A key decision that multi-national corporations must make while establishing a business in India is the choice of a business vehicle. While incorporating companies or limited liability partnerships are popular choices for doing business in India, several foreign corporations also choose to conduct business by setting up a ‘branch’ in India.
A branch is not a separate legal entity under the eyes of law and is merely an extension of an entity. Unlike companies or partnership firms, a branch cannot own assets or enter into contracts in its own name. Yet, a branch is treated as a separate and distinct entity from a regulatory as well as income tax perspective.
Branch - a separate entity?
Income earned by a foreign company through a branch in India may be taxable in India if such a branch constitutes a Permanent Establishment’ (PE) of that company in India. Having a fixed place of business (such as a branch) in India could result in constituting a PE. While profits of Indian companies are generally taxable at 25.17%, the tax rate for a foreign company’s branch in India is 38.22%. The branch is expected to maintain its separate books of accounts as well.
Judicial perspectives: Nokia and Hyatt cases
A controversy arose over whether a branch would be liable to pay income tax on profits earned by it if the foreign company that set up the branch incurs a loss. There were conflicting judicial rulings in this regard, where the Delhi High Court in the case of Nokia Solutions and Networks OY held that in case of a global loss, the Indian PE of a foreign company would not be liable to pay income tax in India. This was premised on the basis that it is the foreign company’s profits which are ‘attributed’ to its Indian branch that are subject to income tax. In other words, if the foreign company does not make any profits, there is nothing left to attribute to its Indian branch. Consequently, there would be no profits that can be taxed in India.
However, a full bench of the Delhi High Court in the case of Hyatt International Southwest Asia ruled that under the Tax Treaties, a PE is treated as a separate and distinct entity from the foreign company to which it belongs. Therefore, once a foreign company has a PE in India, it would be required to pay tax on profits that are attributable to such PE in India, notwithstanding the losses that the enterprise as a whole may have suffered at a global level.
Takeaway
This is an important judgement by the High Court, aligning with the core principle of tax treaties regarding the taxation of permanent establishments. The key principle is that profits earned by a foreign company through its PE in the source country (where income is earned) are taxable in that country, regardless of whether the concerned foreign enterprise has global profits or losses at entity level.
While it remains to be seen whether this ruling would be challenged before the Supreme Court, the importance of maintaining adequate documentation for demonstrating profitability of Indian branches cannot be underscored. Merely demonstrating a loss at the global level would not relieve PE of foreign companies from taxation in India.
Multinational companies who have a PE in India will need to be mindful of this judgment in terms of their tax filings in India, including what position they have taken earlier in this context.
