NASSCOM’s submission to CBDT on PE attribution approach

NASSCOM’s has submitted suggestions to Central Board of Direct Taxes (‘CBDT’) on the report of proposed ‘Amendment of rules for profit attribution to Permanent Establishment

The proposed changes to the rules have been made by a Committee constituted by the CBDT with a mandate to:

  1. Examine the existing scheme of profit attribution to PE under the Double Taxation Avoidance Agreements.
  2. Examine the contribution of demand side and supply side factors in profit attribution.
  3. Recommend the changes needed in rule 10 of Income-tax Rules to provide specific rules on how profits are to be attributed to a non-resident person having PE in India.


Taxation of profits attributable to a Permanent Establishment (‘PE’) is a matter of global concern.  In India’s case, lack of definitive rules under the Income Tax Act, 1961  and inconsistent allocation by the courts in different case laws has been a cause of uncertainty in taxation for non-residents. Under section 5 of the IT Act, global income of a resident in India is taxable. However, taxability of income of non-resident is limited to income that arises/accrues in India, is deemed to arise/accrue in India or is received/deemed to be received in India. This deeming provision relies significantly on the concept of business connection. Recently, the concept of business connection has been expanded to explicitly include significant economic presence (‘SEP’) within the scope of business connection.

A key motivation for introducing the SEP concept is that the existing tax rules can be difficult to apply for the taxation of digital enterprises which do not need a physical presence nexus to actively participate in the economic life of a taxing jurisdiction resulting in a possible mismatch between where their profits are generated and where they are subjected to tax.

In addition to the challenges related to the determination of taxability, it can be difficult to determine the tax liability. The liability, in the usual course, is determined on the basis of relevant books of accounts and financial statements. However, where such books of account are either not maintained or it may not be possible to determine the actual profits, the process often leads to uncertainty as the AO can resort to secondary options prescribed in Rule 10 of the Rules.


The Committee has recommended that in case an assessee, who is not a resident of India, has a business connection in India and derives sales revenue from India by a business all the operations of which are not carried out in India, the attributable profits will be derived as follows:

  1. As a first step, ‘Profits derived from India’ will be computed as the higher of, revenue derived from India x global operational profit margin, or two percent of the revenue derived from India.
  2. Thereafter, this profit will be adjusted for supply and demand side factors and the profit attributable in India shall be determined by apportioning the profits derived from India by a three equally weighted factors of sales, employees (manpower & wages) and assets.
  3. In case where business connection is primarily constituted by existence of users, the profit attributable in India shall be determined by apportioning the profits derived from India on the basis of four factors of sales, employees (manpower & wages), assets and users. The users should be assigned a weight of 10% in cases of low and medium user intensity, while each of the other three factors should be assigned a weight of 30%.

Overall comments:

  1. The main conclusion we draw is that, the proposed formula based approach requires much more deliberation and wider discussion, and in that spirit, these consultations are a good step forward.
  2. The proposed Fractional apportionment method approach is likely to cause uncertainty to the existing arm’s length price principle and its application under TP provisions of the IT Act and tax treaties.
  3. The proposed approach is likely to result in allocation of profits which may bear no sound relationship to the economic facts. It disregards the function, assets and risk analysis, as well as particularly circumstances of the individual enterprises and ignores management’s own allocation of resource. Inherently, it runs the risk of allocating profits to an entity that is in actuality making losses based on what third parties would realistically do in similar circumstances.
  4. The basis of inclusion of the proposed demand and supply side factors and the weights assigned to them is not clear. Within the formula, use of number of employees together with wages as two distinct factors, and treatment of users on par with employees and as a factor is particularly likely to lead to profit attribution quite removed from the fundamental concept of what profits are understood to be. This concern is compounded by the fact that it is not easy to measure/ identify these factors for use in the proposed formula.
  5. A formula based approach will need to consider the possible outcomes for different business models prevalent in the industry and it would need to be sensitive to all relevant factors.  The threshold for application of this kind of an approach will need to be sufficiently high so that only a few firms are potentially covered in the initial years. Such an approach could be, at most, applied selectively and should be used alongside FAR based approach based on arm’s length principles. This may be resorted to only when the traditional transfer pricing methods are unsatisfactory. This should provide a basis for review and learning from the initial experience.
  6. Finally, India’s approach should be aligned with the outcome of OECD.  In any event, the existing treaty framework and separate entity/ arm’s length approach as advocated in the treaties should not be subject to the new Rules until such consensus is achieved.
  7. Views on the subject are evolving and we look forward to engaging in further with our members and with CBDT to discuss areas of concerns and improvements in the proposed approach. Considering the significance and huge impact of the report, we have requested the CBDT to extend the date for providing suggestions on the issue.

Our detailed concerns and justifications are provided in the attached submission.


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