Marketing activities in India: Key tax considerations

Karan Kakkar
Karan Kakkar
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As India moves to become a $5 trillion economy, cross-border trade is expected to play a key role in thisgrowth journey. More and more foreign companies will look to establish either a manufacturing or amarketing presence in India, in order to market/ sell their goods and/or services in the Indian market.When a foreign enterprise creates its marketing footprints in India, it generally does so by establishing aseparate legal entity or by opening a branch in India. While creating such presence, it is important for thegroup to take cognizance of certain taxation aspects, which may have long-term implications in terms of taxcosts as well as litigations for the multinational group in India. In this article, we have discussed varioustaxation aspects which need to be evaluated when planning to set-up a new marketing services entity inIndia. Furthermore, with the evolution of tax framework, especially with the advent of OECD's BEPSProject and introduction of Goods and Services Tax (GST) regime in India, this evaluation is equallyrelevant for companies already having such presence in India.

I. Understanding the transfer pricing (TP) aspects

In a multinational group, Indian marketing entities are generally engaged in assisting their groupcompanies with marketing, advertising and sales support functions for the Indian market. Such supportmay include lead identification, market study and research, creating awareness about products/services ofthe parent company, etc.

When viewed from a TP perspective, a comprehensive analysis of the business and pricing model becomescritical to ensure that the parties involved are appropriately characterized as well as remunerated on anarm's length basis. In a related party scenario, the Indian entity (or branch) maybe functioning as amarketing support service provider, or as an agent, depending on the kinds of functions performed andrisks assumed.

When the role of Indian entity is primarily limited to research, lead identification, market awareness/promotion and similar related activities and it does not assume significant risks such as market risk, R&Drisk, price risk, inventory risk, and credit risk, etc., it is likely that it is working as a marketing supportservice provider. In such case, considering the limited functional and risk profile of the Indian entity, itmay be appropriate to remunerate the Indian entity under a cost-plus model. However, for the model tofunction without any significant TP challenges, it is important to ensure that the Indian entity does notperform any significant strategic decision-making function(s), including any pricing decisions andnegotiation activities. Also, the Indian entity should function within the policy framework and as per themarketing/ business plan laid down by the overseas group company. Furthermore, it is important to do athorough analysis to identify the expenses on which an arm's length mark-up is warranted and expenseswhich may be treated as a pass-through. The arm's length price computation may become a littlecomplicated, in cases where such Indian entity is performing other activities as well, either for its group company or in its independent capacity. In such situations, it becomes important to prepare a dulysegmented profit and loss account for arm's length analysis purposes.

In some cases, the Indian entity, while providing regular marketing support, may also be engaged in somecritical functions such as assisting group company in securing orders, negotiation of sales price, etc. andmay also be assuming some risks such as collection related risk (since its remuneration is dependent onultimate collection of sales proceeds by overseas group company from the customer). In such situations, asimple cost-plus remuneration may not be appropriate, and it may be worthwhile to evaluate other modelslike commission (linked to sales), etc. Such models may also come with other taxation related challenges,which are discussed in subsequent sections of this article. However, in summary, the key point whichdeserves taxpayer's attention when designing their business/ pricing model is that they should give dueconsideration to TP principles while designing their model, as an ex-ante analysis can help them minimiseTP challenges, while at the same time also reduce chances of TP litigation in future.

II. Decoding the GST related challenges

Indian entities engaged in providing marketing support services to their overseas group companies have inthe recent past faced key issues when it comes to indirect taxation. From a GST perspective, there isambiguity around classification of such services as "intermediary" as classification of any service asintermediary service may lead to additional cost to the overseas group company.

The concept of "intermediary" was borrowed in GST from the erstwhile Service Tax regime. Under GST"Intermediary" has been defined to mean "a broker, an agent or any other person, by whatever namecalled, who arranges or facilitates the supply of goods or services or both, or securities, between two ormore persons, but does not include a person who supplies such goods or services or both or securities onhis own account."

Taxability of intermediaries has been a controversial topic in GST as the tax authorities across the countryhave not been consistent in determining the nature of services to be intermediary services. Contradictoryjudgements have been held across various authorities of law. Further, once a service qualifies to beintermediary service, another question of taxability arises when intermediary which is located in Indiaprovides services to the recipient located outside India. As per the provisions of GST law, place of supply incase of intermediary service would be "location of the supplier of services".

Therefore, such service wouldnot qualify as "export" as place of supplier would be the location of supplier and one of the basic requisitesto qualify any service as export is that place of supply must be outside India. The industry has been stronglycontesting that the said provision of place of supply in case of intermediary service in GST law is evidentlycontrary to the fundamental principle of destination-based consumption tax. Also, that this practice oflevying GST on intermediary services to exporters is not in line with European Union best practice and maylead to double taxation which ultimately makes domestic service providers less competitive as compared toservice providers of other countries. Even on this issue there has been conflicting pronouncements by theGujarat and Bombay High Courts.

With an intent to provide some clarification on the concept of intermediary, the Central Board of IndirectTaxes & Customs (hereinafter referred to as "CBIC") issued a circular and stated that in order to qualify anyservice as an intermediary service, consideration should be given to certain aspects, i.e. involvement ofminimum three parties, two distinct supplies should be there, supplier must arrange or facilitate the supplyof goods or services or both, or securities and such supplier does not include a person who supplies suchgoods or services or both or securities on his own account.
One may say that if above mentioned aspects are clearly specified in the agreement, then there may be nodisputes going forward. The said circular also provides clarification around certain ambiguities primarilyon account of exclusion of principal-to-principal transactions, outsourcing transactions, sub-contracting,etc. from the scope of intermediary services. However, this circular by CBIC seems to be merely acollaboration of provisions along with generic illustrations which can be given due consideration while reading the facts of the specific case, but whether a service qualifies as intermediary would depend purelyon facts of that particular case.

However, even after release of the Circular, Karnataka AAAR in case of M/s Airbus Group India PrivateLimited clearly held that illustrations given in the circular are only indicative and not exhaustive and thatdetermination of whether a particular activity would fall under intermediary service or not would dependupon the facts of the case and the nature of the contract/agreement entered into. This has certainly led toskepticism in the minds of industry players as the pandora's box on this long pending issue is still notcompletely closed.

Given the above backdrop, it is important for multinational groups working in such domain to determineapplicability on a case-to-case basis because if such contracts result in supply of intermediary services by aperson located in India, it may result in additional cost in the hands of overseas group company as 18%GST will be charged on such transaction. To mitigate unwarranted litigations on this account, it isimportant that foreign businesses operating in India should be mindful of the coverage/scope whileentering into any agreements and ensure that clauses in such agreements fairly represent the true and exactnature of services. An appropriately drafted agreement, which truly represents the nature of activitiesperformed by the Indian group entity, may help mitigate the "intermediary" risk, at least in the case ofmarketing support service providers discussed above.

III. Corporate taxation aspects to be evaluated

When viewed from an international tax perspective, the most relevant concept in case of Indian companyrendering marketing services to its group entities outside India is one of Permanent Establishment ('PE")as found under the Double Taxation Avoidance Agreements (DTAAs or tax treaties). PE is constituted for aForeign Enterprise if thresholds specified under the tax treaties are breached – once a PE is constituted, theSource State has the right to tax the Foreign Enterprise on its business income.

On 25 June 2019, India ratified the Multilateral Convention to Implement Tax Treaty Related Measures toPrevent Base Erosion and Profit Shifting (MLI), which was signed on 7 June 2017. As a result of this,India's DTAAs with countries which had already ratified the MLI as on 30 June 2019 stand modified byMLI from FY 2020-21 onwards and the remaining DTAAs will get modified once other countries ratify theMLI.

Where India's position on MLI's Article 12 (which deals with expanded scope of PE) matched with othercountries under the MLI, the traditional PE thresholds stood effectively revised. However, in cases wherethe other Country has reservations on any clause or has chosen an option other than the one chosen byIndia, a careful review will be required to evaluate the impact of MLI.

Broadly, the changes ratified by India are aligned with the objective of ensuring taxation of profits takesplace where economic activities generating the profits are performed and value is created. To this effect,India has chosen to make the following changes to its definition of PE:

  • The definition of Agency PE, in addition to habitually concluding contracts on behalf of a principal now also includes cases where the Indian service provider has played a 'principal role' in concluding contracts and/ or 'routinely concludes' contracts 'without material modification' being made by the foreign enterprise.
  • The well-established principle that economically and legally independent agents would not createa PE has been diluted by the Multilateral Instrument (MLI). Now even if the Indian serviceprovider is economically and legally independent, if it is mostly providing services to closelyrelated parties of the foreign enterprise, PE may still be constituted.
    Closely related parties are defined as entities in which the Foreign Enterprise directly orindirectly has more than 50 percent of beneficial interest / control.
  • The exemption from PE for 'preparatory and auxiliary activities' such as storage, display,procurement, etc. is no longer blanket and if these activities play a pre-dominant role in overalloperations/ supply chain of the foreign entity, a PE may still be constituted.

Most of these changes are intent driven with the rationale for the changes being explained in detail by theOECD in the BEPS Action Plan. Furthermore, as accepted in the Vienna Convention on the Law of Treaties, 'treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to theterms of the treaty in their context and in the light of its object and purpose'.

In view of the above, the underlying rationale and the intent of both the Contracting States would need tobe kept in mind while evaluating the impact of the above changes. As mentioned above, for India purposes,the above changes were first made effective from 1st April 2020 and applicable from then in case ofCountries that had submitted their instrument of ratification on or before 30th June 2019 and notified thetax treaty with India as a Covered Tax Agreement.

Therefore, it is important that companies re-evaluate the manner in which the MLI impacts the traditionalPE thresholds. Once this is understood, companies should undertake an assessment of activities performedby group companies in India and the role these activities play in the entire value creation thereby ensuringthat the new PE thresholds are not breached unknowingly.

TP principles also play a critical role in PE related analysis. Once it is established that PE exists, the nextstep is to determine the amount of income which is attributable to such PE in India. TP principles, based ona comprehensive FAR analysis, will help determine the income which should be attributed to India, in caseswhere it is found that the foreign entity has a PE in India. Such income attribution exercises are generallyhighly factual and require an in-depth analysis of facts and circumstances of the specific case. It isimportant to note that the PE attribution principles are also expected to be revamped in India in the nearfuture - while a draft report on the PE attribution principles was released by a committee appointed by theCentral Board of Direct Tax in India in April 2019, the said report is yet to be finalised, as the report willalso be impacted by OECD's ongoing work on Pillar 1. Considering that OECD is also steadily progressingon its work on Pillar 1, one may expect that the Indian Government may also soon come out with the newPE attribution rules soon. Foreign companies are likely to be impacted once these rules are introduced andshould continue to monitor the release of the said rules.

Concluding thoughts

It is evident from the above discussion that foreign companies having or contemplating to startmarketing/sales activities in India, should do a thorough analysis of their existing/ proposed businessmodel. A comprehensive analysis of the model from an Indian TP, indirect tax and corporate taxperspective will help such service providing entities understand the overall tax implications of theiractivities in India. Presently, a large number of taxpayers have a tendency to review their operations inisolation, whether from a TP or taxation standpoint. However, such incomplete review of business activitiesunder one law, may leave the Group exposed to implications under other provisions. Therefore, it isadvisable to always go for a robust and holistic ex-ante analysis (to the extent possible) as it will helpmultinational groups in structuring their activities in such a manner that their commercial objectives areachieved, while at the same time tax exposures are also evaluated and mitigated. As mentioned earlier, suchan evaluation is also advisable on ex-post basis for existing entities, as this will help them takecorrective/remedial action to mitigate existing gaps, if any.

The article was originally published on Taxmann India.