If you are doing business in India but do not have an entity there, you may be classified by the Indian tax authorities as a Permanent Establishment (PE) in India. The consequences of this are severe, in many cases it means the end of your activities in the country. We are happy to explain how you can avoid this situation.
What is Permanent Establishment?
Permanent Establishment (PE) is a term used worldwide, but the definition varies from country to country. Tax laws of the country or trade agreements between countries define when exactly a PE exists. If you, as a company, undertake trading activities abroad without being registered there as a legal entity and therefore pay no tax, the country can still consider you to be a Permanent Establishment, with 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 circumvent this situation. Singhal explains that India has five forms 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 only for them and gets a fixed salary from the head office." Despite the fact that the company is not a legal entity in India, this construction still qualifies as 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 Dependent Agency PE. In that case, the Indian employees are fully dependent on the income and work they perform for the foreign company.
Place of Management Permanent Establishment
If you are a company renting a fixed space in India, such as an office, a warehouse or even a desk in a co-working space, and the rent for that space is paid directly by the European head office to the Indian landlord, this may qualify as PE. Any location where the foreign company has 'access and the right to use it at any time for a period of 6 months or more' falls under this form of PE.
Fixed Place Permanent Establishment
If you as a company use a fixed location to conduct your business activities, such as an office, branch office, factory, workshop, etc., this can be considered as PE. In many cases, the foreign company also uses the address of the location in official correspondence. Again, the location must be in use for more than six months.
Construction, Installation or Assembly Permanent Establishment
A specialised foreign company that carries out a project in India, such as the construction of a new bridge, brings over the necessary machinery and imports special materials. Often, project managers, engineers and architects are also flown in to supervise the project. This may feel harmless, as it is only for a short period of time. But such a project, where the company, through equipment and people, stays in India for more than a period of 6 months, can be classified as PE.
Service Permanent Establishment
In this case, the company is not offering goods, but services. No local party is involved, but the company's employees deliver 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 used by the company and it is therefore often a case of services on a project basis.
The consequences of Permanent Establishment
If your company is classified as a PE, it will have a significant impact on your business in India. Singhal: "The situation we encounter most often is one in which the foreign company has a permanent sales agent and is therefore a dependent agency permanent establishment. The Indian tax authorities often discover this form of PE when they check the agent's tax return and see that he or she is receiving a salary from abroad. All sales activities then come to an immediate halt and all goods already stored in India are locked up until the case is closed, penalties paid and you have officially started a business 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 produce to give them insight into your income in India," explains Thomas Breitinger. He is Senior Manager of Consulting Strategy at Maier + Vidorno. "Therefore, a broad estimate of the income is always made, which is often far above the real figure. An example: your agent has been working for your company for 5 years, which means that for the tax authorities you have been a PE for five years. A PE is always valued as a Branch Office, which is 42% of total income. They estimate that you have a ten million rupees (about 110,000 euros) income per year, of which you therefore have to pay 42%. On top of that, there is the interest and penalty. Some companies get a bill on the mat that is triple what they have earned in five years in India."
Permanent Establishment in India
"To get out of this awkward situation, we sometimes see European companies paying bribes," says Breitinger. "You really shouldn't do that. There is a greater chance of you ending up behind bars in your own country than in India. We strongly advise against accepting such an offer." What you do need to do is hire a good lawyer and have a lot of patience, because according to Breitinger, these procedures take a long time. "But better, of course, is to avoid 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 sell purely in India, it is a lot trickier."
There are two ways in which you can operate safely as a starter in the Indian market without starting an entity. "One is by working with distributors and agents who also do jobs for other companies. Because they do not receive a full fixed income from your business, there can never be dependent agency PE. But then you must be 100% certain that this is the case. We still see too many examples where the company is unwittingly at risk of permanent establishment because the agent has not honestly told you that there are no other clients."
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 they enter the Indian market with are high end. So you need a well-trained agent who not only understands your product, but also the market. Often, this is not someone who will take on two other jobs on the side, so you have to look at legal methods to be able to work 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 will be put on our payroll and the legal liability and responsibility will therefore also rest with us. No more PE risks. In addition, we arrange everything from back office to performance reviews and we have five physical locations where we can accommodate your team. "Over a hundred companies are currently working in India through our incubator," says Breitinger. "It is a safe option to explore the market and grow. If you have any doubts about whether your company is at PE risk, we will do a free screening for you. If it is, then you and your employees can continue to work directly through the incubator in a safe way."