NITI Aayog releases Tax Policy Working Paper on Permanent Establishment (PE) and Profit Attribution for Foreign Investors in India.
About Tax Policy Working Paper
- The Working Paper argues that as India moves toward Viksit Bharat @ 2047, tax rules must be predictable, transparent, and efficient to attract quality Foreign Direct Investment (FDI)/Foreign Portfolio Investment (FPI).
- It focuses on building an investor-friendly tax regime, reducing litigation, and aligning India’s tax policy with global best practices while protecting revenue interests.
About Permanent Establishment (PE) and Profit Attribution
- A Permanent Establishment is a fixed place of business (office, branch, construction site, or even a digital presence) through which a foreign enterprise operates in India.
- It determines India’s right to tax the business income of that foreign entity.
- The Income Tax Act, 1961 uses the term business connection (Section 9), and India’s Double Tax Avoidance Agreements (DTAAs) carry detailed PE definitions.
- The Significant Economic Presence (SEP) rule added in 2018 and operationalised in 2021 extends taxation to digital activity without physical presence.
- Profit Attribution means determining how much of a foreign company’s total profit is linked to its Indian operations ( PE) and can therefore be taxed in India.
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Strategic Recommendations for Enhancing Tax Certainty and Predictability from Working Paper
- Legislative clarity: Codify PE definitions and profit-attribution principles (Aligned to UN/OECD), embed separate-enterprise rule, and adopt safeguards against retrospective amendments (Except narrowly, with due process)
Advance Pricing Agreement (APA)
- An APA is a pre-agreed deal between a taxpayer and the Income Tax Department that fixes how profits and taxes will be calculated for future international transactions.
- It gives certainty on transfer pricing for 3–5 years (or more).
Mutual Agreement Procedure (MAP)
- Treaty-based process where two countries’ tax authorities discuss and resolve cases where a taxpayer might be taxed twice on the same income.
- Helps settle cross-border tax disputes amicably.
OECD TRACE System
- TRACE (Treaty Relief and Compliance Enhancement) is an OECD framework to simplify how foreign investors claim withholding tax relief on dividends, interest, or royalties.
- How it works: Certified intermediaries (like custodians) verify investor identity and treaty eligibility, allowing automatic lower tax withholding instead of delayed refunds.
- Why it matters: Reduces paperwork, prevents double taxation, and increases transparency.
- Global Use: Adopted in countries like Finland and the Netherlands.
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- Robust dispute resolution & cooperative compliance: Expand Advance Pricing Agreement (APA) and Mutual Agreement Procedure (MAP) for quicker settlements.
- Explore binding arbitration in unresolved cross-border cases.
- Adopt the OECD TRACE system to simplify withholding-tax procedures for FPIs.
- Capacity building, stakeholder engagement, charter-based administration: Train tax officers in modern international-tax and digital-economy issues.
- Encourage Mandatory public consultation before major tax changes to institutionalize rights and bring predictability
- Enforce a Taxpayer Charter to strengthen accountability and trust.
India’s Successful Presumptive Regimes
- Mirrors India’s successful presumptive regimes like Shipping (44B), Oil-field services (44BB)
- Finance Act 2024 added 44BBC (cruise operators), and Finance Bill 2025 proposed 44BBD (electronics manufacturing services) showing administrative feasibility and continuity of approach.
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- Introduce Optional Presumptive Taxation Scheme: Foreign companies may opt in to pay tax at a pre-defined percentage of India-sourced revenue, based on industry. Once opted in, tax authorities cannot re-litigate whether a PE exists for that activity (Safe-harbour protection).
- Optional and rebuttable: Firm can opt out and file normal return if actual profits are lower
- Why it matters: This cuts PE/attribution disputes that otherwise stretch 6-12+ year
Challenges in India’s Tax Environment for Foreign Investors
- FDI traction but headroom for more: India’s FDI equity inflows rose from USD 5,856 mn (2005-06) to a provisional USD 50,018 mn (2024-25) showing strong appeal but also volatility.
- Litigation costs & time: Major PE disputes typically take 6–12+ years to reach finality (e.g., Motorola/Ericsson/Nokia, Rolls Royce, Hyatt) raising interest/contingent liabilities and tying up managerial bandwidth
- Evolving, multi-layered rules add uncertainty: Tax nexus is shaped by domestic law (Sec. 9 “business connection”, SEP), Double Tax Avoidance Agreements (DTAAs) (UN-model leaning), and global reforms ( like Base Erosion and Profit Shifting ) changes in any layer ripple through the system
- Digital-era gaps: Many digital companies earn from Indian users without physical offices, making it unclear where profits should be taxed.
- Digital economy gap: India introduced Significant Economic Presence (SEP) (from AY 2021-22) to capture value from digital firms without physical presence, but attribution still needs clearer rules for predictability
About Presumptive Tax Regime
- A simplified tax scheme where income is calculated based on a presumed rate of profit rather than actual income. It is designed to reduce compliance burden and simplify tax filing for small businesses and professionals.
Anticipated Benefits of the Presumptive Tax Regime
- Less Litigation: Clear tax rules reduce endless disputes over PE and profit attribution, saving time and resources for both companies and tax authorities.
Significant Economic Presence (SEP)
- Introduced in the Finance Act, 2018 (effective from April 2021), SEP expands India’s tax nexus beyond physical presence.
- It allows India to tax digital and online businesses that earn revenue from Indian users even without an office or branch here.
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- Investor Confidence: Predictable taxes help foreign firms plan better, improving India’s ease of doing business and attracting long-term FDI in sectors like tech and infrastructure.
- Administrative Efficiency: Simplified presumptive rules cut audit complexity and compliance costs, letting tax officers focus on high-risk cases.
- Revenue Stability: Companies may prefer paying a fixed rate for certainty, leading to steady or even higher tax collections. It also brings previously unregistered firms into the tax net.
- Support for “Make in India”: Simplified rules for technical and service sectors encourage foreign collaboration, technology transfer, and manufacturing partnerships.
- Higher Voluntary Compliance: The optional scheme rewards honest taxpayers with convenience, while discouraging evasion and arbitrary assessments.
Way Forward
- Legislative Changes: New sections (like other presumptive tax laws) should be added for each sector, ensuring other provisions don’t overlap.
- Treaty Compatibility: The scheme must align with India’s tax treaties. Its optional nature helps avoid conflict, but India may negotiate new clauses with key partners.
- Rate Setting: Empower the Central Board of Direct Taxes (CBDT) to fix and review sector-wise rates through notifications, ensuring flexibility as business models evolve.
- Anti-Abuse Rules: Prevent misuse through measures like multi-year lock-ins and limits on frequent switching between regimes.
- Awareness & Guidance: Publish clear circulars, FAQs, and training modules for both taxpayers and officers to ensure smooth rollout.
- Periodic Review: Include a 5–10-year sunset clause to assess results and recalibrate or discontinue parts of the scheme if needed.
India and Global Tax Reforms
Global taxation rules are changing because many companies earn profits in countries without having a physical office there, especially in the digital economy (e.g., Google, Netflix, Amazon).
- OECD- G20 BEPS Project: To address this, India and over 130 countries work under the Organisation for Economic Co-operation and Development (OECD)- G20 BEPS Project (Base Erosion and Profit Shifting).
- Aim: It aims to stop multinationals from shifting profits to low-tax countries. It has 15 “Actions” (recommendations) and one of these is Action 7.
- Action 7: Prevents companies from avoiding taxes by claiming they have no permanent establishment (PE). Even indirect or digital operations can be taxed.
- Pillar One and Pillar Two: In 2019, countries agreed that more reforms were needed, especially for digital companies like Google, Facebook, Amazon. Hence Pillar One and Pillar Two were introduced.
- Pillar One: Gives more taxing rights to market countries (where consumers are) even if companies don’t have an office there.
- Pillar Two: Introduces a 15% global minimum corporate tax, stopping profit shifting to tax havens with very low or zero taxes.
- India’s Early Steps: India already introduced similar ideas through:
- Significant Economic Presence (SEP): Allows India to tax digital firms that earn from Indian users even without an office here.
- Equalisation Levy (2%): A tax on online advertising and e-commerce income earned by foreign companies.
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Conclusion
NITI Aayog’s proposals aim to make India’s tax system clear, predictable, and investor-friendly. By simplifying PE rules, introducing optional presumptive taxation, and aligning with global best practices, India can cut litigation, boost investor confidence, and move closer to its Viksit Bharat @2047 vision.
6 Oct 2025
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