The Hindu Business Line : Issues to address in international tax

Determination of a permanent establishment in India and attribution of profits: If a permanent established (PE), a fixed place out of which the business is wholly or partly carried out, exists in India, then India has the right to tax the profits attributed to such PE.

However, Indian tax authorities, especially at the lower levels, are perceived as adopting an aggressive stance. In some instances, a wholly owned subsidiary in India is treated as a dependent agent merely because it does work for its parent company.

Further, a number of India’s tax treaties provide for a fairly low threshold for existence of a PE (such as securing orders for and on behalf of the foreign enterprise or supervisory activities).

The problem is compounded as profit tends to be attributed in an ad hoc manner. Contrary views have been taken at the assessment level, judicial views have also differed.

In the case of RollsRoyce, based on facts, the tax tribunal adopted a ‘global formulary apportionment’ approach for attributing profits to the PE in India. The SC (decision under appeal by Revenue) in Morgan Stanley’s case had relied on the arm’s length concept.

In the case of SET ruling, the tax tribunal held the dependent agent (an entity in India) and a dependent agent PE to be two separate taxable units. There can be no automatic attribution of profits in India, even if a PE exists, especially so if the PE does not perform any functions in addition to those performed by the dependent agent (business entity in India). Perhaps proper guidelines will reduce the spate of litigation.

Withholding tax issues in India: Royalty payments or those in the nature of Fees for Technical Services (FTS) made to non-residents entail a withholding obligation in India. Some payments such as those for import of shrink wrapped software or use of lease lines continue to be embroiled in litigation.

Some tax treaties entered into by India such as with the UK, the US, and Singapore contain the “make available” clause in the FTS Article, where India has the right to tax only if the technology has been made available to the Indian payer.

The definition of “make available” is subject to varying interpretations resulting in litigation. Appropriate guidelines could help curb litigation.

Transfer pricing: This is another hot bed of litigation owing to several factors. To begin with, in India, not only are taxpayers selected for compulsory audits based on quantitative parameters i.e. international transactions in excess of Rs 5 crore in a fiscal year (proposed to be increased to Rs 15 crore), but India also lacks a mechanism of providing for an advance pricing ruling or even safe harbours (whereby defined transactions meeting certain parameters do not come up for scrutiny). These mechanisms need to be introduced at the earliest.

Key issues facing Indian companies going outbound: One of the principal reasons why Indian companies use companies outside India to hold offshore investments is that repatriating funds to India is extremely inefficient from a taxation point of view – foreign dividends are taxed at 34 per cent in India.

In addition there is economic double taxation, because Indian companies are taxed on dividends received from overseas subsidiaries without receiving any credit for foreign taxes paid by the company paying the dividend (only tax treaties entered into by India with Mauritius and Singapore provide for underlying tax credit).

Developed tax regimes avoid this issue through either through providing a tax credit for foreign taxes or by totally exempting the dividend from tax in the recipient jurisdiction. India should consider introducing similar measures.

(The author is Tax Partner, Ernst & Young)

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