update largely consists of amendments agreed upon as part of the BEPS project and follow up work thereon. In addition, it incorporates certain other changes that were released for public comments previously and finalized now. It also contains the positions of the OECD and non-OECD countries, including that of India.
India’s positions to the 2017 Update are mainly on Article 5 on permanent establishment (PE), Mutual Agreement Procedure (MAP) and on certain other miscellaneous provisions such as the tie-breaker rule for non-individuals, entitlement of benefits clause, treaty eligibility for fiscally transparent entities, etc.
Traditionally, India has sought to have greater source country taxation while allocating taxing rights under a tax treaty by seeking to have a broader definition of PE as compared to the OECD standard. Consistent with this objective, the positions stated by India in the 2017 Update reflect a broader application of some of the PE rules. To tax digital economy enterprises, India has reserved its right to deem a PE of a foreign enterprise, if it has “significant economic presence” in India, including a case where such presence is in the form of a website. India has also expressed a view that a foreign enterprise will be deemed to have a place of business through a website, if such website enables downloading of automated software resulting in collection and processing of valuable data for the foreign enterprise.
BEPS Action 1 report had discussed three options for tackling BEPS concerns in relation to digital economy viz: new nexus rule based on “significant economic presence”, equalization levy and final withholding on digital transactions. These were not specific recommendations by the OECD, whose final report on digital economy is expected in 2020. India has already introduced equalization levy for taxing certain digital advertising transactions.
It is interesting to note that India’s approach to taxing the digital economy seems to be converging with the proposals under discussion by the European Union (EU). Two main proposals are under consideration by the EU Council are: (i) A “digital presence PE” that would create local tax nexus even if the non-resident does not have sufficient physical presence in the source state to allow taxation under existing international tax law; and (ii) An “equalization levy” based on the Indian example which would impose a flat rate of tax on gross revenue derived through specified transactions.
One of the main shortcomings of the current international tax rules is that the taxing right of a jurisdiction only arises when the business has a physical presence in that jurisdiction. One feature of the digitalisation of the economy is that services can be provided digitally with minimal physical presence right from the start, even in the country of residence. It is for that reason that cross-border activities of digitalised businesses just fall into the gaps of international tax rules and remain untaxed in most jurisdictions where the business is digitally present and creating value.
Through signing OECD’s multilateral instrument, India has provisionally accepted the broader Agency PE provisions to be included in its tax treaties. Now, through the 2017 Update, India has to some extent further expanded the scope of BEPS Agency PE provisions. Some key deviations are:
- BEPS Agency PE rule covers a person who habitually plays a principal role in conclusion of contracts that are routinely concluded without material modification by the enterprise. India has reserved a right on non-inclusion of term “routinely”.
- India is of the view that an agent who works exclusively or almost exclusively on behalf of the foreign enterprise will be treated as a dependent on agent, irrespective of whether it is closely related to the foreign enterprise or not.
- As per India, an enterprise which fragments its cohesive business operations into smaller operations to avail the exclusion of preparatory or auxiliary activities will be considered as having a PE even in the absence of a specific anti-fragmentation rule. This appears to be a reiteration of the substance over form approach adopted by the Indian tax authorities in applying the PE rules of the OECD.
- Additionally, a low risk distributor who sells goods in his own name may trigger an Agency PE which is contrary to OECD’s clear position.
India has also expressed certain positions diluting the disposal test for fixed PE. As per India, disposal test can be satisfied even where an enterprise does not have a right to be present at a location and does not use that location itself. Further, contrary to the OECD view, India is of the view that the home office of an employee can be considered as meeting disposal test even if an office is made available to him by the employer.
In relation to the MAP, India has consistently made it clear that it is not in favor of adopting mandatory binding arbitration. It is for the same reason that India opted out of the mandatory binding arbitration provisions of the multilateral instrument. India has now reiterated this in its positions to the 2017 Update.
What is welcome is the change in India’s position on MAP access in TP cases. India has deleted its earlier reservation that it is not bound to grant MAP access in TP cases, in case where the treaty does not have Article 9(2). This would in essence mean that India agrees to the OECD view that TP adjustments results in double taxation which is to be resolved by way of MAP. This stand of India is now also clarified vide an administrative press release dated 27 November 2017. This can be expected to improve the effectiveness of TP dispute resolution for taxpayer’s resident in countries such as Germany, France, Italy, etc. who were earlier denied access to the TP MAP.
Further, India has expressed a view that it would provide MAP access only in cases where it is “certain” and not “probable” to result in taxation not in accordance with the treaty. India is also of the view that the undefined terms in the treaty are to be understood as per the domestic laws of the state applying the treaty and as such its meaning cannot be determined by the competent authorities under MAP. These views of India, diverge from the OECD view as it existed even before the 2017 Update. Interestingly, India had not provided such reservations on the OECD view before.
While the positions stated by India would be a useful guide for taxpayers on the possible views which the tax authority may advocate in audits, the status of the same as an aid for interpreting India’s tax treaties is debatable. As is well accepted, a treaty should be interpreted in good faith in accordance the ordinary meaning to be given to the terms of the treaty in their context and in light of its object and purpose.
The author is Rajendra Nayak, Partner, International Tax Services, EY India.
The contributing authors are:
Aastha Jain, Director, Tax – Knowledge & Solutions, EY India
Pooja Chhajer, Manager, Tax – Knowledge & Solutions, EY India