Summary: India’s tax framework has long posed challenges for foreign investors, particularly around PE and profit attribution rules. NITI Aayog’s working paper proposes a presumptive taxation scheme to simplify compliance and reduce litigation with respect to profit attribution. Through introducing sector-specific profit percentages to turnover, the working paper intends to offer clarity and ease administrative burdens. Its success, however, will hinge on setting realistic rates that are pragmatic and practicable and can balance revenue protection with investor appeal.
Background
India has witnessed a remarkable surge in foreign investment over the past two decades, yet it has not fully realised its investment potential, partly because of certain ambiguities in the tax framework, among other challenges. Foreign investors are particularly concerned about Permanent Establishment (“PE”) and the rules governing profit attribution to such PE. In addition to dealing with regular PEs like branch offices, foreign enterprises often unexpectedly trigger a PE, leading to unforeseen tax liabilities, increased compliance burdens, and prolonged litigation. Such litigation not only creates uncertainties and ties up their limited bandwidth, it also holds valuable assets and results in significant opportunity costs, making India’s investment landscape appear riskier than it is.
The lack of clarity in profit attribution rules further aggravates the issue, causing inconsistent tax treatment across similar businesses. In many cases, the actual tax imposed does not align with the economic rationale behind it, creating a disconnect that discourages long-term investment. The conflicting and often aggressive approach of the revenue and case-specific approach adopted by the judiciary increases this conundrum. Recognising these challenges, NITI Aayog’s Consultative Group on Tax Policy has released a working paper proposing key reforms to standardise profit attribution rules. These recommendations aim to reduce litigation, enhance transparency, and facilitate a more predictable tax environment, ultimately instilling greater confidence among foreign investors.
Presumptive Taxation: Proposed Framework for Simplifying Profit Attribution
The working paper proposes optional presumptive taxation as the key solution to address the complexities and disputes surrounding profit attribution to PEs. Presumptive taxation is a simplified, deemed-profit approach that involves applying fixed profit percentages to turnover and taxing the said profits. Under this approach, NITI Aayog has recommended assigning deemed profit percentages for specific sectors or business models, to be applied to the gross receipts earned ranging from 10% to 30%. These deemed percentages would represent the profits attributable to Indian operations, which will be made subject to Indian corporate tax. The paper proposes this as a practical alternative that is available to taxpayers optionally as against detailed functional analyses and actual profit computations when such methods prove impractical or contentious.
An important feature of this scheme is its optional nature, allowing taxpayers to opt out and file returns based on actual attributable profits. For those who opt in, compliance would be significantly simplified, including exemption from maintaining detailed India-centric accounts. By opting in, foreign entities would be able to avoid litigation on the existence of PE itself. On the other hand, opting out and claiming lower profits would require maintaining and auditing such accounts. To ensure clarity, the paper recommends explicitly notifying that transfer pricing principles will govern the determination of profits attributable to a PE. Importantly, it proposes that income taxed under the presumptive regime should not be subject to any other provision of the Income Tax Act, 1961.
The paper also proposes legislative amendments either through industry-specific provisions or through a unified section containing sub-sections dealing with different industries. The paper recommends the scheme to be compatible with India’s tax treaties by making participation optional to avoid issues of discrimination, and to engage with treaty partners for formal recognition of the scheme. The paper also calls for empowering the CBDT to prescribe rates and conditions via notifications. To prevent misuse, it recommends anti-abuse measures such as multi-year lock-ins or prior approval for reversion. Finally, it suggests including a sunset clause or periodic review mechanism to recalibrate the scheme in line with evolving international tax norms and economic conditions.
The paper justifies its proposal by referring to India’s existing presumptive tax provisions, highlighting the country’s policy support for presumptive taxation. It also draws on international practices such as Brazil’s Presumptive Profit Method and similar deemed profit regimes in Indonesia and Mexico to support its recommendations.
The Road Ahead for Presumptive Taxation
NITI Aayog’s recommendations mark a welcome step toward making India’s tax framework more predictable and certain for foreign entities. They reflect the government’s sensitivity to the challenges currently being faced by international businesses operating in India. The implementation of a sector-specific presumptive taxation scheme would ease compliance, significantly reduce litigation for taxpayers, and also lift a considerable administrative burden off the shoulders of Assessing Officers.
However, the success of the scheme will largely depend on the deemed profit percentages that will be prescribed if this suggestion were to be accepted. The key lies in aligning these percentages with actual profit margins of the concerned industries. While the rates should be high enough to safeguard revenue interests, setting them too high could force many enterprises to opt out of the scheme, bringing us back to the present logjam. However, if the rates are reasonable enough to be attractive, the scheme stands a better chance of success. Reasonable rates would also discourage aggressive tax planning, as companies may be willing to pay tax on deemed profits in exchange for reduced compliance and litigation costs. It is important to note that this is currently a working paper, and the suggested percentages are likely to undergo further fine-tuning. Before implementation, it would be advisable for the government to engage in consultations with industry bodies, tax experts, foreign investors and other stakeholders to ensure that the selected percentages correspond with the economic realities of the concerned sectors.
For further information, please contact:
S.R. Patnaik, Partner, Cyril Amarchand Mangaldas
sr.patnaik@cyrilshroff.com
