BEPS Action Plan 7 Preventing the Artificial Avoidance of Permanent Establishment Status 15 June 2019

Background

Base Erosion and Profit Shifting (BEPS) BEPS refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations BEPS Action Plans : 15 Action plans (AP) across 3 main pillars AP 1: Address the tax challenges of digital economy “Coherence” Establishing international coherence on corporate income taxation “Substance” Restoring full effects and benefits of international standards "Transparency and Certainty” Ensure transparency while promoting increased certainty and predictability AP 2: Neutralize the effects of hybrid mismatch agreements AP 6: Prevent treaty abuse AP 11: Establish methodologies to collect and analyse data on BEPS and the actions to address it AP 3: Strengthen controlled foreign company (CFC) rules AP 7: Prevent the artificial avoidance of PE status AP 12: Require taxpayers to disclose tax planning arrangements AP 4: Limit base erosion via interest deductions and other financial payments AP 8: Intangibles Assure that transfer pricing outcomes are in line with value creations AP 13: Re-examine transfer pricing documentation AP 9: Risk and capital AP 5: Counter harmful tax practices more effectively, taking into account – transparency and substance AP 14: Make dispute resolution mechanisms more effective AP 10: other high-risk transactions AP 15: Develop a multilateral instrument (MLI)

Action Plan 7 - Overview Permanent Establishment (PE): sole criteria of taxing business profits of foreign enterprise Business profits of a foreign enterprise are taxable in a State to the extent attributable to the PE in that State Establishment of PE also enables taxation of passive income [e.g. royalties, FTS, interest, capital gains] effectively connected to PE Present concept of PE [Article 5 of OECD] revolves around “substantial and physical presence” Fixed place of business Construction / Supervisory PE Presence through dependent agents OECD suggested updating definition of PE to avoid the following: Shifting profits out of the country of sales through “commissionaire arrangements” Fragmentation of activities by MNEs to qualify for PE exceptions Splitting up of contracts Action 7 aims to develop changes to the definition of PE to prevent artificial avoidance of PE status to address the BEPS strategies Action agenda to be achieved through: Amendments to OECD Model Convention (MC) Signing of Multilateral Instruments (MLI) [AP 15] Tax treaty renegotiations

PE Concept – OECD Model Convention Article 5(1) - General Rule: PE must be a fixed place of business at the disposal of the enterprise through which the business of the enterprise is carried on. Article 5(2) - Contains a list of places of business, which prima facie constitute PE, provided they satisfy the requirements of Article 5(1). Article 5(3) - Special rule for construction & installation sites; limitation on Article 5(1). Article 5(4) - Lists activities, which may be carried on at a fixed place of business without giving rise to a PE. (EXCLUSIONS) Article 5(5) - Provides that dependent agents constitute PE on satisfaction of certain conditions Article 5(6) - Identifies certain forms of independent agents who do not constitute PE Article 5(7) - States that an associated company will not necessarily give rise to PE 5(1) Fixed Place 5(2) Specific 5(7) Ass. Co 5(3) Construction PE 5(6) Indep Agents 5(4) Exclusion 5(5) Dep Agent

Artificial splitting up of contracts Key Concerns Business profits of a foreign enterprise is taxable in a State to the extent attributable to its PE in that State Concerns were mainly threefold: Exploitation of exemptions applicable for Preparatory and Auxiliary activities Use of commissionaire and similar arrangements to avoid Dependent Agent PE Artificial splitting up of contracts Business models have evolved significantly Activities that were considered ‘preparatory and auxiliary’ for conventional business are now core activities. Benefit from exceptions applicable to ‘preparatory and auxiliary’ activities are being obtained through fragmentation of business activities among closely related enterprises. Commissionaire Arrangements and similar strategies have been used by enterprises to overcome creation of a DAPE This involved situations where sales contracts substantially negotiated in a State are not concluded in that State because they were finalized or authorized in another State Artificial fragmentation of operations (particularly in construction contracts) between closely related enterprises has been used to abuse the provisions of tax treaties and avoid creation of PE

Areas covered in Action Plan 7 Artificial avoidance of PE through Commissionaire arrangements and similar strategies Artificial avoidance of PE through specific activity exemptions Exclusions in Article 5(4) Anti-fragmentation rule Splitting-up of contracts Recommendations of BEPS AP 7 have been incorporated under OECD MC 2017 and Commentary Also, India has accepted all the recommendations of BEPS AP 7 in its position on the relevant articles in MLI

Analysis

Article 5(5) & 5(6) Agency PE

Article 5(5) of OECD MC Pre BEPS Post BEPS Notwithstanding the provisions of paragraphs 1 and 2, where a person — other than an agent of an independent status to whom paragraph 6 applies — is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph. Notwithstanding the provisions of paragraphs 1 and 2 but subject to the provisions of paragraph 6, where a person is acting in a Contracting State on behalf of an enterprise and, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are in the name of the enterprise, or for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or for the provision of services by that enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.

Agency PE Pre-BEPS Article 5(5) Agency PE created if a person (other than an agent of independent status) acting on behalf of a foreign enterprise has ‘authority to conclude contracts in the name of the enterprise’ Commissionaire arrangements (more common in Europe) were employed to overcome formation of PE under Article 5(5) as goods were sold by an agent in its own name in the other State on behalf of the foreign enterprise, though owned by such enterprise PE under Article 5(5) was also avoided in situations where contracts though substantially negotiated in one State were finalized/ signed/ authorized abroad Person habitually exercising authority to conclude contracts constitutes an independent agent in spite of being closely related enterprise

Commissionaire arrangement Agency PE Commissionaire Arrangements Normal arrangement Commissionaire arrangement F Co F Co sells goods to I Co at ALP I Co obtains title to goods, further sells such goods to customers of Country I Profit of I Co is taxed fully in Country I F Co I Co appointed as “Commissionaire agent”; I Co does not obtain title to goods, further sells such goods in its own name to customers of Country I Contract for sale is concluded between F Co and customer thru I Co I Co is paid commission, which is brought to tax in Country I Country F Country F Country I Country I I Co I Co 1 Commissionaire arrangement may be loosely defined as an arrangement through which a person sells products in a given State in its own name but on behalf of a foreign enterprise that is the owner of these products. Commissionaire generally does not legally bind the principal. Commissionaire is a civil law concept generally recognized under European Civil law concept of agency. If the fact that agent is acting as a commissionaire is not disclosed to third parties, then they can enforce the contract only against the commissionaire, which is indemnified by the principal. In contrast, under common law an undisclosed principal is legally bound to a third party by a contract made by an agent acting within its authority. Under most tax treaties, a commissionaire may not create a permanent establishment of the principal because the contracts it makes with third parties are not legally binding on the principal. However, a commissionaire in a common law country does bind the principal to third parties under the doctrine of undisclosed principal and will create a permanent establishment of the principal. 2 Concept found in civil law countries 3 India, being a common law country, may not be much impacted by commissionaire arrangements as such structures are not permissible under the provisions of the Indian Contract Act

Supply of goods without transfer of title Agency PE Case Study - Commissionaire Arrangements Facts U Co commercialized its products in France through French distributor F Co until 1995 Later, a commissionaire agreement was executed Under the arrangement, F Co could accept orders present estimates and documents within the framework of tender offers conclude sales contracts for the account of the taxpayer negotiate prices grant discounts and payment facilities to existing or new clients without the prior approval of U Co Issues Whether U Co, carried on a business in France through a dependent agent as per UK-France treaty? Supreme Court verdict For constitution of DAPE, contracts should be concluded "in name of" foreign enterprise, whilst a commissionaire acts "in its own name" Commissionaire does not create a direct contractual relationship between principal and third-party customer Therefore, no PE constituted by F Co in France Court also noted commissionaire agreement may be recharacterized as an agency relationship in situations where the legal characterization adopted by the contract conflicts with the substantive provisions included in the agreement U Co Supply of goods without transfer of title UK France F Co Sales force Sale of goods

01 03 02 Agency PE Other Similar Strategies Contracts substantially negotiated but not concluded in a State; finalization or authorization done abroad Any similar arrangement 02 Person habitually exercising authority to conclude contracts constitutes “independent agent” [as per Article 5(6)] even though closely related

Agency PE Post-BEPS Agency PE is created under Article 5(5) if a person acting in a Contracting state on behalf of an enterprise either: Habitually exercises authority to conclude contracts; or habitually concludes contracts [existed before BEPS], or Habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise [extended scope] In addition to contracts entered into by the agent in the name of the enterprise, following contracts are also included: Contracts for provision of services by foreign enterprise Contracts for the transfer of the ownership of property owned by foreign enterprise, or Contracts for the granting of the right to use property in respect of which foreign enterprise has the right to use I think additional contracts (mentioned in sub clauses. A, b and of Article5(5) ) are for Commissionaire Arrangement- Para 91 to 95 OECD Agent with contract concluding authority has been expanded to cover an agent who concludes contracts or habitually plays the principal role in concluding contracts.

Conditions for dependent agent to create PE Agency PE Post-BEPS Conditions for dependent agent to create PE Pre BEPS Post BEPS Acting on behalf of foreign enterprise a Habitually exercising authority to conclude contracts ,or Habitually concludes contracts in the name of foreign enterprise Habitually plays principal role leading to conclusion of contracts (whether or not in the name of foreign enterprise) that are routinely# concluded without material modification by the enterprise Contracts that are: in the name of the enterprise, or for the transfer of the ownership of, or for the granting of the right to use, property owned foreign enterprise or for the provision of services by foreign enterprise r # India has reserved the right for not including the word “routinely” in paragraph 5 of Article 5. (this conflicts with India’s position under MLI)

Meaning of the phrase “habitually concludes contracts” Agency PE Meaning of the phrase “habitually concludes contracts” Test of ‘conclusion of contract’ determined based on relevant contract law If acceptance of offer results in contract by third party under relevant contract law, contract is concluded even if signed outside of source state Person negotiating all elements and details of a contract in a source state to bind Foreign Enterprise leads to contract conclusion even if signature is by another person outside source state

01 02 Agency PE Activities that are not included Meaning of the phrase ‘habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise’ 01 Phrase to be interpreted in the light of the object and purpose of paragraph 5 (i.e. to cover cases where a person acts as the sales force of the enterprise even though, under the relevant law, the contract is not concluded by that person in that State) 02 Phrase “principal role leading to the conclusion of the contract” will therefore typically be associated with the actions of the person who convinced the third party to enter into a contract with the enterprise. Activities that are not included Advertising of goods and services Marketing and promotion of goods and services which does not directly result in conclusion of contracts Actions sought to be covered Convincing prospective customers Soliciting and receiving orders Forwarding orders which is routinely approved by foreign enterprise

Agency PE Low Risk Distributor (LRD) LRD concludes contracts on its own behalf; obtains ownership in goods / services from another enterprise and assumes limited inventory risk LRD (irrespective of whether it is an associated enterprise or not) has been specifically excluded from the ambit of Agency PE India does not agree with the above interpretation because it considers that distribution of goods owned by an enterprise, associated or related enterprise may create PE, particularly in a case where the risks are not borne by such distributor Other Points Contracts “in the name of” does not literally mean in the name of the enterprise and would cover situation where name is undisclosed in a written contract For PE to trigger, activity needs to be done “habitually” Scope of “habitually” same as existing commentary - reiterates that it is something more than mere transitory Need to be tested based on facts of each case; No precise frequency test possible Contracts should relate to the business operations of the foreign enterprise and not for administrative purposes. For instance, authority to hire employees.

Illustration – Conclusion of contracts (1/2) RCO Facts R Co is a global distributor of goods and services through its website Employees of S Co facilitate sales of R Co in Country S Identify potential customers Use relationship building skills to understand need of customers Convince them to buy the products/ services offered by F Co through emails, meetings / visits Responsible for large accounts Explain standard terms (viz. fixed price, quantity, mode of concluding contracts online etc.) S Co’s employees cannot modify price structure and contractual terms Contracts are concluded online between R Co and customers basis price structure presented and discussed Is there a PE exposure? Online sale of goods Service Fees State R State S Facilitation of sales without formal conclusion of contracts SCO (WOS of RCO)

Illustration – Conclusion of contracts (2/2) RCO Analysis Employees play a principal role leading to the conclusion of the contract Inability of S Co’s employees to vary the contract terms not a relevant factor Presence of non-alterable standard terms do not impact that the contracts were as a result of performance by S Co employees to convince the customers to accept the terms Role of S Co’s employees – crucial element to conclusion of contract Triggers dependent agent PE of R Co in State S Online sale of goods Service Fees State R State S Facilitation of sales without formal conclusion of contracts SCO (WOS of RCO)

Agency PE Scope of ‘Authority to Conclude Contracts’ Criteria Pre BEPS Post BEPS OECD MC India Position Mere attending or participating in negotiations Not sufficient to infer that ‘authority to conclude contracts’ is exercised It may be sufficient in certain circumstances Same as Pre BEPS Negotiation of all elements Negotiation of all elements in a way binding on foreign enterprise can get covered Authority to negotiate essential elements (and not necessarily all) of a contract is sufficient Negotiation of essential elements have to be interpreted considering the following: Negotiation of all elements of a contract which are in a way binding on foreign enterprise may qualify as conclusion of contracts In certain cases, negotiation of essential elements may be considered as playing a principal role which leads to routine conclusion of contract.

Agency PE Analysis from India Perspective Commissionaire arrangement may not be relevant for India since India is a common law country Indian tax treaties have wide agency PE rule which covers the following: Securing orders Maintenance of stock Delivery Changes could impact foreign companies having subsidiaries in India which undertake marketing and sales support activities Tax authorities may take aggressive views on role played by agents vis-à-vis negotiations of contracts/ securing contracts Maintaining robust documentation on the roles and responsibilities,; detailed mapping of activities of agent and principal in relation to the generation of Indian sales would be critical. Where such subsidiaries habitually play the principal role leading to the conclusion of contracts that are routinely concluded by the foreign principal without material modification, it could create a PE of the foreign principal in India The terms ‘principal role’, ‘routinely concluded’ and ‘material modification’ have not been defined and could, therefore, lead to different tests being applied by different taxing authorities. The mischief sought to be avoided seems to be where all essential activities in relation to the conclusion of sale is performed by the agent in the source country, but the final contract or order is ‘rubber stamped’ by the foreign principal outside the source country.

Agency PE Analysis from India Perspective Meaning of ‘Securing order’ Securing of orders may be understood in: Its ordinary meaning wherein activities that result in ensuring that the foreign enterprise gets an order for sale or supply of goods or A wider sense to include solicitation of orders For instance, in India-USA DTAA, scope of securing of orders is restricted; A person shall be considered to habitually secure order wholly/almost wholly for NR only if: Such person frequently accepts orders on behalf of NR Such person habitually represents to the purchasers that its acceptance to the supply order tantamounts to NR acceptance of supply Actions of NR give reasonable belief to purchasers that the person has authority to bind the NR

Agency PE Analysis from India Perspective Guidance on ‘Securing order’ Most of the Indian tax treaties have generic ‘securing order’ rule; Such tax treaties may not get impacted For Indian tax treaties based on OECD model, substance based analysis would be important Extracts from OECD Commentary “The phrase “habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise” therefore applies where, for example, a person solicits and receives (but does not formally finalize) orders which are sent directly to a warehouse from which goods belonging to the enterprise are delivered and where the enterprise routinely approves these transactions”

Impact - Operation of Liaison office (1/2) R Co. Business model Permitted activities for a LO in India contained in FEMA regulations Ratio laid down in Court rulings* in relation to the issue of whether LO in India constitutes a PE of the foreign enterprise in India Permissible activities Supply of information Acting as a communication channel Doing preliminary and preparatory work Advertising Facilitating meetings, arranging stay and travel arrangements etc. Non permissible activities Negotiating prices Pursuing customers Whether BEPS AP 7 has any impact ? State R State S LO Sale of goods Sales & Marketing Customer * Favourable rulings- IAC v Mitsui & Co. Ltd. [1991] 39 ITD 59 (Del)(SB), Sumitomo Corporation v DCIT [2007] 110 TTJ 302 (Mum), Visakhapatnam Port Trust [1983] 144 ITR 146 (AP), Motorola Inc. v DCIT [2005] 95 ITD 269 (Del) (SB), Airports Authority of India [2008] 299 ITR 102 (AAR)K.T. Corporation [2009] 224 CTR 234 (AAR) Unfavourable rulings- Jebon Corporation 2011-TII-15-HC-KAR-INTL, Rolls Royce PLC v DDIT [2008] 113 TTJ 446 (Del) [ as affirmed in Rolls Royce PLC v DIT [2011] 339 ITR 147 (Del)]

Impact - Operation of Liaison office (2/2) R Co. Analysis Court rulings in the past have already held if the LO is engaged in activities (eg. Negotiating with customers, convincing, persuading etc.) it would result in creation of a PE in India Amendment in Article 5(5) will now reinforce the ratio laid down in these rulings State R State S LO Sale of goods Sales & Marketing Customer LO would constitute PE in India, if it habitually plays the principal role in concluding contracts or attracts anti-fragmentation rule, if sales are undertaken in India

Impact - Marketing support service providers (1/2) R Co. Business model Presence set up in India in the form of a subsidiary to carry out marketing support services (as opposed to setting up a liaison office) State R State S Subsidiary Sale of goods Sales & Marketing Customer

Impact - Marketing support service providers (2/2) R Co. Analysis Fine line of demarcation between providing support to the foreign enterprise and playing the principal role in concluding contracts Activities that would trigger a high risk to PE exposure (illustrative list): Actively pursuing customers to solicit orders Persuading/ convincing customers to provide orders Direct nexus between efforts and orders obtained Verbal contract (eg. Acceptance of offer to enter into a contract with customers or holding out to have that authority( although contract may be signed outside India) Permissible activities (illustrative list): Advertising and promotional activities in respect of products Conducting market research Collecting feedback from customers and providing to foreign enterprise State R State S Subsidiary Sale of goods Sales & Marketing Customer Subsidiary would constitute PE in India if it habitually plays the principal role in concluding contracts or attracts anti-fragmentation rule if sales is undertaken in India

Article 5(6) of OECD MC Pre BEPS Post BEPS An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. Paragraph 5 shall not apply where the person acting in a Contracting State on behalf of an enterprise of the other Contracting State carries on business in the first-mentioned State as an independent agent and acts for the enterprise in the ordinary course of that business. Where, however, a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent within the meaning of this paragraph with respect to any such enterprise. For the purposes of this Article, a person is closely related to an enterprise if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same persons or enterprises. In any case, a person shall be considered to be closely related to an enterprise if one possesses directly or indirectly more than 50 per cent of the beneficial interest in the other (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) or if another person possesses directly or indirectly more than 50 per cent of the beneficial interest (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) in the person and the enterprise.

Independent Agent Pre BEPS Article 5(6) Article 5(5) did not apply if the business of the foreign enterprise was carried on in the other state by a broker, general commission agent or any other agent of independent status. Post BEPS Article 5(6) Article 5(5) shall not apply if the business of the foreign enterprise is carried on in the other state by independent agent acting in the ordinary course of business Person qualifies as independent agent if the following conditions are cumulatively satisfied: Acts in ordinary course of business Does not act exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related A person will be closely related to an enterprise [“CRE”] if : One enterprise possesses directly or indirectly more than 50 percent of the beneficial interest / 50 per cent of the aggregate vote and value of the company’s shares in the other; or If another person possesses directly or indirectly more than 50 per cent of the beneficial interest in the person and the enterprise Article 5(6) does not apply where person acts on behalf of NR as an employee or partner

Independent Agent Meaning of certain terms Term Meaning/ Interpretation Ordinary course of business An independent agent cannot be said to act in the ordinary course of its business as agent when it performs activities that are unrelated to that agency business For instance, if a person acts as distributor for multiple unrelated parties and also as an agent of another enterprise. The distribution activity will not be considered to be part of the activities that the company carries on in the ordinary course of its business as an agent Exclusively or almost exclusively Person working for more than one enterprise does not automatically become independent. The Article 5(6) criteria of legal & economic independence and ordinary course of business needs to be fulfilled Independent status is less likely if the activities are performed wholly or almost wholly on behalf of only one enterprise / CRE over a long period of time. All the facts and circumstances would need to be taken into account A person would be considered to be acting “almost exclusively” on behalf of enterprise where it has no significant business activities apart from activities conducted for CRE’s; For example, if the sales that an agent concludes for unrelated enterprises represent less than 10 percent of total sales. Such agent should be viewed as acting “exclusively or almost exclusively” on behalf of CRE’s

Independent Agent Holding Subsidiary Relationship Holding-subsidiary relationship is not sufficient in itself to conclude dependent agent Even subsidiary should fulfill independence test at par with any entity If a subsidiary acts on behalf of its parent company in such a way that the parent will be deemed to have a PE under Article 5(5); a subsidiary acting exclusively or almost exclusively for its parent may be regarded as dependent agent India’s Position on Article 5(6) and commentary India reserved the right not to include the words “to which it is closely related” in Article 5(6). [This conflicts with India’s position on MLI] India has reserved the right to make it clear that an agent whose activities are conducted wholly or almost wholly on behalf of a single enterprise will not be considered an agent of an independent status.

Agency PE Treaties with many countries (for instance US, UK, Canada, Singapore, Mauritius, France, China) contain conditions similar to BEPS for independent agent Some treaties (US, Canada, France, Netherlands) further impose additional arm’s length condition for it. It is summarized as under: Extracts of tax treaties Independent Agency Rule under Indian DTAA’s Activities of agent wholly/almost wholly on behalf of NR? Transactions between agent and NR at ALP? Will it be considered as independent agent? No Not relevant Yes India US India Singapore 5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph. 9. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent or any other agent of an independent status provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise itself or on behalf of that enterprise and other enterprises controlling, controlled by, or subject to the same common control, as that enterprise, he will not be considered an agent of an independent status within the meaning of this paragraph.

Amendment to Agency PE clause Implementation of Article 5(5) and 5(6) of OECD through Article 12 of MLI MLI Provisions Article 12 of MLI seeks to amend Article 5 of the tax treaties to include following aspects within the ambit of PE : Extended scope of agency PE in line with AP 7 i.e. creation of agency PE when the agent habitually plays principle role leading to conclusion of contracts with routine approval of the principal Scope of Independent agent India Perspective As per the provisional notifications, India would adopt this Article in its tax treaties These provisions will apply to the extent that India’s relevant treaty partner has not exercised its right of reservation, and notified India with respect to Article 12. Recent tax treaty negotiations / amendments by India: Negotiated tax treaty with Hong Kong; Amendments to India Kazakhstan and India Kenya tax treaties BEPS provision of Agency PE not adopted in the recent treaty negotiations / amendments with above mentioned countries

Article 5(4) Specific activity exemptions

Article 5(4) of OECD MC Pre BEPS Post BEPS Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that such activity or, in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character.

Article 5(4) – Specific activity exemptions Pre BEPS Article 5(4) of OECD Model Convention Article 5(4) contains list of business activities treated as exceptions to general PE definition To qualify for the exemption, place of business should be used only to carry out specified activities mentioned in Article 5(4) Rationale for the exclusion in Article 5(4) – listed exceptions consist of activities that are very remote from actual realization of profits although these activities may contribute to enterprise productivity Common feature of the activities listed in Article 5(4) – Such activities were in general preparatory and auxiliary in nature ‘Preparatory and auxiliary activities’ condition explicitly included only in sub-paras (e) and (f) OECD Concern: Specific activity exemption open to BEPS abuse specially where such activities are core functions or cohesive business activities are artificially fragmented Preparatory activity : An activity carried out in contemplation of carrying on an essential and significant part of activity of enterprise as a whole Auxiliary activity : Activity carried on to support without being part of the essential and significant part of activity of enterprise as a whole

Article 5(4) – Specific activity exemptions Existing Article 5(4) Activities mentioned at sub-paras (a) to (d) are not subject to the condition that activities should be preparatory or auxiliary Amended Article 5(4) All activities listed under Article 5(4) would need to be ‘preparatory and auxiliary’ in nature to qualify for exemption under Article 5(4) Key Amendment

Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise a) the maintenance of stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery b) Illustrations where PE shall be constituted Maintaining a large warehouse for storage and delivery of goods sold online; large number of employees work in the warehouse and the warehouse is an important asset of the enterprise Storage and delivery activities performed through the warehouse, which represents an important asset and requires number of employees, constitutes an essential part of the sale/distribution business. Therefore, such activities do not have a preparatory or auxiliary character Delivery of spare parts to customers for machinery as well as maintenance / repairs of such machinery This activity would go beyond the pure delivery and form part of after-sales service which is an essential and significant activity of the enterprise vis-à-vis the customers

Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise a) the maintenance of stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery b) Illustrations where PE shall not be constituted Bonded warehouse with special gas facilities that an exporter of fruit from one state maintains in another state solely for the purpose of storing in a controlled environment during the custom clearance process Delivery of spare parts to customers for machinery sold to those customers. Fixed place of business maintained solely for the said purpose. Illustrations where PE may be constituted Enterprise allowed unlimited access to a separate part of warehouse of third party for the purpose of inspecting and maintaining the goods or merchandise stored therein. Since disposal test is met, para b would be relevant. Existence of PE shall depend on whether the activities constitute preparatory or auxiliary activity. Whether activities of storage, display or delivery is preliminary and auxiliary in nature should be determined in light of various factors having regard to overall business activities The above para are irrelevant if the facilities where goods stored is not at the disposal of F Co

Illustration - E-commerce companies (1/2) Business model R Co (E-commerce operator) Typical business model for E-commerce companies is that customers purchase goods from an online portal Stock of goods are stored at a warehouse engaging significant personnel for storage and delivery of goods Goods are delivered to customers pursuant to online sale of goods Whether R Co has a PE in India ? Sale of goods State R State S Places order online Customer Large Warehouse Delivery of goods

Illustration - E-commerce companies (2/2) Analysis R Co (E-commerce operator) Preparatory and auxiliary condition’ attached to each of the business activities listed in Article 5(4) Storage and delivery function may not qualify as ‘preparatory and auxiliary’ in the above factual matrix Storage and delivery functions performed through the warehouse which represents an important asset and requires large number of employees would be considered an essential part of enterprise’s sale and distribution business Sale of goods State R State S Places order online Customer Large Warehouse Delivery of goods Storage & delivery not preparatory and auxiliary for e-commerce companies. May also extend to non-online sales through warehouse

Illustration - Toll Manufacturing (1/2) Business model R Co (owner of RM/Semi FG) Arrangement in which a company (which has a specialized equipment and workforce) processes raw materials or semi-finished goods for another company Raw materials/semi-finished goods are supplied by the principal to the toll manufacturer Principal remains the owner of the raw materials/semi-finished goods After processing, the final product is either sent back to the principal or sold to third party on behalf of the principal Toll manufacturer receives a fee for his services State R State S Final Product (after processing) Supply of RM/Semi FG Customers (Third Party) S Co (Toll Manufacturer) Final Product (after processing)

Illustration - Toll Manufacturing (2/2) Analysis R Co (owner of RM/Semi FG) R Co has no fixed place at its disposal – test of disposition not satisfied - No PE in State S If R Co is allowed unlimited access to separate parts of facilities (inspection etc), it needs to be examined whether it would fall under Pep & Aux activities If R Co acts as a distributor of products of other enterprises; The activity of mere maintenance of stock of goods belonging to an enterprise for processing by another enterprise would not form an essential and significant part of the activity of the distributor. State R State S Final Product (after processing) Supply of RM/Semi FG Customers (Third Party) S Co (Toll Manufacturer) Final Product (after processing) What if R Co is a manufacturer ? Enterprises may need to review the need to shift from a toll manufacturing model to a contract manufacturing model.

Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the maintenance of fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise. d) Purchase Function Illustrations where PE shall be constituted F Co, a trader of particular product produced in State S, [which it sells from State R to distributors situated in different countries], maintains a purchasing office in State S Employees working in office at State S are experienced and visit producers in that state, determine the type/ quality of the products according to international standards and enter into different types of contracts (spot or forward) for the acquisition of products by F Co. Exception of para d shall not apply because the purchasing function forms an essential and significant part of F Co’s overall activity. Illustrations where PE shall not be constituted F Co operates a number of large stores, maintains an office in State S during a two-year period for the purpose of researching the local market and lobbying the government that would enable it to establish stores in State S. During that period, employees of F Co occasionally purchase supplies for their office. Overall activity preparatory in nature.

Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the maintenance of fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise. d) Purchase Function (contd.) Position under Indian domestic law As per Explanation 1 to Section 9(1)(i), no income shall be deemed to accrue or arise in India through or from operations which are confined to the purchase of goods in India for the purpose of export Discussion Points Substantive change to the scope of purchase function Impact of amendments in light of domestic provisions Whether purchase by manufacturers on regular basis be affected ? Whether functions of LOs engaged in purchasing activities requires evaluation ?

Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 the maintenance of fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise d) Collection of information Illustrations where PE shall not be constituted An investment fund sets up an office in a State solely to collect information on possible investment opportunities in that State An insurance enterprise that sets up an office solely for the collection of information, such as statistics, on risks in a particular market” Newspaper bureau set up in a State solely to collect information on possible news stories without engaging in any advertising activities” Illustrations where PE shall be constituted Where a fixed place of business which is used for the supply of information, not only gives information but also furnishes plans etc. specially developed for the purposes of the individual customer Relevant and necessary to determine whether collection of information goes beyond the preparatory or auxiliary threshold

Article 5(4) – Specific activity exemptions Illustrations of preparatory and auxiliary activities in Action 7 Activities not expressly listed in (a) to (d) as long as that activity has preparatory or auxiliary character [Other Activities] d) Illustrations where PE shall be constituted Management office set up to manage the entire or part of an enterprise. The function of managing an enterprise wholly / partly, constitutes an essential part of the business operations of the enterprise Illustrations where PE shall not be constituted Training employees at one place before these employees are sent to work at remote work sites located in other countries, the training that takes place at the first location constitutes a preparatory activity for that enterprise. Scientific research (no manufacture involved)* Sale of merchandise, which was displayed at a fair/convention, at the end of the fair/convention *Scientific research is explicitly covered in exclusion under Article 5(4) in certain tax treaties e.g. India-Switzerland tax treaty

Article 5(4.1) Anti - fragmentation rule

Article 5(4.1) of OECD MC Pre BEPS Post BEPS Not present in OECD Model convention Paragraph 4 shall not apply to a fixed place of business that is used or maintained by an enterprise if the same enterprise or a closely related enterprise carries on business activities at the same place or at another place in the same Contracting State and a) that place or other place constitutes a permanent establishment for the enterprise or the closely related enterprise under the provisions of this Article, or b) the overall activity resulting from the combination of the activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, is not of a preparatory or auxiliary character, provided that the business activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, constitute complementary functions that are part of a cohesive business operation.

Anti-fragmentation rule Pre BEPS Commentary provided safeguard measures against fragmentation of activities by a foreign enterprise though Article 5(4)(f) 1 Safeguards were not sufficient to prevent fragmentation of operations through related enterprises 2 No remedy was available in existing Article 5 and OECD Commentary to deal with cases where complementary functions were segregated among related enterprises 3 BEPS Action Plan 7 recommends extending the analysis to activities carried by closely related enterprise at different or same places

Anti-fragmentation Rule Post BEPS New Para 4.1 inserted in Article 5 Purpose - To prevent use of Article 5(4) exemptions to artificially avoid PE status by fragmenting a cohesive business operation into several small operations Pre-BEPS guidance in OECD on anti-fragmentation only covers activities undertaken by foreign enterprise BEPS covers situations where the combined activities of group entities at the same place or different places in the same country exceed Preparatory and auxiliary threshold Key Difference

Anti-fragmentation Rule Conditions for the applicability of Article 5(4.1) CONDITION 1 Foreign Enterprise or its group entity carries on business activities at the same place or another place in the state CONDITION 2 at least one of the places constitute a PE OR overall activity resulting from the combination of the activities carried on by Foreign Entity or its group entity is not of a preparatory and auxiliary character CONDITION 3 Aggregate business activities constitute complementary functions that are part of cohesive business operation Requires detailed analysis of activities undertaken by an organization to identify complementary functions that are part of a cohesive business operation

Anti-fragmentation Rule Interplay with Clause (f) of Article 5(4) In cases where an enterprise maintains several fixed places of business to which other listed PE exemption clauses apply. Unless anti-fragmentation provisions are applicable, the preparatory/auxiliary activity condition under clause (f) of Article 5(4) is of no relevance [Para 74 of OECD MC] 1 In such cases, each place of business has to be viewed separately and in isolation for deciding whether a PE exists. 2 India’s Reservation: India has expressed reservation to above interpretation, as per which, even when the anti-fragmentation provision does not apply, an enterprise cannot fragment a cohesive operating business into several small operations in order to argue that each is merely engaged in a preparatory or auxiliary activity

Illustration – Anti fragmentation Verify client information for loan application Facts R CO Bank R Co, has number of branches in India which constitute PEs It also has a separate office in India where few employees verify information provided by clients that have made loan applications at branches The results of the verifications done by employees are forwarded to R Co where it analyzes the information included in the loan applications and provide reports to the branches where the decisions to grant the loans are made. Reports sent to branch State R State S Document Verification office Branch [PE] Grants Loan Loan applications Analysis Exemptions under Para 4 will not apply to verification office as: The branches in India (to whom loan application has been made) constitute PE The activities performed by the office and relevant branch are complementary functions that are a part of cohesive business operation of giving loan to clients in India.

Illustration – Delivery of spare parts and after-sales service (1/2) R Co. Facts R Co. would sell goods to customers in State S Spare parts would be delivered to customers from warehouse in State S. Group company in State S would provide after sales service to customers. Is there a PE exposure? State R Sales in State S State S Warehouse Group Co. Sale of goods Physical movement of goods/ services

Illustration – Delivery of spare parts and after-sales service (2/2) R Co. Analysis Pre BEPS Repairs/ after sales service is undertaken by a group entity. Only supply of spare parts through warehouse. Exemption under Article 5(4) would be available. Post BEPS After sales service would form an essential and significant part of the services of an enterprises vis-à-vis its customers Even if the activity of after sales service is undertaken by a group company and it is argued that mere delivery of spare parts through the Indian warehouse does not create a PE in India, the arrangement may attract the anti-fragmentation rule where it may be alleged that delivery of spare parts and after sale service are complementary functions forming part of a cohesive business activity undertaken by connected enterprises. Therefore, Article 5(4) benefit may not be available and R Co would have a PE in India. State R Sales in State S State S Warehouse Group Co. Sale of goods Physical movement of goods/ services

Illustration – Maintenance of warehouse (1/1) R Co (manufacturer and seller) Business Model R Co, manufactures and sells appliances S Co, wholly owned subsidiary of R Co owns a store where it sells appliances acquired from R Co R Co owns a warehouse in State S where it stores a few large items identical to the ones owned by S Co When customers places order for large items with S Co, employees of S Co go to warehouse to take possession of items before S Co sells to customers Sells appliances State R State S Stores appliances Analysis Para 4.1 shall apply; Exemptions under para 4 shall not be available because of following: S Co and R Co are related enterprises Business activity carried out by R Co at its warehouse and by S Co at its store constitute complementary functions forming part of a cohesive business operation R Co Warehouse S CO (Seller) Customer

Illustration – Research and Manufacturing (1/1) R Co. Facts R Co is engaged in manufacturing goods in India through a closely related enterprise R Co. has a captive R&D unit in India. Certain findings from scientific research may be employed in manufacturing goods in India. Whether PE can be constituted ? State R Analysis State S Scientific research qualifies preparatory and auxiliary under sub-para (e) Whether anti-fragmentation rule can be applied ? Whether manufacturing and research are interdependent ? Captive R&D If anti-fragmentation rule is applied to consider R&D and manufacturing as complementary activities, it may be rebutted as under: Purchase and manufacturing for instance may be considered as complementary functions that are part of a cohesive business operation, not research and manufacturing Manufacturing and research are not interdependent (eg. Manufacturing can be undertaken even without research) Conclusion Article 5(4) exemption should be available in respect of research activities and F Co. is not likely to have a PE in India. It may be noted that this issue is fact specific. Group Co. (Manufacturing)

Illustration - Business Process Outsourcing Units (1/2) Business model The business model of Business Process Outsourcing Units (‘BPOs’) may be categorized as under: 01 02 03 Category A – Back-office support services (Accounting, Payroll, HR, Tax etc.) (In- house for the foreign enterprise) Category B - Back-office support services (as a service to clients) by a third party Category C - Acting as the marketing and sales force of an enterprise

Illustration - Business Process Outsourcing Units (2/2) Analysis Category A : In house Back- office support services May be regarded as auxiliary activities provided anti-fragmentation rule does not apply and overall activity is considered as Prep & Aux Category B : Back-office support services (as a service to clients) by third party Service obtained by foreign clients for a fee from a third party BPO which is not likely to create a PE in India as: (i) BPO may not be a dependent agent qua the foreign enterprise; (ii) BPO may not qualify as an Article 5(1) PE for the enterprise as it would not be at the disposal of the foreign enterprise Category C - Acting as the marketing and sales force of an enterprise If the BPO is a dependent agent qua the foreign enterprise and plays a principal role in marketing and selling its goods/ services is likely to constitute a PE of the foreign enterprise in India BPOs that function akin to the sales force of a foreign enterprise in India run a high risk of exposure to creation of a PE in India

Anti-fragmentation Rule – Discussion Points 01 Involvement of independent third party may not be impacted 03 Interpretation of terms such as “cohesive business operations” and “complementary activities” may result in ambiguity Combining the activities of related entities may enable piercing the corporate veil Impact on genuine business arrangements involving segregation of business activities within a group 02 04

Specific activity exemptions and Anti Fragmentation Rule Relevance in Indian Context 01 02 03 04 Each case to be separately examined based on facts to determine whether enterprise qualifies for PE exemption in view of narrowed scope of article Preparatory and auxiliary judicially interpreted; Some principles already part of Indian jurisprudence Functions of LO Proposed tightening of conditions relating to prep and aux activities, coupled with anti-fragmentation rule may involve greater scrutiny from the Revenue authorities Spurt of e-commerce in India: Functions such as warehousing, display, delivery, and supply chain model may not be considered as ‘prep or aux’ A significant number of foreign companies have set up liaison offices in India – the argument taken in such cases is that the activities of the liaison office are preparatory or auxiliary in nature, and accordingly, no PE is created. With the proposed tightening of the conditions relating to preparatory or auxiliary activities, coupled with the antifragmentation rule for specific activity exemptions, the Revenue authorities are likely to look at such functioning of liaison offices in greater detail.

Amendment for Specific Activity Exceptions Implementation through Article 14 of MLI MLI Provisions Two options provided to counter artificial avoidance of PE status through specific activity exemptions: Anti fragmentation Rule India Perspective As per the provisional notifications, India has opted for Option A. India’s tax treaties will be modified to replace existing provisions with respect to specific activity exemptions, but only to the extent that India’s treaty partner also notifies Option A. India has not reserved application of anti fragmentation rule. Hence, it shall apply to its tax treaties provided treaty partner also refrains from exercising its right to reserve. Option A Exemption from PE is available only if the activities carried on are preparatory and auxiliary in nature Option B Specific activity exemption provided as per 2014 OECD MC Recent tax treaty negotiations/amendments by India: India Hong Kong/India Kenya Option B of MLI adopted i.e. as per OECD 2014 Anti-fragmentation provision: Not Adopted India Kazakhstan Option B of MLI pre-existed Anti-fragmentation provision: Not Adopted

Article 5(3) Splitting-up of contracts

Splitting-up of contracts OECD Concern 01 Article 5(3) deals with the creation of construction PEs if such construction, building or installation site lasts for a period of at least 12 months 03 12 month rule is open to BEPS abuse Contracts for construction-type activities can be split up so that they are: Carried out under separate contracts that are allocated to different associated enterprises Over a period of less than 12 months, such that no PE is created Profits relating to these construction activities that should be taxed in the Source State are instead taxed where the associated enterprises are tax resident 02 04

Splitting-up of contracts Proposed Changes Principal Purpose Test These abuses to be addressed through the application of the general anti-abuse rule in the form of Principal Purpose Test [This is dealt with AP 6] Under general anti-abuse rule, a PE may be deemed to exist if contracts are concluded with a Principal Purpose of claiming exemption under Article 5(3) Alternative provision in the tax treaty to address contract splitting In order to determine PE, aggregate the time spent by the enterprise in relation to the building site or construction or installation project and time spent on connected activities during different periods of time each exceeding 30 days, by one or more closely related enterprise Necessary to evaluate the activities carried on by one or more closely related enterprises to determine whether they are connected activities that should be aggregated

Illustration 1 – Splitting of Contracts Business Model R CO R CO-1 Contract 2 R Co and R Co-1 are closely related enterprises R Co is awarded contract for the construction of power plant for ICO. The Contract period is 22 months Project is divided into 2 different contracts each lasting 11 months and concluded with R Co and R Co-1 R Co would be contractually liable for entire contract with ICO DTAA between State S and R provides 12 months threshold for determination of PE 100% Joint and several responsibility of R Co and R Co 1 State R State S Analysis Contract 1 One of the principal purposes for the conclusion of the separate contracts was to obtain the benefit of the rule in Article 5(3) Granting the benefit of rule in these circumstances would be contrary to the object and purpose of that paragraph as the time limitation of that paragraph would otherwise be meaningless S CO

Illustration 2 – Splitting of Contracts S Co Business Model R Co successfully submitted a bid for the construction of a power plant for S Co Construction project expected to last 22 months During negotiation, the project is divided into two different contracts, each lasting 11 months First contract is concluded with R Co and the second contract is concluded with Sub Co R Co is jointly and severally liable with Sub Co for the performance of Sub Co’s contractual obligations under the Sub Co contract Country S Country R Contract 1 R Co Contract 2 Joint and several liability of R CO and sub Co Analysis 100 percent One of the principal purposes for the conclusion of the separate contracts was to obtain the benefit of the rule in paragraph 3 of Article 5 Granting the benefit of that rule in these circumstances would be contrary to the object and purpose of that paragraph as the time limitation of that paragraph would otherwise be meaningless Sub Co

Amendment for Contract Splitting Implementation through Article 14 of MLI MLI Provisions Period of time spent by the enterprise for projects (such as building site, construction, installation or other specific project) is determined by: Aggregating the time spent by the enterprise carrying on the activity with period of time spent by closely related enterprises for connected activities Subject to the condition that period(s) of time spent by enterprise and the related enterprises, each exceed 30 days Similar to Alternative provision as per OECD 2017 India Perspective India has not reserved application of above provision. Hence, it shall apply to its tax treaties provided India’s treaty partner also refrains from exercising their right to reserve.

Action 7 – Summary

To Summarize Final report 2015 on AP 7 covers avoidance of PE status Through commissionaire arrangements and other similar strategies Through specific activity exemptions Through splitting-up of contracts Scope of Article 5(5) expanded by lowering the threshold for constitution of PE Independence criteria in Article 5(6) tightened Scope of PE exemptions in Article 5(4) narrowed Anti-fragmentation rule introduced Application of PPT in accordance with AP 6 Alternatively, inclusion of provision for aggregation of time spent by closely related enterprise on connected activities

Interplay with Action 1 Addressing tax challenges of digital economy

Interplay with Action Plan 1 Action Plan 1 was initiated due to the following concerns: Tax planning by multinationals to artificially reduce taxable income or shift profits to low tax jurisdictions in which little or no economic activity is performed Lack of coherence of international tax rules with the new digital business models with heavy reliance on intangibles New business models in a digital world permit interaction with customers in another country without physical presence resulting in base erosion in source country Characterization of income from new business models was one of the key tax challenges with respect to digital economy Action 7 focuses on following key changes which are relevant for Digital Economy Restriction on scope of exemptions available for “preparatory or auxiliary” activities Anti-fragmentation rule to prevent fragmentation of business activities amongst closely related enterprises Widening the scope of Agency PE rule

Interplay with Action Plan 1 Nexus test in the form of ‘Significant Economic Presence’ (SEP) – Potential option evaluated in the report Sustained interaction of an entity with the economy of a country via technology and other automated tools to create taxable presence Potential factors to determine existence of significant economic presence: Revenue based factors [such as nature of transactions covered, level of threshold, administration of threshold] Digital factors [such as local domain name, local digital platform, local payment options] User based factors [such as monthly active users, online contract conclusion, data collection]

Attribution

Attribution – BEPS Action Plan 7: Overview 01 02 03 04 Report on AP 7 concluded that changes to the definition of PE does not require substantive modifications to existing guidance on profit attribution to PEs It mandated development of additional guidance to determine application of existing rules In March, 2018 OECD released a report detailing additional guidance on the attribution of profits resulting from the changes in the Report on BEPS Action 7 The Report sets out general principles for the attribution of profits to PEs in light of the changes to Article 5

Attribution – Domestic Law: Snapshot Basic framework for attribution of profits Explanation 1(a) to Section 9(1)(i) If NR has ‘business connection’ in India, only that income of the NR will be taxed in India which is attributable to Indian operations Rule 10 provides if profit attributable to business connection cannot be definitely ascertained, tax authorities may resort to any of the three methods: Percentage of turnover method (Presumptive) Proportionate method Discretionary method Circular No. 14/ 2001: Transaction between foreign enterprise and its PE would be subject to TP regulations Circular No. 5/ 2004 recommends determination of profit attribution to a PE (IT enabled business process outsourcing units) on the basis of TP provisions Definition of “enterprise” contained in Section 92F(iii) includes reference to PE. Transactions between PE and HO are subject to TP provisions APA Guidance with FAQs (FAQ No. 23) recognizes that profit attribution can be determined by application of TP principles and accepts APA applications for attribution of profits

Attribution Principles under Tax Treaties Profit Attribution under Tax Treaties Article 7 of majority of India’s tax treaties provides for taxation of business profits of foreign enterprise only to the extent such profits are attributable to the PE and basis that PE is a ‘distinct and separate’ enterprise 01 Some of the tax treaties also allow for apportionment method if: it is customary in the domestic law; and its results are as per principles of Article 7 (i.e. ‘distinct and separate’ enterprise approach) 02 Pre-2010 OECD MC was revised in 2010 as regards Article 7: Specific application for FAR analysis for ‘distinct and separate’ enterprise approach was incorporated in Article 7(2) and Article 7(4) allowing apportionment method was deleted 03 04 India has not accepted the authorized OECD approach to attribute profits based on FAR analysis Principles held by Indian Judiciary on Profit attribution FAR analysis Presumptive/ad-hoc attribution of profits Proportionate/ formulary apportionment

Attribution – Recent CBDT Proposal Lack of clear guidance / computation mechanism led to disputes and protracted litigation Recognizing the significance of issues relating to profit attribution, a Committee was formed by CBDT to examine the existing scheme of profit attribution and recommend changes to the existing rule contained in the Domestic Law. The Committee’s report released for public consultation on 18 April 2019. Report recommends mixed or balanced approach that allocates profits between the jurisdiction where sales take place and jurisdiction where supply is undertaken, with necessary safeguards to prevent excessive attribution as well as to protect the interests of Indian revenue Summary and way forward Legal and practical aspects as highlighted by the stakeholders would require consideration for finalization of proposals Once the report is finalized; taxpayers to assess the impact of proposals on their business