India’s new intermediary rules: Reasons why the fear of tax-slapping is unfounded – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-commentary/indias-new-intermediary-rules-reasons-why-the-fear-of-tax-slapping-is-unfounded/articleshow/83788477.cmsSynopsis

The new rules require that the three officers employed by the significant social media intermediary must be resident in India. Now, the essential feature of a PE is that it is a fixed place through which the foreign company carries on its business. It will be impossible to argue that employing a few persons to ensure compliance will lead to a PE.

Arvind P Datar

Arvind P Datar

The writer is a senior advocate.A June 21 ET report claimed that compliance with the new information technology (IT) rules could lead to a ‘huge tax liability’ on the part of top digital companies. This apprehension is misplaced.

Rule 4 of the new Intermediary Guidelines and Digital Media Ethics Code Rules, 2021, mandates that a significant social media intermediary has to appoint a chief compliance officer, a nodal contact person for 24×7 coordination with law enforcement agencies, and a resident grievance officer. Social media intermediaries that have more than 5 million users are ‘significant’. The question is whether the appointment of these three officers can be treated as a permanent establishment (PE) in India of these digital companies, and whether this will attract additional tax liability.

The two fundamental principles of international taxation are that every country gets the sovereign right to levy taxes on income whose source lies within its territory (source rule), or on persons resident in that territory (residence rule). Under Section 9 of the Income-Tax (I-T) Act, a foreign company is liable to pay tax on income earned in India, through a business connection, or from a property or any asset or source in India, or through the transfer of a capital asset in India. Most social media intermediary companies are foreign, and none of these conditions may apply.

However, a foreign company is liable to I-T if it has a PE in India. The tax is on the income attributable to this PE. In most tax treaties, the phrase signifies a fixed place of business through which the business of the enterprise is carried on wholly or in part, and will typically include a branch office, a factory or a place of management within India. However, almost all treaties provide that the maintenance of an office only to carry out preparatory or auxiliary activities will not make it a PE.

Undoubtedly, the new rules require that the three officers employed by the significant social media intermediary must be resident in India. Now, the essential feature of a PE is that it is a fixed place through which the foreign company carries on its business. It will be impossible to argue that employing a few persons to ensure compliance with IT rules and to address grievances will lead to a PE.

These activities can certainly be classified as auxiliary in character. None of these officers carries on business in India, and no revenue is earned by their activities. On the other hand, their employment represents compliance costs for the foreign enterprise.

A July 2020 Supreme Court ruling settles all doubts on this issue. Samsung Heavy Industries Ltd of South Korea was part of a consortium that was awarded a turnkey contract by the Oil and Natural Gas Corporation (ONGC). Samsung set up a project office in Mumbai with two employees. Its application submitted to RBI stated that the project office was being established to coordinate and execute delivery of documents in connection with the construction of offshore platform modification of existing facilities for ONGC.

The Supreme Court held that such a project office was not a PE. It did not carry out any core activity related to the execution of the turnkey contract, and also did not incur any expenditure relating to this contract. This was an office that was merely involved in auxiliary activity and meant to act as a liaison office between Samsung and ONGC.

The same principle will apply to any office set up to comply with the Intermediary Rules and address grievances. The functions of such offices will be auxiliary in nature and not related to the core functions of the intermediaries. After the Samsung ruling, there is no basis to treat these offices as PEs and no additional tax burden can be fastened on the foreign intermediaries.

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