A rich-country tax deal is dead in the water. But India is sailing ahead

The timing of the rules, the broad principles of which were first outlined by the Central Board of Direct Taxes (CBDT) in a 2019 expert committee report, coincides with the withdrawal of the US from a global tax deal. The deal was brokered by the Organisation for Economic Co-operation and Development (OECD) to curb aggressive tax avoidance mainly by tech giants and the race to lower taxes by countries to attract capital.

“The new rules for attributing profits to non-resident companies with business connection in India is ready and will be brought out soon," said one of the persons quoted above. These rules are framed under Section 9 of the Income Tax Act and will amend Income Tax rule 10, said the person, who spoke on the condition of anonymity. Current rules allow a percentage of the sales in India, or a commensurate share of global profits going by India’s share in global sales, or any other method to compute taxable profits in India, which is believed to entail discretion to a large extent.

Queries emailed on Friday to the finance ministry and CBDT seeking comments remained unanswered.

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The new rules will set the template for tax officials to objectively compute the extent of profits that can be attributed to offshore companies which have a taxable presence in India, taking into account their sales in India, supply side factors like employees and assets and in the case of digital economy firms, their user base. Taxable profits attributable to Indian market will be computed based on weights given to these factors. One important addition is the emphasis given to user base, which will help to better estimate the actual contribution of the Indian market to the global profits of the non-resident company.

Profit attribution has always been a subject matter of extensive litigation in India, said Rakesh Nangia, founder and managing partner of Nangia & Co LLP, a tax advisory firm.

“While Indian tax treaties, domestic law and several court decisions have upheld apportionment method for profit attribution, there is no universal and consistent approach for apportionment of profits in India. This allowed tax officers to exercise wide discretion and different methodologies in different cases, thereby leading to ad hoc percentages of profit attribution, thus causing significant uncertainty and gave rise to unnecessary litigation," said Nangia, explaining the rationale for the tax department’s effort to bring fresh rules.

The proposed rules are definitely a step in the right direction and will not only help the industry by providing guidance and certainty, but would also help tax department by reducing unnecessary long-drawn litigation, said Nangia.

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In last year's full budget in July, the government dropped the 2% ‘equalization levy’ that was introduced in 2016. This levy used to apply on a large number of services rendered in India remotely by offshore companies including software as a service, platform services, data-related services, cloud services and financial services. Dropping of the levy, a bone of contention with the US government, was seen as a prelude to the implementation of a global tax deal by OECD that would have addressed both the aggressive tax avoidance by tech firms and the competition among countries to keep corporate taxes low.

Global tax deal

However, the Donald Trump administration in the US pulled out of the global tax deal on 20 January, saying the global tax deal allows extraterritorial jurisdiction over American income. Finance secretary Tuhin Kanta Pandey had last week said that India will evaluate the benefit of joining the tax deal given that US’ withdrawal from it has made it "impractical to implement."

The proposed profit attribution rules under India's income tax law seek to put in place an objective and balanced framework taking into account the economic activity here, need for simplicity and certainty in taxation and the business model of new age globalised companies.

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The factors the department will take into account for profit attribution—sales (representing the demand from the market), manpower and assets (representing supply) and user base in the case of digital economy firms—was proposed in an expert panel report on the subject CBDT had released in April 2019.

“The report’s approach of considering both demand and supply side factors for profit attribution (also known as fractional apportionment method) and also prescribing objective formula for each of the element will have the effect of reducing overall subjectivity of the existing scheme," said Nangia. Nangia expressed hope that government will iron out the implementation challenges before releasing the final rules.