India quickly embraces BEPS; Will digital-PE be the new norm?

ameya's picture

India has been one of the leading voices in the OECD's BEPS movement since its inception and has strongly suggested for more 'source' based taxation. The final BEPS action plans released in October 2015 by the OECD's Inclusive Framework  (which has now 110+ countries) required domestic tax law changes by the respective member countries as well as bilateral/multilateral measures.  India has been very quick on both the accounts in the last 3 years. 

India not only re-negotiated many of its treaties but has signed MLI and also notified all of its 90+ treaty partners as covered tax jurisdictions. Since the release of the BEPS reports in October 2015, the three successive Budgets have witnessed BEPS-driven changes introduced in Indian domestic tax law.

The first budget after the finalization of BEPS-reports, i.e. Budget 2016 witnessed introduction of CBCR regulations in India.  But for the extension of the due dates (in last 6 months), India would have been among the first countries to have witnesses CBCR-filings! The 2016 Budget also saw the introduction of "equalization levy". Digital economy taxation was an unfinished agenda at the OECD level then (and it is work in progress even now). But India chose to quickly adopt one of the options discussed in BEPS Action Plan 1. In the same Budget, India was also quick to introduce "permissible" patent-box regime (which provides for the reduced tax rate on royalties at 10%).

Last year, Budget 2017 introduced interest deduction limitation rules (restricting related party interest to 30% of EBIDTA).

Budget 2018 proposals released today introduce two major BEPS-related changes. First, India proposes to align the scope of “business connection” with modified PE Rule as per Multilateral Instrument (MLI). Business connection under Section 9 of the Income Tax Act is the domestic law version of permanent establishment (PE) rules. Accordingly, it is proposed that a non-resident agent will create a business connection in India, not only when agent habitually concludes the contracts but also habitually plays a principal role leading to the conclusion of contracts. Another significant proposal in Budget 2018 is to introduce digital-PE in the domestic law based on the 'significant economic presence' of the non-resident in India.  The Government has clarified that virtual or digital PE rule shall not be applicable in case of tax treaty scenario.

 It is widely expected that some resolution will be reached at the OECD's multilateral forum by April 2018 (which is less than 3 months away) on this very topic and where India is also actively participating. A few months ago, European Commission (EC) had expressed concern on 'patchwork unilateral measures' by EU Member States and also warned that "In the absence of adequate global progress, the EU should implement its own solutions to taxing the profits of digital economy companies". EC, however, expressed that it would observe the OECD solution (expected in early 2018).

It is surprising that India has moved quickly to amend the domestic law, pending the discussions on digital economy taxation at the level of OECD. India has introduced equalization levy and now has also proposed the digital PE.  In Budget 2018, however, India has not expanded the scope of services covered under the 'equalization levy'.  This, therefore, raises a question on whether India should have waited for BEPS resolution and not rushed? Or does it mean that possible emerging multilateral consensus is around the introduction of virtual PE which is reflected in India's Budget 2018?