By Ashish Mehta, Partner, and Ujjval Gangwal, Senior Associate, Khaitan & Co., Mumbai
The Indian Supreme Court on 7 September decided not to entertain petitions filed by taxpayers seeking directions for exclusion of COVID-19-induced forced/involuntary stay for financial year 2020-21. The taxpayers were seeking an exclusion of days on account of the COVID-19 induced international travel ban for the purpose of determining residential status under the Income-tax Act, 1961.
In addition to having wide ramifications for individuals stranded in India insofar as their residential status is concerned, the decision could also impact multinational enterprises (MNEs), which may face challenges on account of unintended creation of permanent establishment in India and place of effective management risk on account of stay of their personnel in India.
Background
In view of the global outbreak of COVID-19, on 23 March 2020, a ban on international travel was imposed. This was followed by a complete nationwide lockdown. The sudden shutting down of borders left a lot of foreigners that were employees of offshore entities (who could have been in India on business tours, visits, etc.) stranded in India.
The international travel restrictions continue to apply with certain relaxations. To address challenges faced by such stranded individuals, the Indian government issued circular number 11 of 2020, dated 8 May 2020, which provided for a blanket exclusion for a maximum of 10 days (22 March 2020 to 31 March 2020) when calculating stay in India for the purpose of ascertaining residency in India.
The Indian government in a press release dated 9 May 2020 also clarified that because the lockdown continues during FY 2020-21 and it was not clear as to when the international flight operations would resume, a circular excluding the period of stay up to the date of normalisation of international flight operations for determination of the residential status for FY 2020-21 would be issued after such normalisation.
As there was no clarification from the Indian government regarding exclusions from the period of stay of individuals for FY 2020-21 until almost the end of the FY 2020-21, various representations were made for clarity on this crucial aspect of residency determination. A petition was filed before the Indian Supreme Court seeking clarity on this point, and, via its order dated 10 February, the Indian Supreme Court directed the petitioner to approach the Central Board of Direct Taxes (CBDT) and directed the CBDT to consider such representation within three weeks of receipt.
Subsequently, Circular No 2 of 2021, dated 3 March 2021, was issued by the CBDT, wherein no relief/allowance for exclusion of days was given despite the assurance in the press release dated 9 May 2020. The 2021 circular inter alia provided an option to the taxpayers (likely to suffer double taxation), to provide all requisite details in a prescribed form (Form NR) by 31 March 2021. On receipt of such details, the CBDT would consider providing a general relaxation or relaxation in a specific matter (on a case-to-case basis) as it deems fit. Notably, no such general relaxation has been announced by CBDT yet.
Certain taxpayers challenged the 2021 circular before the Indian Supreme Court. The taxpayers sought a review of the circular and appropriate directions from the Indian Supreme Court for exclusion of forced/involuntary stay for FY 2020-21 on account of continuing international travel restrictions. These taxpayers contended that the 2021 circular was contrary to the commitment of exclusion given in the press release dated 9 May 2020.
The exclusion of at least a three-month period (April to June) was sought as, until then, there was no possibility of international travel and hence no one could have left India. During this period, there were no international travel arrangements, as even air bubbles were created for bilateral travel amongst nations only in July 2020. The situation now is that individuals will need to make their claims in the income return filed in India and this matter will be decided in due course. Courts in the past have had the occasion to consider issues arising out of involuntary stay, and individuals will need to make their arguments at the appropriate forum as and when required.
Permanent establishment risk
Inclusion of such days in an individual’s stay may have unintended consequences for MNEs as they may be saddled with permanent establishment and place of effective management risks on account of the presence of their employees and key personnel in India.
An MNE employee working from India may result in the creation of a fixed place permanent establishment for the employer MNE in a situation where the MNE has a business interest in the employee carrying out work in India, core business operations are carried out by such employee, the MNE pays such employee towards use and/or provides office equipment to the employee in India, the employee’s Indian address is registered as a place of business of MNE, activities of such employee do not fall within the ambit of “auxiliary or preparatory” services, etc.
If a person resident in India represents or acts on behalf of an MNE, the person’s presence in India may be regarded as the presence of such MNE in India and could trigger the establishment of a permanent establishment in India of that MNE. An employee of an MNE may result in the creation of an agency permanent establishment for the employer MNE if such employee has the authority to conclude contracts or plays a principal role leading to the conclusion of contracts on behalf of the employer MNE.
Similarly, if the MNE renders services in India through employees or other personnel and if the duration of such services in India exceeds a threshold limit provided under the relevant tax treaty, it may result in the creation of a service permanent establishment of such MNE.
Once it is established that an MNE has a permanent establishment in India, profits of the MNE that are attributable to such permanent establishment will be taxed as “business income” at the rate of 40% (plus applicable surcharge and cess) on a net income basis. Besides this, the MNE will be required to undertake other compliance obligations, such as filing of tax returns in India, undertaking withholding tax obligations, etc.
Place of effective management risk
Under the Income-tax Act, a foreign company can be treated as a resident in India for tax purposes if its place of effective management in the relevant financial year was in India. Place of effective management is defined to mean a place where key management and commercial decisions that are necessary for the conduct of the business of an entity are made.
Thus, a situation may arise where senior executives of an MNE are stuck in India due to COVID-19-related travel restrictions and business decisions would thus invariably be made from India, thereby resulting in the risk of creation of place of effective management of such MNE in India. Treatment of an MNE as an Indian tax resident will result in taxation of its global income in India and attract compliance and related obligations.
OECD’s updated guidance on tax treaties and the impact of COVID-19
On the global front, the OECD issued an updated guidance document dated 21 January 2021 on the issues related to the creation of permanent establishments, tax residency status of individual and foreign companies, etc., in view of the COVID-19 pandemic.
With respect to the creation of fixed place permanent establishment, the OECD guidance provides that individuals teleworking from home as a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved to prevent the spread of the COVID-19 virus would not create a fixed place of business permanent establishment for the business/employer.
Similarly, with respect to agency permanent establishment, the OECD guidance provides that an agent’s activity in a jurisdiction should not be regarded as ”habitual” if the agent has exceptionally begun working at home in that jurisdiction as a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved to prevent the spread of the COVID-19 virus and, therefore, would not constitute a dependent agent permanent establishment provided the person does not continue those activities after the public health measures cease to apply.
With respect to place of effective management challenges arising on account of a change in location of board members/senior executives, the OECD guidance provides that a temporary change in the location of board members or other senior executives is an extraordinary and temporary situation due to the COVID-19 pandemic and such change of location should not trigger a change in treaty residence. In the case of dual residence of the companies, tiebreaker rules as provided under the relevant tax treaty would come into play. All relevant facts and circumstances should be examined to determine the “usual” and “ordinary” place of effective management and not only those that pertain to an exceptional period such as the COVID-19 pandemic.
Conclusion
While the OECD guidance does provide certain guidelines to MNEs to evaluate any potential permanent establishment or place of effective management risk, one hopes that the Indian government also comes out with detailed guidelines and temporary relaxations on this issue. Further, a pragmatic approach on the part of the Indian tax administration in formulating the guidelines would go a long way in establishing trust with taxpayers and will eventually result in the avoidance of unwarranted litigation.
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