Desperately seeking higher ground

[ SUNDAY, APRIL 25, 2004 12:06:00 AM ]
The country’s BPO industry stands to gain if new OECD proposals on ‘permanent establishments’ are accepted. It will be useful if the CBDT clarifies such issues as well. With increase in cross-border trade and businesses globalising their operations, the concept of permanent establishment (PE) has assumed more significance now than ever before. A PE envisages a situation where a foreign enterprise has established a sufficient nexus in the state where its operations are carried out, by virtue of which, its business profits can be taxed in the state of source. Policy makers around the world are continuously grappling with the challenge of applying existing principles of international taxation to multinationals operating in the evolving borderless world. The Working Party 1, which is the sub-group of the OECD (Organisation of Economic Co-operation and Development) committee on fiscal affairs, is mandated for updating the OECD Model Tax Convention. It has recently issued a public discussion draft on the proposed clarifications to the PE definition. The proposals contained in this discussion draft are open for public comments till June 30, ‘04. This discussion draft has come at a time when the business process outsourcing (BPO) industry in India is coping with the interpretation of a Central Board of Direct Taxes (CBDT) circular which provides for the levy of Indian tax in certain circumstances when core activities are outsourced by a foreign company to an Indian entity. Though, the CBDT has clearly stated that such tax would be imposed only if the foreign company has a PE in India, it has created a lot of confusion in the minds of foreign companies and the tax officers have begun to bring foreign companies into the Indian tax net using the circular, albeit wrongly.The OECD’s discussion draft, if incorporated in the commentary, would bring a sigh of relief to the BPO and IT industry currently blooming in India and would also help in clearing the clouds of confusion cast upon this industry due to potential mis-interpretation of the mentioned circular. The purpose of this discussion draft is to clarify some basic aspects of the PE concept and to expressly include in the OECD Model Commentary (commentary) some widely accepted interpretations related to that concept. In substance, this discussion draft provides clarifications on the PE exposure on account of parent-subsidiary relationships as also the agency relationships. As regards the parent-subsidiary relationships, it is clear that a subsidiary per se does not constitute a PE of the parent. The working party of the OECD, with respect to this aspect seeks to differentiate between two scenarios where the parent is carrying on its business from the premises of its subsidiary and where the subsidiary is carrying on its own business through its premises. It expressly states that if the premises belonging to the subsidiary are at the disposal of the foreign parent company, and such premises constitute a fixed place, through which the foreign parent carries on its own business, then, in such cases, the subsidiary would constitute a fixed place PE and the attributable business profits of the foreign parent would be subjected to tax in the country of the subsidiary. Applying this clarification in the context of the outsourcing industry, in many cases, the Indian subsidiaries of foreign outsourcers could contend that the business which is carried on by them in their premises, is their own business and their premises are not at the disposal of the foreign parent, for carrying out the parent’s business. Hence, the premises of the Indian service provider would not constitute a fixed place of business PE in India, and thus no business profits of the foreign parent could be subjected to tax in India. In the context of multinational enterprises, applying the same principle, the working group has clarified that when a particular service (for example, management services, recruitment services, etc) is provided by a group company to its sister entities, and if such service is provided by this group entity in its own premises and using its own personnel, then in such circumstances, the premises of the group entity should not constitute a ‘fixed place of business’ of the sister entities.

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