Dynamics of Indian Tax Scenario

The past year 2018 has been a witness to some unforeseen economic challenges at the global level. With the backdrop of the Turkish financial turmoil, Brexit crisis and the trade war between the two biggest superpowers – the USA and China, it was expected that the Indian economy was sure to feel the impact. In addition to that, on the home turf, worrying issues, such as the IL&FS liquidity crisis was already building mounting internal pressure. The situation began to appear brighter towards the later half of 2018, as the oil prices fell. This resulted into the consolidation of Rupee thereby increasing foreign inflows in India.

Since 2018 was marked by consolidation, 2019 might be marked by realistic optimism, especially with general elections just around the corner. In the meantime, the array of amendments/introductions in Budget 2018 (which included issues pertaining to SEP, LTCG Tax, etc.,) OECD report on Digital Economy, GST updates and others will play a crucial role in the decisions and policies adopted by taxpayers in FY 2019-20.

It is with this backdrop that we have tried to capture, in this publication, the key tax events of 2018 and present our thoughts on what can be expected from 2019.

2018 — The year gone by!


Enlarging ambit of Business Connection — India leads the way

Introduction of SEP

India has been a frontrunner in implementing the Base Erosion Profit Shifting (BEPS) Project. India in Budget 2018 has expanded the Business Connection definition by introducing concept of "Significant Economic Presence" (referred as 'SEP' or "Digital Permanent Establishment") to tax digital transactions.

Open Areas

  • Even though the law has been implemented from April 2018, no limits have been prescribed by the government. The government had sought suggestions from stakeholders on limits in August 2018. Also, once the limits are out, it would be clear as to whether only tech giants are impacted, or even mid-size companies would be under the tax net.
  • The provisions of the current law are extensive. It appears that the same may also cover non-digital transaction for goods and services. Also, it is still unclear as to which business models the SEP tests shall apply. Would the intermediaries that merely provides online platforms to facilitate interaction between the domestic buyer's foreign sellers be taxable in India if they meet the prescribed thresholds?
  • Profit attribution: Computation of income attributable to the business connection would be a complex and highly subjective exercise. Also, the profit attribution currently is based on "functions, assets, and risks;" the responsibilities involved in shifting this established principle is enormous on India due to risks that it can be extended to transfer pricing as well.
  • The phrase 'systematic and continuous' is both subjective and ambiguous. It could be open to tax litigations.
  • Need to renegotiate tax treaties: Concept of Digital PE finds a place in the domestic tax law of India; however the tax treaty definition of PE remains the same. As such, until tax treaties are re-negotiated, Digital PE rule remains a domestic tax law concept and may not apply to non-residents who are eligible for tax treaty benefits.

India has taken the lead to carve out provisions to tax digital transactions. These provisions presently are at a nascent stage and are likely evolve over a period of time. However, businesses should evaluate their business model and see how these regulations would impact them.

Expanding the scope of Dependent Agent PE (DAPE)

India has been at the forefront in implementing the initiatives of the Organisation for Economic Cooperation and Development (OECD) and the G20 on the BEPS Action Plan. The final report on the BEPS Action Plan had recommended various amendments to domestic laws and tax treaty provisions to deal with international tax issues faced globally due to changing business environment.

In line with the same, India expanded the definition of 'business connection' under the domestic tax laws. The expanded definition of business connection under the Indian local tax laws now provides for a more stringent definition of DAPE.

Pre-Amendment Post-Amendment
Dependent Agent acting on behalf of Foreign Enterprise and:
  • Habitually exercises the authority to conclude contract;
  • Habitually maintains stock of goods in India;
  • Habitually secures order in India.
  • Has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident or habitually concludes contracts or habitually plays the principal role leading to the conclusion of contracts by the non-resident principal and the contracts are:
    • In the name of the non-resident;
    • For the transfer of the ownership of, or for the granting of the right to use, property owned by that non-resident or that non-resident has the right to use; or
    • For the provision of services by the non-resident
  • Habitually maintains stock of goods in India;
  • Habitually secures order in India.

Typically, most agency arrangements in India are structured in such a manner that the that the agent in India performs the entire sales function and the foreign principal does the mere signing of the ultimate contract. Based on the earlier definition, such situations were not brought under the tax net as contracts were concluded outside India. This issue was highly litigated in India.

In order to capture such situations, the revised definition provides that a DAPE would be established even in cases where the agent plays a principal role in concluding contracts. The term 'principal role' has not been defined and it would be interesting to see how the Indian Tax Authorities, as well as taxpayers, would interpret this term. In common parlance, the principal role would mean playing an important role in concluding the transaction and not merely acting as a coordinator.

Furthermore, it also appears that the revised definition would also capture cases where contracts (including service contracts) are in the name of an Indian party, but a majority of the obligations of the contract are to be fulfilled by the foreign company.


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