Business Connection Under Indian Domestic Tax Laws

The Indian domestic tax laws have stated that all the incomes generated or arising in India, regardless of it being directly or indirectly earned, through or from any business connection in India shall be deemed to accrue or arise in India itself. In simpler terms, any income obtained from a business by Non-Residents of India is taxable in India if the said individual has a business connection in the country. This article talks about the

Business Connection under Indian Domestic Tax Laws and the essentials information related to the same.

Overview

The scope of

business connection under the Indian domestic tax laws was similar to those provisions under the Dependent Agent Permanent Establishment (DAPE) in Article 5(5) of the Double Taxation Avoidance Agreement (DTAA) that is entered into by India with other countries. Under the said terms, if an individual acting on behalf of a Non-Resident is habitually authorised to conclude contracts for the Non-Resident. Then, such an agent would constitute a permanent establishment in the source country. However, under various cases, with the intention of avoiding a permanent establishment under Article 5(5) of the DTAA, the individual acting on behalf of the Non-Resident negotiates a contract but does not conclude the agreement. Therefore, a review was conducted by the Organisation for Economic Co-operation and Development (OECD) under the Base Erosion and Profit Shifting (BEPS) to redefine the definition of a Permanent Establishment in order to prevent the avoidance of tax payments by circumventing the existing Permanent Establishment definition according to commissionaire arrangements or fragmentation of business activities.

Amendments

The initiation taken includes the BEPS Action Plan 7 that bought forth modifications to the Article 5(5) that at the moment states that an agent would not only include a person who habitually concludes a contract on behalf of a Non-Resident, but also a person who usually plays a principal role leading to the conclusion of agreements. The recommendations under BEPS Action Plan 7 has been included in Article 12 of the Multilateral Convention to Implement Tax Treaty Related Measure (MLI), to which India is a signatory too. Consequently, these provisions will modify India's respective DTAAs covered by MLI automatically. This would broaden the scope than the provisions included by the Indian domestic tax laws. According to the Indian Government, the scope of b

usiness connection has been expanded as defined under the Indian domestic tax laws consistent with Permanent Establishment Rule as amended by the BEPS Action Plan 7 and MLI by introducing the concept of agent habitually playing the significant role leading to the conclusion of a contract. In this context, the contracts are:

In the name of the Non-Resident;
For the transfer of the ownership, or for granting the right to use a property owned by the Non-Resident or for which the Non-Resident has a right to use;
Or for the provision of services by that Non-Resident.

The amendments in the tax laws of India will align the same with the provision of the DTAA as modified by the MLI to make the requirements of the DTAA effective. Although, it should be noted that since the existing definition of the PE under the DTAAs is narrower than the aforesaid amended definition under the Indian tax laws, therefore, the provisions of DTAAs being far more beneficial than the Indian domestic tax laws would continue to apply to a Non-Resident till the MLI laws come into force.

Significant Economic Presence

With effect from April 01, 2018, the Government of India has expanded the scope of

Business Connection to include Significant Economic Presence. Under this context, Significant Economic Presence recent shall mean:

Any transaction concerning any goods, services or property carried out by a non-resident in India including the provision of download of data or software in India if the aggregate of payments arising from such transaction(s) during the previous year exceeds the amount as prescribed; or
Continuous and systematic soliciting of its business activities of engaging in interaction with digitized users as specified, in India through digital means.

The BEPS Action Plan 1 on addressing the tax challenges of the digital economy recommended modifying the existing definition of Permanent Establishment to provide that:

An enterprise engaged in fully de-materialised digital activities would constitute a PE if it maintained a significant digital presence in another country's economy;
Virtual PE would be constituted when an enterprise maintains its website on a server of another enterprise located in a jurisdiction and carries out its business through that website.

The BEPS Action Plan 1 also recommended that countries may introduce the following safeguards in their domestic laws to prevent BEPS:

A new nexus rule based on the concept of a significant economic presence.
Withholding the tax on certain types of digital transactions.
An equalization levy

Earlier the Indian domestic tax laws provided for a physical presence-based nexus rule for taxation of business income of the Non-Resident in India-territorial nexus. Emerging business models such as a digitised business, which does not require a physical presence of itself or any other agent in India, were not covered by the domestic tax laws in India.

Applicability

The amendments mentioned above will apply to all online advertisements, online searches, cloud services and other digital products to ensure that the profits obtained by these firms attribute to the users in India and are taxed in India itself. This could bring big firms such as Google, Facebook, Amazon and Netflix and application developers such as Uber Inc. with huge consumer bases in the country into the tax net. The amendments come at the back of equilisation levy at the rate of 6 per cent imposed from the First of July, 2016, on online advertising payments to foreign entities not owning a Permanent Establishment in India. Accordingly, companies that sell goods digitally or execute digital services in India with or without a taxable presence in India may fall within the fields of this amendment. The revenue-based factor and use-based factor approach proposed by the Finance Bill to determine nexus based on the concept of

significant economic presence is in line with the Action Plan 1. However, the guidelines on this regard prescribing the conditions and the threshold limits are yet to be issued.

Back to Learn

Frequently Asked Questions

Common questions about Business Connection Taxation India.

The concept of 'Business Connection' under Indian domestic tax laws refers to the taxation of income earned by non-residents in India through any business activities or presence in the country. Any income generated directly or indirectly from a business connection in India is considered taxable in India for non-residents.

The definition of 'Business Connection' has been expanded to align with the recommendations of the BEPS Action Plan 7 and the Multilateral Convention to Implement Tax Treaty Related Measures (MLI). The amended definition includes agents who habitually play a significant role leading to the conclusion of contracts on behalf of non-residents.

The introduction of the 'Significant Economic Presence' concept aims to bring digital businesses operating in India without a physical presence under the tax net. It considers factors like the volume of digital transactions, user engagement, and data exchange to determine a taxable presence in India.

The amended rules could impact various digital businesses, including online advertisements, online searches, cloud services, digital product sales, and application-based services like Uber, if they have a significant user base or economic presence in India.

The changes in Indian domestic tax laws are intended to align with the provisions of Double Taxation Avoidance Agreements (DTAAs) as modified by the MLI. However, until the MLI comes into force, the more beneficial provisions of the existing DTAAs will continue to apply.

The 'Significant Economic Presence' concept aims to address the challenges of taxing digital businesses that operate in a country without a physical presence. It ensures that profits derived from Indian users or economic activities are taxed in India.

The equalization levy, introduced in 2016, is a 6% tax on online advertising payments made to foreign entities without a permanent establishment in India. It complements the expanded 'Business Connection' rules by ensuring taxation of digital transactions.

Companies offering digital goods, services, or advertisements in India, even without a physical presence, may now fall under the purview of Indian taxation based on their economic presence or user base in the country.

The amendments to the 'Business Connection' definition and the introduction of the 'Significant Economic Presence' concept are in line with the recommendations of the BEPS Action Plan 1 on addressing tax challenges in the digital economy.

The Indian government is expected to issue guidelines and prescribe conditions and threshold limits for determining the 'Significant Economic Presence' of digital businesses in the country for taxation purposes.