[By Shikha Mohini]
The author is a student at Symbiosis Law School, Pune.
In sync with international standards, India follows two types of taxation mechanisms- residence-based and source-based. In case of residence-based taxation, the tax is levied on the global income whereas in source-based, the tax procured is only on the income generated from the source country. In order to avoid double taxation on the same income in a particular time period in two different jurisdictions, countries usually enter into a Double Tax Avoidance Agreement (DTAA). The different articles of the DTAA govern taxation in matters where two states have simultaneous right to tax a particular income.
Article 7 of the DTAA concerning taxation of business profits settles that the profits of an enterprise of one contracting state shall be taxable in the other contracting states only when a ‘Permanent Establishment (PE)’ is maintained in the latter. The source state shall tax the profits of the enterprise only to the extent attributable to the PE. In order to constitute a PE, there must be an existence of a fixed place of business where a foreign enterprise either partly/wholly carries out the business.[i] Due to the ongoing Covid-19 pandemic, countries have imposed lockdowns and international travel is banned. The employees of various multinational corporations have been stranded in different jurisdictions or have returned back to their home state, both of which may be different from the residential or incorporating state of the corporation. The employees are contributing to the generation of profits for the foreign enterprise by working from their home in a different jurisdiction which can lead to the emergence of a PE and consequent taxation of the profits of the enterprise in the state where the employee is residing. The present article seeks to analyse the emergence of unintended PEs and tax liability arising out of the Covid-19 pandemic. It also sheds a light on the grey area existing in international taxation with respect to a permanent ‘Work from Home’ model.
Analysing The Concept Of Permanent Establishment
As mentioned above, a PE must fulfill three essential criteria which are the existence of a place of business, the place should be fixed and a part/whole of the business of the foreign enterprise must be carried through it.[ii] A place of business[iii] can cover any premise, facility, or installation which is used for carrying out the business of the foreign enterprise in the source state. Exclusivity in carrying out the business and a formal legal right[iv] on the place is not considered a requirement for a PE. It is however necessary that the place of business carries on the core functions of the enterprise and the same is not intermittent in nature. The term ‘fixed’ means that the PE must be located at a distinct place and there must essentially be a link between the place of business and a specific geographical point in the source state.[v] There must be an identifiable location that constitutes a “coherent whole-commercially and geographically with respect to that business.[vi]” In addition, there must be a degree of permanency, i.e., the place of business must fulfill the threshold limit enumerated in the DTAA to constitute a PE. The threshold limit usually varies between 6 months and 1 year.
The two exceptions to the ‘fixed place’ criteria is when the activities are of recurrent nature or when activities are wholly carried out in the source state for a short period of time. In the former scenario, all the periods of time during which the PE is in use is calculated in combination, and in the latter case, since the connection with the source country is exceptionally strong, the place may constitute a PE despite not crossing the threshold period. A third criteria mandates the PE to carry out the business of the foreign enterprise, in part or whole. It is necessary to note that interruptions in the operations will not lead to the ceasing of a PE status. A PE begins to exist at the commencement of the business activity of the foreign enterprise through it and ceases with the cessation of activity or disposal of the fixed place.[vii]
Establishment Of Home Office As Fixed Place PE In India
A complete lockdown was announced in India on 25th March, 2020 with international travel still majorly suspended. Due to the lockdown, either the employees of multinational companies were stranded in India or Indian employees of foreign enterprises returned back to their country. In either situation, provided they resumed their operation from their home, it could be argued that a possible PE is constituted. India will then have a right to tax the foreign enterprise on the income arisen or accrued here due to the operations of the employee.
If such a home office operates, it satisfies the condition of ‘place of business’ and ‘fixed place’. The criteria of the foreign enterprise running its business ‘wholly or partly’ through the PE will depend on the facts and circumstances of each case.[viii] It is also necessary that such a home PE must carry out functions that are not preparatory or auxiliary in nature but constitute the core functions of the foreign enterprise.[ix] This again is a factual exercise and a subjective test.[x] The OECD commentary also mandates that for PE’s constitution, the foreign enterprise must require its employee to use the location for carrying out its business either by not providing an office when the nature of employment requires it or otherwise.[xi] It further goes on to give an example of a cross-border worker working from his home office in one State rather than the office made available to him in the other State. The commentary states that this scenario would not constitute a PE as the home office was not a requirement of the foreign enterprise. India in its observation however disagrees with the above example holding the stated situation to constitute a PE.[xii] Hence, when Indian nationals working in foreign companies returned back to India and constituted their work from home, it is can be argued that the enterprise did not require the constitution of a Home PE in India. It was a result of the lockdown imposed by the government. However, the argument may be rejected completely in line with India’s observation of OECD commentary and the profits of the foreign enterprise arising out of India can be made taxable.
Tax Implications of the Work From Home Model
The guidance issued by the OECD characterizes the lockdown due to the COVID-19 pandemic as a force majeure event. It states that in the present situation, a Home PE resulted due to government directives and not because of the requirement of the enterprise[xiii]. Since this is a temporary measure, the office would lack permanency and total control of the foreign enterprise. Stating these facts, the OECD concludes that a home office operating during the lockdown should not constitute a PE. Nevertheless, India not being a part of the OECD is not bound by its guidelines. It is notable to state that Indian tax treaties do not prescribe a strict threshold for the constitution of a PE.[xiv] The Supreme Court has in the Formula One case[xv] considered three days as ‘reasonable period’ to constitute a PE. The said period was held necessary for the conduction of business activities of the financial enterprise and therefore held to be a ‘reasonable’ for a PE constitution. This view was again reiterated by the AAR in its opinion to Production Resource Group[xvi], where it considered a period of 66 days as sufficient to constitute a PE in India. The CBDT has issued a notification regarding the tax implications of non-resident individuals stranded here, however it is yet to clarify the taxation status in case of unintended PoEM[xvii] and PE in India.
The prominent consideration however is the change in the working style of the companies post the pandemic. Due to the highly contagious and mutating nature of the SARS-CoV-2 virus, the pandemic is likely to stay for at least a year if not more. In light of it, various multinational companies around the globe are permanently switching towards a more efficient and safer work from home model. Siemens[xviii] and Tata Consultancy have already started implementing the model with the later stating that only one-fourth of its task force will be required to come to office by 2025.[xix] Twitter, Google, Apple, and Facebook have also followed suit.[xx] In the not so distant future, employees may be required to work from their home office at the behest of the foreign company leading to a definite PE. The consequence of such a situation may arise in huge tax implications of the foreign enterprise in numerous jurisdictions. The international tax statutes and treaties are not equipped to deal with such a situation. It is hence imperative that the international treaties and domestic laws are revised to accommodate the work from home model. In the view of the author, various definitions including that of the ‘Permanent Establishment’ will have to be amended. The focus should shift to qualitative standards of nature of work carried on in the PE rather than the time period spent by the PE in the source state. Any delay or failure to bring about the suitable changes can result in excessive taxation, consequent losses, and unnecessary litigation for various multinational companies.
[xiii]OECD Secretariat analysis of tax treaties and the impact of the Covid-19 crisis at (3rd April 2020), http://www.oecd.org/coronavirus/policy-responses/oecd-secretariat-analysis-of-tax-treaties-and-the-impact-of-the-covid-19-crisis-947dcb01/.
[xiv] Supra at x
[xv] Formula One World Championship (Civil Appeal No. 3849 of 2017).
[xvi] AAR No. 1330 of 2012
[xvii]Place of Effective Management- It is used to determine the residency of a company under Article 4 of the DTAA.