New age business models may have their presence in different jurisdictions globally. Businesses aiming to expand their market-reach set up operations in foreign countries as well. While this trend may bring fortune for business, it also poses a challenge in taxation due to operation in the varied countries on the other hand. Over time, it has been witnessed that taxpayers take undue advantage of the said challenges to avoid or reduce their tax liability by keeping their base in a low tax or no-tax jurisdiction.
In order to curb these tax avoidance strategies, steps are being taken worldwide to streamline the taxation of the businesses. However, stricter changes being brought in today both at the domestic and international level to address the base erosion, are resulting into withdrawal of the benefit that were intentionally provided in the law. One such benefit, which is being impacted, is the tax exemption in case of the purchase of goods for exports from India. The said purchases have always enjoyed the tax benefit under the Indian Income Tax Act, 1961 (Act) and tax treaties also. However, the evolving tax reforms are restricting this perk enjoyed by the exporters engaged in the sole activity of purchasing the goods for the purpose of export. Let us understand how this change has been effected in the law.
Changes in the International tax laws: Tax treaties that govern the tax liability of a non-resident doing business in another jurisdiction provide that business income of a foreign company shall be taxed in the other jurisdiction if it has a permanent establishment (PE) in such other jurisdiction. As per the extant provisions of the tax treaties, activity of an agent are not considered as giving rise to PE, if it is limited to purchase of goods.
The Organisation for Economic Co-operation and Development (OECD) under BEPS Action Plan 7 reviewed the definition of ‘PE’ with a view to preventing avoidance of payment of tax by circumventing the existing definition of agency PE. It provides that an agent would include not only a person who habitually concludes contracts on behalf of the non-resident, but also a person who habitually plays a principal role leading to the conclusion of contracts. The recommendations under BEPS Action Plan 7 were later included in the Multilateral Convention to Implement Tax Treaty Related Measures (herein referred to as ‘MLI’), to which India is also a signatory. Consequently, these provisions automatically modify India’s tax treaties covered by MLI. As a result, the agency PE provisions of India’s tax treaties, as modified by MLI, become wider in scope than the Act.
Changes in the domestic law: The provision in the Act seeks to tax the income of the foreign company in India if it has a business connection in India. Under the erstwhile provisions, non-resident whether by himself or through agent, purchasing the goods in India for the purpose of export were out of the purview of business connection. Thus, income arising to non-resident exporter were not taxable in India. It is pertinent to note that the exemption was available whether the non-resident purchased the goods himself or through an agent.
However, the development of MLI led to a need to align the provisions of the Act with the provisions in the tax treaties as modified by MLI, so as to make the provisions in the treaty effective. A recent modification in the Finance Act 2018 has changed the scenario of taxation for exporters. Now, only purchases made by the non-resident himself will be kept outside the purview of business connection. In the other words, non-residents effecting purchases by an agent for undertaking export shall constitute business connection in India and consequently, such transaction shall be charged to tax under the Act.In the current scenario, when efforts are being made to abolish loopholes in the tax treaties and domestic tax law leading to tax evasion, it is also taking away the exemptions for taxpayers.
Suraj Nangia is partner & Neha Malhotra executive director, Nangia Advisors LLP