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Evolution of Dependent Agency Permanent Establishment
By Samir Shah and Rushabh Barbhaya
Aug 01, 2019

THIS article discusses evolution of dependent agency permanent establishment over the years and how it will modify India tax treaties once multilateral instrument (MLI) with respective tax treaty enters into effect.


A foreign enterprise may resort to strategies of shifting profits to low/ no tax regime. These tax planning strategies used by the foreign enterprise to exploit gaps and mismatches in tax rules to avoid paying tax, is referred to as Base Erosion and Profit Shifting (BEPS). To overcome BEPS, Organization for Economic Co-Operation and Development (OECD) and Group of Twenty countries (G20) came up with their recommendations in 15 Action Plans, which will tackle tax avoidance, improve the coherence of international tax rules and ensure a more transparent tax environment.

BEPS Action Plan 7

Prior to recommendation of OECD in BEPS Action Plan 7, foreign enterprises created a Dependent Agency Permanent Establishment (DAPE) in another country only if a person in that other country habitually exercises authority to conclude contracts on behalf of the foreign enterprise. However, if the person acting on behalf of the foreign enterprise is an independent agent acting in the ordinary course of business, it does not lead to creation of DAPE of the foreign enterprise.

In 2015, OECD issued final report on BEPS Action Plan 7, which provides guidance to restrict the practice of foreign enterprise trying to avoid constituting Permanent Establishment (PE) artificially in the countries in which they conduct their business. One of the recommendations in the OECD report was to modify the definition of DAPE from "habitually exercises authority to conclude contracts" to a case where the dependent agent "habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts, which are routinely concluded without material modification by the foreign enterprise." Further, OECD also suggested that a person should not be considered as an independent agent if such a person acts almost exclusively on behalf of one or more closely related enterprises.

In 2017, OECD updated the Article 5 of Model Tax Convention incorporating both the above amendments.

Principal role leading to the conclusion of contracts

The intention of the amendment is to cover a situation where the conclusion of a contract directly results from the actions that the person performs in other Contracting State on behalf of the foreign enterprise even though, under the relevant law, the contract is not concluded by dependent agent in that State.

The principal role leading to the conclusion of the contract will typically be associated with the actions of the person who convinced the third party to enter into a contract with the foreign enterprise. For example, where an agent solicits and receives orders but does not formally finalise the same, which are sent directly to a warehouse from which goods belonging to the foreign enterprise are delivered and where the foreign enterprise routinely approves these transactions.

However, the amendment does not apply to dependent agent who merely promotes and markets goods or services of foreign enterprise in a way that does not directly result in the conclusion of contracts. For example, representatives of a pharmaceutical company actively promote drugs produced by the foreign enterprise by contacting doctors who subsequently prescribe these drugs. This marketing activity does not directly result in the conclusion of contracts between the doctors and the foreign enterprise. Therefore, even though the sales of these drugs may significantly increase because of that marketing activity, it cannot be said that dependent agent is playing principal role that lead to conclusion of contracts.

The implication of the above amendment will be that an Indian subsidiary or agent playing an active role in the foreign enterprise's business may create a DAPE for the foreign enterprise.

Independent agent

As mentioned above, OECD suggested that a person should not be considered as an independent agent if such a person acts almost exclusively on behalf of one or more closely related enterprises. Foreign enterprises are closely related enterprises if one has control of the other or both are under the control of the same enterprise. It will cover the cases where a person possesses directly or indirectly more than 50 percent of the beneficial interest in the other or in the case of a company more than 50 percent of the aggregate vote and value of the company's shares or the beneficial equity interests is held by other company.

The implication of the above amendment will be that the Indian subsidiary of foreign enterprise providing services only to its group companies will be considered as a dependent agent of the foreign enterprise.

India domestic tax law - Business Connection

India has been swift to incorporate various initiatives suggested in BEPS Action Plans in its domestic tax law. India domestic law defines the term "business connection" in inclusive manner. India amended the definition of the term "business connection" to include an agent who plays principle role leading to conclusion of contract by the foreign enterprise. India already had a similar provision in the term "business connection" as per which agent is not considered as independent agent if it works mainly or wholly on behalf of closely related enterprise/s.

The only difference between the definition in BEPS Action Plan 7 report and domestic tax law is that under the domestic tax law the dependent agent who plays a principal role leading to the conclusion of contract will be covered. It does not require foreign enterprise to conclude contract without any modification i.e. even if foreign enterprise materially modifies the contract before concluding, it will still create a DAPE in India as per the domestic tax law.

The domestic tax law does not define "principal role leading to conclusion of contracts" and reference may be made to the guidance provided by OECD in its BEPS Action Plan 7 report as discussed above.

The Indian judicial authorities even prior to the amendment being effective have decided the cases both in favour Saudi Arabian Oil Company - 2018-TII-16-ARA-IT Lubrizol Corporation USA [2017] 83 taxmann.com 13 (Mumbai Tribunal) and [2013] 33 taxmann.com 424 (Mumbai Tribunal) = 2013-TII-57-ITAT-MUM-INTL, International Global Networks BV - 2017-TII-123-ITAT-MUM-INTL, Reuters Ltd. - 2015-TII-207-ITAT-MUM-INTL and against Daikin Industries Limited - 2018-TII-165-ITAT-DEL-INTL Oy Sisu AB - 2013-TII-153-ITAT-MUM-INTL, Reuters Limited Construction House - 2013-TII-229-ITAT-MUM-INTL the taxpayer depending upon the facts and circumstances of each case. Going forward, it will be interesting to see how the judicial authorities interpret the term "principal role leading to the conclusion of contracts" and to what extent agent's role is considered as not playing the principal role which lead to conclusion of contracts.

Tax treaty provisions

The foreign enterprise of jurisdiction with which India has entered into tax treaty, has an option to apply the provisions of the applicable tax treaty or the Indian domestic tax law, whichever more beneficial.

As per most of the India's tax treaties, if a dependent agent has the authority to conclude contracts on behalf of the foreign enterprise then it will create DAPE of the foreign enterprise. Tax treaties do not include above amendments related to "principal role leading to the conclusion of contracts" and independent agent as recommended by OECD in its BEPS Action Plan 7 report as discussed above. Therefore, even after the above amendments in the domestic tax law, foreign enterprise may avoid creating DAPE as per the respective tax treaty.

Position of tax treaties after Multilateral Instrument

Recently on 25 June 2019, India has deposited its instrument of ratification for Multilateral Instrument (MLI) along with list of reservations and notifications with OECD to implement tax treaty related measures recommended in BEPS Action Plans.

The provision relating to dependent agent PE is in Article 12 of the MLI, which deals with "Artificial avoidance of PE status through commissionaire arrangements and similar strategies". It includes both the recommendations of Action Plan 7 discussed above. Article 12(1) includes a scenario where dependent agent playing principal role leading to the conclusion of contracts will create DAPE and Article 12(2) covers a scenario where an agent shall not be considered as an independent agent if it acts almost exclusively on behalf of closely related enterprise/s.

Article 12 is a non-mandatory standard. MLI gives an option to countries to reserve the right not to apply this article in its entirety. Modification of a tax treaty is subject to adoption, as well as notification of the provision by the other contracting jurisdiction. India has not made any reservation on Article 12 and has notified all its 93 tax treaties to adopt the above provisions of broader agency PE and modified independent agent rule.

MLI provisions will be applicable to a bilateral tax treaty only if both parties to such treaty notify it as a Covered Tax Agreement. The deposition of ratified instrument with the OECD triggers the concept of "entry into force". As per the MLI provision, the MLI enters into force from the first day of the month following the expiry of three calendar months from the date on which the jurisdiction deposits its ratified copy of MLI. Applying this, from India perspective, as the instrument is ratified on 25 June 2019, the MLI provision will enter into force on 1 October 2019.

Entry into effect is the date from which the tax treaties of each of the covered tax agreement needs to be read along with the MLI provision. For applicable date of entry into effect, India has opted for taxable year instead of calendar year. As per the MLI, the timeline for MLI to come into effect is based on the type of taxation.

As on date, Belgium, France, Israel, Japan, Lithuania, New Zealand, Slovak Republic and Slovenia have adopted Article 12 in their ratified MLI instrument and India and these countries have notified each other as Covered Tax Agreement in their ratified MLI. Accordingly, MLI with these countries will enter into effect in India from 1 April 2020. Thus, amendments relating broader agency PE and modified independent agent rule will supplement with the existing India tax treaties with these countries i.e. over and above existing treaties of these countries, additional MLI provisions related to Article 12 of the MLI will be effective. The entry into effect of MLI for these countries will depend on taxable year followed by these countries and option exercised by them.

Further, it is pertinent to note that MLI provisions will apply only when the position adopted by one jurisdiction on particular article matches with the position adopted by the other jurisdiction. For example, various countries such as Luxembourg, Singapore, United Kingdom etc. have reserved the right not to apply Article 12 to their tax treaties. Therefore, Article 12 of MLI will not apply between India and such countries, even if India has adopted Article 12 in its instrument and existing tax treaties will continue to apply. In such scenario, broader agency PE and modified independent agent rule will not apply to these treaties.

Way forward

Once MLI enters into effect, taxpayers will have to read tax treaties along with MLI provisions, which may either supplement, complement, supersede or modify the treaty application. It is high time for foreign enterprise having subsidiaries or agents in India to revisit the amended domestic tax laws and tax treaties along with MLI provisions, to determine whether now foreign enterprise creates any business connection or a DAPE in India.

(Samir Shah is Senior Manager and Rushabh Barbhaya is Deputy Manager with Deloitte Haskins and Sells LLP. )

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