April 2019 CBDT proposes to amend rules for profit attribution to PEs – calls for public consultation The issue of profit attribution to a Permanent Establishment (PE) has been the subject matter of extensive litigation. The Indian Revenue authorities and the Indian judiciary have, in the past, adopted/ upheld different approaches to profit attribution based on the facts of each case by applying Rule 10 of the Income-tax Rules, 1962 (the Rules).
With a view to bring greater clarity, objectivity, and predictability in the matter of attribution of profit to a PE, the Central Board of Direct Taxes (CBDT) formed a Committee (the Committee) to examine the existing scheme of profit attribution under Article 7 of the Double Taxation Avoidance Agreements, and to recommend changes in Rule 10 of the Rules.
The Committee has suggested a three-factor apportionment approach, by assigning an equal weightage to sales, manpower (i.e., employees and wages) and assets. This represents a mix of both demand and supply related factors, thereby allocating profits derived from India, partly to the jurisdiction where sales take place (driven by consumers and market), and partly where factors of production are located or where supply related activities are conducted.
Further, referring to the concept of Significant Economic Presence introduced in the Finance Act, 2018 (specifically in the context of digital enterprises), a four-factor approach has been suggested to apportion profits. The fourth factor being ‘users’, whereby a weightage of 10% has been assigned for business models involving low or medium user intensity, and 20% in other cases. In this scenario, the weightage given to sales would remain fixed at 30%, while the balance would be assigned to employees and assets equally.
Further, the Committee has suggested that the aforesaid apportionment shall be applied to "profit derived from Indian operations" which will be the higher of the following amounts:
I. The amount arrived at by multiplying the revenue derived from India by the global operational profit margin, or
II. Two percent of the revenue derived from India.
Thus, even in a situation where the foreign enterprise has global losses or global profit margin of less than 2%, a minimum of 2% of the turnover derived from India, shall be deemed as "profits derived from Indian
operations".
If arm's length profits derived from Indian operations have already been taxed in India in the hands of an Indian subsidiary of the foreign enterprise, then to that extent, such profits should be deducted from the profits
apportioned to the PE (which has come into existence primarily due to the presence of the subsidiary). No profits, however, shall need to be apportioned to such PE, where the foreign enterprise does not receive payments exceeding INR 1 million from sales or services from any person resident in India.
Notably, the Committee has also explained its rationale for not entirely adopting the OECD guidance that gives primacy to the 'Functions, Assets & Risk' (FAR) analysis while attributing profits. The Committee is of the view that the OECD guidance focuses only on the supply side factors for attribution of profits and ignores factors related to markets and demand, which could have significant adverse consequences for developing economies like India that are primarily importers of capital and technology.
On an overall basis, the report submitted by the Committee is fairly detailed in terms of analysing judicial precedents in India on attribution of profit to PEs, models of profit attribution followed internationally, and views of academicians and experts.
The conclusions and recommendations set forth in the report have been put up for public consultation by the CBDT. This consultative and inclusive approach being adopted by the CBDT of inviting comments from stakeholders with respect to new policy measures and statutory amendments, is certainly appreciated.
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PwC TRS Team
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