According to proposals for companies with global losses or global profit margin of less than 2 per cent, the Indian profits would be deemed to be 2 per cent of the revenue or turnover

Loss-making multinational companies with a permanent establishment (PE) or business connection in India could be adversely hit if the income tax department’s recent proposals are implemented.

According to domestic laws, an MNC having a fixed place of business in India is considered as having PE and is taxed.

According to proposals, as contained in the draft report released for public consultation, for companies with global losses or global profit margin of less than 2 per cent, the Indian profits would be deemed to be 2 per cent of the revenue or turnover.

This, tax experts argue, is an incorrect way of taxation and could impact multinational companies engaged in projects with a long gestation period, say the infrastructure sector, for instance.

“This will impact several PEs. Assuming that if MNCs are continuing with Indian operations in spite of losses, the proposal to treat it as higher profits is not correct,” said Amit Maheshwari, managing partner, Ashok Maheshwary & Associates.

The continuation of Indian operations justifies the presumption of higher profitability of Indian operations, and in such cases, a provision that deems profits of Indian operations at 2 per cent of the revenue or turnover derived from India should be introduced, the report, by a committee appointed by the Central Board of Direct Taxes (CBDT), said.

The CBDT committee proposed to change the methodology for taxing multinational companies, including digital firms, with PE in India, by giving weight to domestic sales, employee strength, assets, and user base.
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Amit Singhania, partner, Shardul Amarchand Mangaldas & Co, said the approach by CBDT considered the Supreme Court judgment in the Morgan Stanley case, which said if the Indian subsidiary had already been compensated at arms’ length, then no further attribution was to be made to PE in terms of profits.

“However, computationally, the report provides for increase in attribution of profits and hence, further attribution may be required,” Singhania added.

As such, the approach may lead to more attribution of profits in India.

In case of digital companies, the weight will be on additional fourth criteria of “user” base, the report said.

Maheshwari suggested that the methodology may be flawed as, although these digital companies such as LinkedIn, Gmail etc, do have a high user base in India, the revenue generation from users is quite low.

Rakesh Nangia, managing partner, Nangia & Co., said profit attribution had been the most controversial and more litigated matter in international taxation. Though the formula mentioned in the report was likely to give more certainty and reduce disputes litigations, “The overall intent seems to be positive”, he added.

The Central Board of Direct Taxes (CBDT) had on Thursday invited comments from stakeholders on the report within 30 days.