The Indian tax authorities are generally seen to be extra vigilant in scrutinizing the transactions undertaken by non-residents in India. Primarily this may be because the probability of income completely escaping the tax net in India is comparatively higher in case of non-residents, as against the Indian residents. One more factor which makes tax officers take more aggressive view on taxation could be the tax targets set by the department on them. The zeal to realise or meet their targets, leads to a situation where the officers pry for an opportunity to levy tax instead of approaching the transaction neutrally.
Although courts of law would ultimately ensure that the taxability is determined based on the legal position applicable to the dispute, the reputational risks and the litigation cost in the process cannot be compensated. Also, this result takes years due to large number of tax litigations and the pendency thereof. Therefore, as a matter of strategy, it is important for the non-residents, especially foreign companies, to revisit their business activities in India with the objective of identifying the tax risks and be prepared to both mitigate the risk and for the questioning by tax authorities.
The activities undertaken by the foreign companies and the manner in which they are undertaken may give rise to unintended or accidental tax exposure in India.
Some of the most common activities that give rise to adverse tax implications in the hands of the foreign companies are the activities that are carried through their Liaison Office ("LO") in India or through the use of the premises of their Indian subsidiaries by their employees in India.
The LOs are generally set-up to act as a communication channel between the foreign entity and its Indian customers and acting as such would per se not create tax exposure in India. However, the tax authorities increasingly allege that LO exceeds its scope of work in India and is engaging in business activities and therefore, constitute a business connection ("BC") under the Income Tax Act, 1961 ("IT Act") or a Permanent Establishment ("PE") in India under the provisions of the applicable double taxation avoidance agreement ("DTAA") between India and the home country of the foreign entity.
Insofar as transactions undertaken by the foreign parent with its Indian subsidiaries are concerned, the tax authorities allege that the activities of the employees of the foreign parent who visit India are not restricted to the shareholder activities (which is usually the stated and intended purpose of the visits) or meeting their clients, but also undertake certain business activities of the foreign company, which in turn, give rise to the constitution of BC/PE in India.
Some of the most common allegations made by the income tax department are as under:
(a) Indian LO undertaking business activities viz. attending meetings/ undertaking discussions with Indian clients ‐ Creates Fixed Place PE exposure;
(b) The employees of the foreign company visiting India for shareholder activities/ business purposes and furnish certain services in India ‐Service PE exposure;
(c) Subsidiary/LO of the foreign company in India projecting as a representative of the foreign company ‐ Fixed Place/ Dependent Agent PE exposure;
(d) Indian subsidiary playing an active role in facilitating the foreign parent to conclude contracts ‐ Dependent Agent PE exposure;
(e) The business premises of the Indian subsidiary being at the disposal of the employees of the foreign company when they visit India to meet customers ‐ Fixed Place/ Service PE exposure;
(f) Agent/Indian subsidiary raising invoice on behalf of the foreign parent ‐ Fixed Place/Dependent Agent PE exposure
(g) Indian subsidiary or LO providing customer support as well as maintenance support ‐ Dependent Agent exposure
Whether or not the foreign company has a PE in India is a factual analysis which needs to be carried out every year, by examining the manner in which the business of the foreign parent is conducted in India and the involvement of the Indian subsidiary or the LO in the conduct of such business as well as the presence of the employees of the foreign parent.
Move beyond the dotted lines!
As it can be seen there is a thin line of difference between the activities which may or may not constitute PE in India as also depends on actual functioning on the ground. Therefore, it would not be sufficient to rely on the documents setting out the arrangement between the two companies for the activities to be carried out in India to allay the risk of PE in India. It is equally important to analyze the actual operations carried out on the ground by the persons actually engaged in executing the functions. In most cases, the person who carries out the business operations on the ground (usually a non-tax person) would not be aware of the potential tax risks, which could create an unforeseen tax risk to the foreign company.
Extensive powers given to tax authorities
The domestic tax legislation has given significant powers to the tax authorities to probe to ascertain the real picture on ground. They have the power to carry out a survey/search operation (a dawn raid) by entering into and searching the premises without any prior intimation. The search proceeding could be quite onerous and the procedures involved could be daunting, if not hostile, as the same involves:
Disconnecting the telephone and seizing mobile phone so as to prevent the employees from alerting the seniors, etc;
Accessing each and every place of the premises without any restriction and seize documents, if required;
Record the statements of the important employees on oath;
Accessing/seizing digital documents i.e. official mailboxes and mobile phones.
There are instances where tax authorities continue their search operations for more than a day or two also without any break.
A mere survey by tax department of the premises or offices of the LO or Indian subsidiary is less onerous and probing compared to search procedure. However, tax officers could pick up any information or rely on any document lying around for making the case for higher tax exposure of the foreign parent. During survey, they cannot record any statement on oath
It is pertinent to note that the tax authorities could also collect information from the customers of the foreign company in India to ascertain the activities carried out by the said foreign company in India.
Be prepared - Importance of a health check!
In view of the above, it is important for the employees/representatives/agents, who act on behalf of foreign companies in India, to understand and appreciate the extent to which they can represent the foreign company in India, including the potential tax risks that the foreign companies could be exposed to in India.
In multiple instances the Indian tax authorities have made huge additions to the income and consequent tax on the foreign companies, basis their findings from search or survey in respect of the functioning of the foreign company, such as e-mail exchanges between employees and from the statements given by the employees during the search/survey proceedings.
While there is thin line distinguishing the functions and activities which constitute or NOT constitute a PE and it would often get blurred in the day to day business operations, it is certainly better to take preventive action. This may include undertaking a thorough tax health check-up of the day to day activities carried out in India by the Indian company for the foreign company, by the employees of the foreign company, the arms length relationships, educating and training the on-ground employees about their relationship with their foreign parent in India and also equip them with the information on their rights and duties in cases if a dawn raid were to happen. An appropriate preparedness would certainly give better results in avoiding long drawn litigation and high pitched tax demands.
About the Authors:
Daksha Baxi has vast experience in International Taxation of over 30 years. She has advised clients on all aspects of taxation, including structuring of cross border mergers and acquisitions, restructuring and reorganisations as well as spin off of businesses to unlock valuation. She has also successfully advised clients in tax controversies before various forums and tax authorities on issues ranging from availing the tax treaty benefits to contesting invocation of anti-avoidance rules and characterisation of income. Daksha is recognized as a leading Tax professional in India by various league tables and ranking forums including but not limited to International Tax Review Leading Women in Tax, Legal 500, Chambers & Partners, Asia Leading Lawyers, Whos's Who Legal, et al.
Thangadurai VP is an expert in direct tax litigation and advisory. He has advised some of the noteworthy multinational enterprises across various sectors viz. IT & ITES, Automobile, FMCG, Real Estate, Defence, etc. He has also assisted clients in their tax assessments and proceedings before various judicial fora including High Courts and Supreme Court of India.
Disclaimer: Above expressed are the personal views of the author, and the publisher or the author disclaim all, and any liability and responsibility, to any person on any action taken on reliance of it.
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