How to avoid Permanent Establishment in India
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When you do business in India but do not have an entity there, you can be declared a Permanent Establishment (PE) by the Indian tax authorities. The consequences of this are significant, in many cases it means the end of your activities in the country. We would like to explain how you can avoid this situation.
What is Permanent Establishment?
Permanent Establishment (PE) is a concept that is used worldwide, but the definition varies from country to country. The tax laws of the country or trade agreements between countries stipulate when exactly a PE exists. If you, as a company, undertake commercial activities abroad, without being registered as a legal entity there and therefore not paying taxes, the country can still regard you as a Permanent Establishment and that has unpleasant financial consequences.
Permanent Establishment in India
Praveen Singhal is Chief Financial Officer at Maier + Vidorno, IndiaConnected’s partner in India, and has helped hundreds of European companies to circumvent this situation. Singhal explains that India has five types of Permanent Establishment, namely:
Dependent Agency Permanent Establishment
“One of the most common mistakes made by European companies that start selling their products in India is that they hire a permanent agent or sales manager,” says Singhal. “This agent works exclusively for them and receives a fixed salary from the head office.” Despite the fact that the company is not a legal entity in India, this construction is still considered a Permanent Establishment. The same applies to companies that only have a liaison office in India and start sales activities from there. This is not allowed and is considered tax evasion. Finally, foreign companies that outsource work to Indian employees who work for them full-time are also considered a Dependent Agency PE. In that case, the Indian employees are completely dependent on the income and the work they do for the foreign company.
Place of Management Permanent Establishment
If you as a company rent a permanent space in India, such as an office, a warehouse or even a desk in a co-working space, and if the rent for that space is paid directly by the European head office to the Indian landlord, this can be considered a PE. Any location that the foreign company ‘has access to and the right to use at any time for a period of 6 months or longer’ falls under this form of PE.
Fixed Place Permanent Establishment
If you use a fixed location as a company to conduct your business activities, such as an office, branch, factory, workshop, etc., this can be considered a PE. In many cases, the foreign company also uses the address of the location in official correspondence. Here too, the location must be in use for more than six months.
Construction, Installation or Assembly Permanent Establishment
A specialized, foreign company that carries out a project in India, such as the construction of a new bridge, brings over the necessary machines and imports special materials. Often, project managers, engineers and architects are also flown in to supervise the project. This may feel innocent, because it is only for a short period. However, such a project, in which the company stays in India for more than 6 months by means of equipment and people, can be considered a PE.
Service Permanent Establishment
In this case, the company does not offer goods, but services. There is therefore no local party involved, but the employees of the company provide the services to the customer in India. They stay in the country for more than six months. An example is the provision of project management services. In this case, there is no physical location that is used by the company and therefore it often concerns services on a project basis.
The consequences of Permanent Establishment in India
If your company is classified as a PE, this has a significant impact on your business in India. Singhal: “The situation we encounter most often is when the foreign company has a permanent sales agent and there is therefore a dependent agency permanent establishment.
The Indian tax authorities often discover this form of PE when they check the tax return of the agent and see that he or she receives a salary from abroad. All sales activities are then immediately halted and all goods that are already stored in India are locked up until the matter is concluded, the fines paid and you have officially started a company in India.”
The tax authorities not only fine you, but also calculate what you owe them in tax and interest. “Because you are not an official legal entity in India, you also do not have any books that you can provide to give them insight into your income in India,” explains Thomas Breitinger, Senior Manager Consulting Strategy at Maier + Vidorno.
“There is therefore always a generous estimate of the income, which is often far above the real figure. An example: your agent has been working for your company for 5 years, which means that you have been a PE for the tax authorities for five years. A PE is always taxed as a Branch Office, which is 42% of the total income. They estimate that you have ten million rupees (around 110,000 euros) in income per year, of which you have to pay 42%. On top of that, there is the interest and fine. Some companies get a bill that is three times what they earned in India in 5 years.”
Preventing Permanent Establishment in India
“To get out of this difficult situation, we sometimes see European companies paying bribes,” says Breitinger. “You really should not do that. The chance that you will end up behind bars for that in your own country is greater than in India. We strongly advise against accepting such an offer.” What you should do is hire a good lawyer and have a lot of patience, because according to Breitinger these procedures take a long time.
“But it is of course better to prevent the situation altogether. For companies that work on a project basis, and could fall under the heading of construction permanent establishment, there are ways to make this PE legal in a simple way. But for companies that purely sell in India, this is a lot more difficult.”
There are two ways in which you can operate safely as a starter on the Indian market without starting an entity. “One is by working with distributors and agents who also carry out assignments for other companies. Because they do not receive a full fixed income from your company, there can never be a question of dependent agency PE. But then you have to be 100% certain that this is the case. We still see too many examples where the company unknowingly runs the risk of permanent establishment because the agent has not honestly told them that there are no other customers.”
Avoid PE risks with the Business Incubator
According to Breitinger, a part-time sales agent is not enough for many European companies to succeed in India. “The products with which they enter the Indian market are high end. So you need a well-trained agent who understands not only your product, but also the market. Often this is not someone who can take on two other jobs on the side, so legal methods have to be considered to be able to get started with a permanent employee.”
Maier + Vidorno and IndiaConnected offer a solution for this through the business incubator. You as a company find the right people to start selling your products in India and we take care of the rest. Your employees are placed on our payroll and the legal liability and responsibility therefore also lies with us. No more PE risks. In addition, we take care of everything from back office to performance reviews and we have five physical locations where we can accommodate your team.
“More than a hundred companies are currently working in India through our incubator,” says Breitinger. “It is a safe option to explore the market and to be able to grow. If you have any doubts about whether your company is at PE risk, we will do a free screening for you. If this is really the case, you and your employees can continue working safely via the incubator.”
