Attribution of profit to Permanent Establishments

Recognizing  the need to bring greater clarity, objectivity, and predictability in the matter of attribution of profit to a Permanent Establishment (‘PE’), the Central Board of Direct Taxes (‘CBDT’) in India formed a Committee with the following mandate:

1. Examining existing scheme of profit attribution to PE under Article 7 of Double Taxation Avoidance Agreements (‘DTAAs’);

2. Examining contribution of demand side and supply side factors in profit attribution; and

3. Recommending changes needed in Rule 10 of the Income-tax Rules, 1962 (‘IT Rules’) to provide specific rules on how profits are to be attributed to a non-resident person having PE in India.

The draft report on attribution of profits to permanent establishments (‘PEs’) of non-resident enterprises was issued on April 18, 2019. The observations and recommendations of the Committee covers following areas–

• Existing scheme of profit attribution to PE under Article 7 of DTAAs

• Contribution of demand side and supply side factors in profit attribution

• Final recommendations of the Committee

The Committee has suggested a three-factor formula-driven apportionment approach, by assigning an equal weightage to sales, manpower (i.e., employees and wages) and assets. In a way, this represents a mix of both demand and supply related factors, thereby allocating profits derived from India, partly to the jurisdiction where sales take place (driven by consumers and market), and partly where factors of production are located or where supply related activities are carried out.

Additionally, in relation to the concept of Significant Economic Presence, a four-factor approach has been suggested to apportion profits. The fourth factor is ‘users’, whereby a weightage of 10% has been assigned for business models involving low or medium user intensity, and 20% in other cases. In this case, the weightage given to sales would remain 30%, however, the balance are to be assigned to employees and assets equally.

The report also enlist the summary of various judicial precedents in the area of attribution of profit (Refer page 56-61 of the report).

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