CBDT draft report on PE Profit Attribution - Treading the unbeaten path?


Attribution of profits to PEs’ has been one of the most controversial issues in the Indian tax litigation scenario in recent times. Recently, CBDT issued an 86 pager draft recommendatory report for public consultation, laying out proposals for amendment of the Income-tax Rules for profit attribution to PEs. While recommending either an amendment of Rule 10 or in the alternative, amendment of the Income tax Act itself to incorporate a provision for PE profit attribution, the Report suggests the adoption of a "three factor" approach to determine attribution of profits to PE. The report further explains the rationale for not adopting the OECD guidance that gives primacy to 'Functions, Assets & Risk' (FAR).

How will the recommendations provided in the draft report interplay with the tax treaties entered into by India? Will the proposed fractional apportionment approach be practical to implement? Should CBDT reconsider applying the Authorized OECD Approach (AoA)/ TP principles for attribution of profits to PE, in line with international best practices?

Philip Baker
Queen's Counsel, UK

"The report made available for public comment on 18th April by the Ministry of Finance is a fascinating document, well worth discussion and debate.  It is important to see it not as a final set of conclusions, but rather as a challenging set of proposals that warrant further discussion.  Clearly, given that they emanate from a high-level committee in the Ministry, and that they reflect the legislation, treaty practice and Court decisions of India on this topic, they merit significant attention.

It is hugely important to initiate a further debate on the attribution of profits to permanent establishments.  The Authorised OECD Approach, adopted by the OECD in 2010, has failed to win more than a relatively minimal level of support worldwide.  There are unresolved problems with the application of that Approach.  The Indian Report sets out very clearly why India has declined to follow that Approach, and why India (and, for that matter, most other developing countries) have not entered into treaties with the new wording introduced by the OECD in 2010.

Discussion of this topic is also particularly timely, given the discussion of the taxation of the digital economy that is presently occupying so much attention worldwide.  As...

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Vipul Jhaveri
Managing Partner, Tax & Regulatory, Deloitte India

"The Central Board of Direct Taxes (CBDT) recently issued a draft report with amendments proposed to extant rules governing profit attribution to a Permanent Establishment (PE) of non-residents in India. Findings of the committee constituted by the CBDT has been put out for public consultation. The existing rules under domestic tax law (ie Rule 10 of Income-tax Rules, 1962) provide wide discretion to Revenue authorities for income attribution; a rather inconsistent application of Rule 10 has led to significant uncertainty for non-resident taxpayers in the past. In the draft report, the committee has made an attempt to provide for a degree of predictability to income attribution process through a apportionment methodology.

Although apportionment method is recognised within existing Rule 10, as well as the courts in India have in the past upheld this approach for profit attribution to PE, larger concerns have stemmed from the degree of discretion existing rules permit, thus, invariably leading to inconsistent outcomes. Besides, the present formulation can be found lacking when seen in the context of digitalised businesses, which can benefit from scale without necessarily creating mass physical presence in the market country.

It's interesting that the committee indeed considered the historic approaches to...

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Ketan Dalal
Managing Partner, Katalyst Advisors LLP

“The report is clearly aimed at amending Rule 10 of the Income Tax Rules regarding profit attribution.  Over a period of years, the profit attribution principle has tended to converge around the FAR analysis, and India has had an objection to that over many years.  A key dimension of India's view has been that this attribution principle is supply side based and there needs to be some weightage given to the demand side; this seems to emerge from the thinking that MNCs are using India's demand potential, but paying less tax in India.  Whilst there may be some truth in this thinking, the thinking seems to be tilting a bit too much in the other direction.  One example of that is that in Para 161 of the report, there is a reference that even if the MNC makes a loss, a minimum of 2% should be attributed as the profit.  This seems extremely unfair and unjustified and goes against the principle of taxation of real income.

The key aspect that India needs to bear in mind that at some stage, India needs to do away with the mind-set that the world is out to exploit India, that India will endlessly continue...

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Vijay Iyer
National Leader, Transfer Pricing, EY India

"Attribution of profits to Permanent Establishment (“PE”) is one of the most litigated aspect ininternational tax in India. CBDT had formed a committee to examine the existing scheme of profit attribution to PE and recommend changes.

OECD through Article 7 of Model tax convention, provides for attribution as per Authorised OECD approach (“AOA”), which in simple words means attribution through TP principles - i.e. based on Functions, assets and risk (“FAR”) analysis. However, deviating from OECD AOA approach, the committee preferred “fractional apportionment” method to attribute profits to a PE, primarily on account of following reasons:

· Committee seems to be of the opinion, that the AOA approach restricts the taxing rights of the jurisdiction that contributes to business profits by facilitating demand. Committee believes that while AOA approach may be favourable to the interests of certain countries that are net exporters of capital and technology, committee believes that it is likely to have a very significant adverse impact on all other stakeholders, especially the developing economies like India, which are primarily importers of capital and technology.

· Hence, on the premise that profits are contributed by demand as well in a jurisdiction, in addition to supply, the taxation of PE in that...

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K. R. Sekar
Partner, Deloitte Haskins & Sells LLP

"The recent report of committee constituted by Central Board of Direct Taxes (CBDT) recommending three factor approach rejecting FAR approach needs larger debate.  The rationale for this report is arising out of following:

• Article 7 on attribution of profits does not support the developing economies.

• Separate entity approach based on FAR adopted under Article 7 is not a right approach for Developing Economies.

• The role of demand factor is not considered or given adequate weightage for determining profits under Article 7,

• Due to changes in the business model, apportionment approach is considered as better approach.

There has been always a conflict on attribution of profits between Developed Economies and Developing Economies. Though OECD adopted separate entity approach and UN adopted apportionment approach, but a unilateral position adopted by CBDT ignoring Article of the DTA's has a bigger challenges.

The challenges are at conceptual level and at computational aspect. 

At conceptual level, amendment to Rule 10 on the basis that Rule 10 will co-exit though Article 7 of DTA applies is completely incorrect and against the basic tenets of law. The established principles is that rule 10 can...

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CA Uday Ved
Partner, KNAV & Co

"The Central Board of Direct Taxes (CBDT) had formed a Committee to address issues with respect to attribution of profits to permanent establishment ('PE') and recommend necessary changes, with an objective to bring more certainty and clarity on this front. The committee's draft report was issued on April 18, 2019 and comments/suggestions from various stakeholders have been invited. This shows the inclusive approach of the CBDT. 

The United States was one of the first countries to have a formula in place to determine the attribution of profits. The said formula provided that to determine the attributable profits one third weightage was to be given to sales, wages and assets. However, many states in the US have done away with the three-factor formula and currently less than one-third states follow the said equal weighted formula. Mostly, the states have now shifted to a demand-based approach, whereby the US domestic laws may attribute profits ranging from 33.33% to a higher rate of 100% on basis of sales as the only factor. Countries like Canada, Germany provide for a formulary apportionment method, whereas China provides for deemed profit method. 

In line with the above, there may be broadly three...

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Rajendra Nayak
Partner - International Tax Services, Ernst & Young LLP

"Recognizing the significance of issues relating to profit attribution to a permanent establishment  (PE) as well as the need to bring greater clarity and predictability, a Committee was formed by the Central Board of Direct Taxes (CBDT) to examine the existing scheme of profit attribution to PE and to recommend changes to the existing rule contained in the Indian Income Tax Law (ITL). The Committee's report was released for public consultation on 18 April 2019.

After considering various options, the report therefore concludes that the option of 'fractional apportionment' based on apportionment of profits derived from India would be acceptable under tax treaties as well as the Indian ITL. The Committee found considerable merit in the three-factor method based on equal weight accorded to sales (representing demand) and manpower and assets (represent supply including marketing activities). While reaching this conclusion the Committee rejected the Authorized OECD Approach (AOA) of attributing profits to PE on grounds that the same is not consistent with the provisions of India's tax treaties. This is one of the several conclusions of the report that requires a reconsideration.

Since at least the 1930s, the international consensus has been that the profits should...

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Girish Vanvari
Founder, Transaction Square

 "Recognizing the significance of issues relating to profit attribution to a Permanent Establishment (“PE”) as well as to bring greater clarity and predictability, the Central Board of Direct Taxes (“CBDT”) had set-up a Committee to examine the existing scheme of profit attribution to PE and to recommend changes to the existing rule. CBDT has released the Committee's report for public consultation.


The taxation of a non-resident in India is governed by the provisions of the Income-tax Act, 1961

(“the Act”) and the provisions of the relevant Double Taxation Avoidance Agreement (“DTAA”)

whichever is more beneficial. Therefore, for business income of a non-resident to be taxed in India, conditions under the Act as well as DTAA needs to be satisfied.

Section 5 read with section 9 of the Act, provides that business income of the non-resident would be liable for tax in India if it is received or deemed to be received in India or accrues or arises or is deemed to accrue or arise to him in India through or from any business connection in India and subject to satisfying the PE conditions under the relevant DTAA.

However, the...

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T. P. Ostwal
T P Ostwal & Associates

"CBDT wants the principle of attribution to take into account the place where goods are sold/ consumed, which principle, in the last 70 years, the Indian Govt. did not think it necessary to follow. Therefore, despite the fact that the proposition of CBDT, in my opinion, is correct, it is going to be difficult for other countries to follow. In other words, acceptability of the draft rules of CBDT is going to be challenging and will lead to double taxation. However, personally, I am of the opinion that market place must be given due importance & attribution should not be restricted to  Functions, Assets, Risk (FAR) analysis but should be based on Functions, Assets, Risk and Market (FARM) analysis."