In an unprecedented judgment that could have far reaching ramifications, the Income Tax Appellate Tribunal (ITAT) has ruled that foreign companies having local agents with Permanent Establishment (PE) will have to pay taxes in India. 
 
The concept of PE is one of the most complex issues that international tax treaty laws have to deal with. That is because a foreign companys profits are taxable in a country only if the enterprise is deemed to be a PE, usually defined as a fixed place of business through which business is carried out.

With this order though, income earned by foreign companies in India will come under the tax net even if the foreign company has paid the Indian agent on the basis of the Arms Length principle (ALP). Under the terms of this principle, the prices paid to a foreign companies agent would be the same as they would have been, had the parties to the transaction not been related to each other.

While the order will bring in at least Rs 200 crore in taxes from the entertainment industry, it is the BPO business that will now come under the scanner as IT officials train their guns on this sector. None of the foreign companies in the BPO space that have Indian agents are filing returns in India. We are planning to send notices to these companies under section 163 of the I-T Act to file returns in India on the basis of the recent ITAT order, sources said.

It is likely that representatives from the BPO business may urge government to categorically spell out that when the Arms Length pricing has been adhered to, the tax liability of the foreign company in India is extinguished. The order was passed on account of a case that filed by SET Satellite (Singapore), the parent company of Sony Entertainment Television. SET is in the business of broadcasting and uplinking of television channels. It appointed an Indian company as an agent to market ad space on its behalf for a commission during assessment year 1999-2000.

While filing returns, SET argued that it is not taxable in India as it did not have a PE as defined by a tax treaty between India and Singapore. The stand was adopted because SET pointed out it had compensated the agent on the Arms Length principle.