Over the last few decades, India has established itself as one of the fastest developing countries in the face of the world economy. The steep rise in development has resulted in an upsurge in economic activities over foreign investments influx, paired with technological collaborations. This increased transactions across the border, throwing several challenges on India’s taxation front regarding such foreign entities.
Principally, when a company is incorporated in Indian soil, the income generated via its revenues is taxable in the country itself. Based on the principle of “Residential base,” India also holds the right to account for tax on the company’s global income. Further, India also holds the right to tax income for a foreign company if its revenue is generated from activities in India.
What Does The Indian Income Tax Act Say?
As per the Indian Income Tax Act, if income from any foreign company is deemed or received in India OR deemed to have raised/ accrued in India, such revenue is generated. And, following the “source base” principle of taxation, India holds the right to tax such income. Such taxation is generally at a reduced rate of tax and on gross receipt of the foreign company. This section covers only specific income categories like Royalties, Fees for technical services, interest, dividends, etc., which are covered by this section.
Other Use Cases Of Permanent Establishment In India
Suppose the foreign company has extended its presence in the country and is carrying out its activities in the country. In that case, their derived income is to the extent that it becomes taxable in India. With this logic, we derive the concept of Permanent Establishment (PE) for companies in the country.
Article 5 on DTAA (Double Tax Avoidance Agreements) signifies that India has collaborated with multiple countries, thus defining the term PE as “A permanent establishment or fixed place for organizations via which operations of an enterprise can be executed either wholly or partly.”
There are the following types of PEs:
A fixed place permanent enterprise or PE of foreign enterprise exists in the source country (India) only when they satisfy the following tests:
- Physical place: The business must operate from a physical place; it doesn’t matter whether leased or owned.
- Location: The location or place for business needs to be fixed. Further, the employee’s residence may also be used as a PE if the operations are carried out from there, and the place is used as an office for business.
- Permanence: The place of business should not be floating and needs to be fixed for an extended period. It needs to have a reasonable degree of regularity and continuity. It needs to be ‘carried on,’ signifying that a mere transient, passing, or everyday activity, though carried out from a particular place, will not come under the scope of PE’s definition.
- At Disposal: It states that the business must be at the disposal of a foreign entity. Suppose the organization is located at the business premises of any other foreign enterprise or Indian enterprise. In that case, it needs to have a particular part of the place at its constant disposal. This way, it might be considered as having a PE in India.
- Business activity: Organizations need to carry out proper activity from a fixed place of operation.
To add to the list, here are some specific inclusions to PE in Article 5(2) of treaties:
- Place of Management: The place of management refers to the place where ‘control and management’ reside for an enterprise.
- Branch: When non-resident enterprises execute their operations via a branch in India, it is generally referred to as PE of the non-resident enterprise.
- Office: Office refers to a fixed room, place, and building from which business operations can be carried.
- Factory: It is a place where the manufacturing and processing of goods are carried out.
- Workshop: A workshop is a place where industrial processes are executed. It generally highlights any place where collective manual labor under an employer is done via making, trade, repairing, etc.
In addition to the above, Oil, Mines, Quarry, Gas well, Oil exploration is also considered PE in India.
Consequences of Establishment of PE in India
Once a foreign organization is determined to have a PE in India, the profits generated from its operating activities are taxed under the “Business Income,” according to Article 7 of the treaties. The list of consequences include:
- Profits operated from the PE are the revenues that the PE would have generated if used independently in similar or same activities within similar or identical conditions as the rest of the company.
- They need to maintain their books of accounts compulsorily.
- They must apply for PAN and get their businesses registered under Indirect tax regulations.
Now You Know!
PE is one of the most crucial aspects for organizations when it comes to running operations across borders. This works as a significant means by which companies are exposed to filing tax returns, value-added tax, corporate income tax, and comply with a vivid range of other similar obligations. Therefore, before you plan to establish a business, ensure that you know everything around PE.