Taxman seeks clarity on foreign entities

The Central Board of Direct Taxes has sought a clear definition of the term 'permanent establishment' for assessment of tax payable by foreign entities in India. Currently, the Act defines a 'permanent establishment' as a fixed place of business.

According to sources in the tax department, the new definition may be included after amending the Income Tax Act, 1961.

The CBDT is concerned that a lack of clear definition to 'permanent establishment' has elicited legal wrangle related to international tax matters and transfer pricing and that a new definition should be compatible with that in double tax avoidance agreements.

Sources said the double tax avoidance pact's definition with the US was comprehensive.

For, apart from including establishments like a place of management, branch, factory, workshop, mine, oil or gas, quarry, and others, the pact incorporated sales outlets, installations or structures used for exploration of natural resources, building sites, assembly project -- on the condition that such places should have had use for more than 120 days.

The forthcoming Budget may also address the definition of 'India' for I-T purposes. At present, the territorial jurisdiction of India is restricted to the entire country within its borders, stretching 12 nautical miles to the sea.

The board argues that a new definition is needed to tackle cases like the undersea optical fibre cables laid by telecom companies for international locations. It prefers an 'all inclusive definition' in which India is defined as the 'territory of India and includes territorial sea, airspace above it as well as maritime zone in which India has sovereign rights, other rights and jurisdiction.'

The issue came to the fore after the recent Mumbai Appellate Tribunal's order in the case of Dresdner Bank. According to the order, the Indian establishment of a foreign company is to be treated hypothetically, independent of its head office, with regard to the taxation of foreign companies operating in India.

This is the underlying principle in transfer pricing as well. Experts feel the amendments in tax laws vis-à-vis taxation of non-residents have also not kept pace with globalisation of businesses.

Another controversy relating to permanent establishment has been the recent directive of the Supreme Court where the tax liability on multinational firms has been waived off for payments received by the Indian counterpart for offshore supply of equipment and materials. The company in this case was Ishikawajma-Harima Heavy Industries Ltd from Japan.

The Supreme Court order is in direct contrast to the Advance Ruling Authority that ruled that the foreign company has to pay taxes to Indian authorities since the source of income is arising from the Indian company, even if the payment is made for offshore projects.

This has far reaching implications on international taxation, especially in turnkey projects handled by Indian companies with the help of foreign suppliers and contractors.