Permanent establishment risk in India – an often underestimated problem!
Find out why your market entry quickly becomes a PE risk
Entry into India: Lean models instead of a separate company
Thousands of European companies are now active on the Indian market. Most of them, however, do not operate in the form of a subsidiary, but through Indian commercial agents in the narrower sense (dealers, distributors, importers) and commercial agents in the broader sense (individuals, representatives) or through direct exports. Understandably, for many (especially) medium-sized companies, the Indian market in the high-tech segment is still too small to justify setting up their own local structure. It is also understandable that (especially in the beginning) companies prefer to choose a path that is associated with significantly fewer risks and liabilities than having to manage – and finance – their own local company. Last but not least, the German head office often does not have sufficient time or personnel resources available to “manage” India from Europe on a day-to-day basis.
Why many companies start with sales representatives
These are all very good and sensible reasons to test market access to India with an alternative model. Often – e.g. at a trade fair or India event – you have even met people who appear to be trustworthy, who offer their services and signal a serious interest in developing the market in India for the European company. These can be traders as well as individuals / private persons who then work very closely for the company and are managed almost like an “own employee in India”.
When a test phase becomes a permanent solution
Sometimes this model works so well that the initially planned “first-time-start phase” turns into several years.
The often overlooked tax risk: permanent establishment
However, very few companies are aware of the risks of such models. And here we are not talking about the risk of choosing the wrong partner (link to Superinder https://wamser-batra.com/de/blog/ihr-indischer-geschaeftspartner-wertvoll-oder-bollywood-beziehung/ ) or the general problems associated with working with Indian sales partners, but rather we want to focus on a tax risk: The permanent establishment risk.
Many models used in practice lead to the (unintentional!) establishment of a taxable permanent establishment – without the European parent company being aware of this.
Typical examples from practice
A few typical examples:
– exclusive commercial agent: If a representative/agent works exclusively for only one principal, he is quickly considered a “dependent representative” of the European company in India, which also leads to a permanent establishment. The problem is that this model is particularly favored by SMEs: I have someone who concentrates entirely on our products. Preferably with power of attorney and a distribution center…
– Individual / representative: Many foreign companies employ an Indian individual who acts as a local contact / representative without any other structures such as a subsidiary or any other registered company. The individual appears on the market with the European company’s business card and in many cases is even paid directly from Europe. This constellation is very quickly regarded as a permanent establishment by the Indian authorities, partly because the use of the European company’s business card is taken as a clear indication of affiliation with the company. Similarly, all payments to the individual, especially if they are monthly lump sums, are interpreted as salary payments.
– Assembly services: If, for example, a plant is sold to India and the European company provides assembly services for a period of more than 6 months during the course of the project, this will result in a permanent establishment. For this purpose, not only the presence of a foreign assembly employee is counted, but it is sufficient that an Indian subcontractor works on site on behalf of the European company and the actual work of the foreign employees is limited to supervisory functions.
– Own subsidiary: Even if a foreign company operates its own local subsidiary, the permanent establishment risk may remain. This is a problem that many companies are not even aware of, according to the motto “Permanent establishment? I have my subsidiary!”. Constellations can be:
- The presence of a seconded employee of the European parent company for longer than 180 days
- The Indian subsidiary is only apparently independent, indicated by the fact that it has accepted contracts from the European parent company, for example, which an independent third party would never accept.
Why the permanent establishment problem will never go away
There are numerous other examples, which we will discuss further in a series of subsequent articles. The topic of “permanent establishment” will probably remain a never-ending story, partly because
- Indian authorities will continue to delight us with new interpretations, and
- the topic of permanent establishments is also a hot topic of discussion internationally – especially in the face of ever-decreasing tax revenues.
Possible consequences of an unrecognized permanent establishment
When we talk about “problems”, we do so for various reasons:
- A tax liability arises – without you being aware of it
- There may be a tax liability for income that was already taxed in Germany years ago.
- The result is an unplanned and quickly escalating administrative burden.
- The result is an Indian jurisdiction for the foreign company with all its excesses, unpredictability, covetousness and typical “inflationary” claims for damages.
- Another problem will be with follow-up orders and payments. Let’s take the current documentation effort to obtain a payment from India (keyword “no PE declaration”). Any further payment will be delayed immeasurably or made with extreme advance deductions (20-40%), so that a deal may no longer be worthwhile.
Prevention through smart contract design and behavior
This makes it all the more important to examine every distribution model in India with regard to the permanent establishment tax risk. Very often, it is possible to avoid critical areas of attack that allow the Indian tax authorities to make an interpretation that is unfavorable to you by following simple procedures and drafting contracts precisely.
Such risks can therefore be avoided in advance. And even if risks have only existed for a short time, they are still “easily controllable” and can be eliminated without considerable effort. Initially, the risk of possible penalties is also rather low.
Why waiting is dangerous
But we keep hearing: “Why should we change anything? It’s worked well for the last 10 years!”. However, this underestimates the fact that the risk of detection has increased significantly due to increasing digitalization, among other things, and that Indian tax authorities are increasingly targeting foreign permanent establishments… “Wait and see” is therefore a risky approach. The worst thing is when Indian tax officials (especially at the lower levels) come across specific deviations from the law by foreign subsidiaries. In such cases, the maximum possible penalty is always sought – if only out of the official’s fear of making a mistake – “if in doubt, against the accused”.
Long-term risks: blackmailability and subsequent reprocessing
Furthermore, you make yourself vulnerable or susceptible to blackmail for years to come. A dissatisfied former employee, competitor or similar is enough to trigger the entire investigation in an uncontrolled and correspondingly risky manner with a small anonymous tip-off to the authorities. This may well take place many years later.
Conclusion
The Indian market offers enormous opportunities, but the permanent establishment risk is often underestimated by European companies. Whether commercial agent, representative, assembly project or even subsidiary – many constellations can unintentionally lead to a taxable permanent establishment. The consequences are serious: retroactive tax liability, high administrative costs, payment delays and legal uncertainties.
Companies should always review their market strategy in India from a tax perspective in advance and safeguard it with well thought-out contracts and clear rules of conduct. Prevention is much easier, cheaper and safer than damage limitation later on. Get in touch with us. We have been your strategic partner for India for more than 20 years.
