If you do business in India, but do not have an entity there, you can be designated as a Permanent Establishment (PE) in India by the Indian tax authorities. This is something every foreign company wants to avoid. This is because the consequences are big, in many cases, it means the end of your activities in the country. We are happy to explain how you can prevent this situation.
What is Permanent Establishment?
Permanent Establishment (PE) is a term used worldwide, but the definition differs from country to country. Tax laws of the country or trade treaties between countries define when exactly a PE exists. If you as a company do business abroad, without any registration there as a legal entity and therefore do not pay taxes, the country may still consider you as a Permanent Establishment and this 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 avoid this situation. According to Singhal, India has five forms of Permanent Establishment, which can be divided into two categories: companies that sell in India and companies that carry out projects in India.
Category “Sales in India
• 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. This agent works only for them and receives a fixed salary from the head office. Although the company is not a legal entity in India, this construction is still classified as a Permanent Establishment. The same applies to companies that start a liaison office in India and start their sales from there. This is also not allowed and is considered tax evasion.
• Place of Management Permanent Establishment
If your company rents a fixed space in India, such as an office, a warehouse or even an office in a co-working space, and the rent of that space is paid directly by the European headquarters to the Indian landlord, it can be classified as PE. Any location to which the foreign company ‘has access and the right to use it at any time for a period of 6 months or longer’ falls under this form of PE.
• Fixed Place Permanent Establishment
If as a company you use a fixed location to develop your business activities, such as an office, branch, factory, workshop, etc., this can be considered 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.
Category “Projects in India
• Construction, Installation or Assembly Permanent Establishment
A specialized foreign company carries out a project in India, such as the construction of a new bridge. For this purpose, it transfers machines and imports special materials. Project managers, engineers and architects are also flown in to supervise the construction. Such a project in which the company, by means of 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 does not offer goods, but services. So there is no involvement of local party, but the company’s employees provide the services to the customer in India. They stay in the country for more than six months for this purpose. An example is providing project management services. In this case, there is no use of the physical location by the company and it is therefore often 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 that the foreign company has a permanent sales agent/ It 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 receives a salary from abroad. All sales activities then come to an immediate standstill and all goods already stored in India go under lock and key until the case is completed, the fines 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. “Since you are not an official legal entity in India, you don’t have any books that you can produce to give them an insight into your income in India,” Thomas Breitinger explains. He is Senior Manager Consulting Strategy at Maier + Vidorno, so there is always a large estimate of the income, which is often far above the real number.
For example, your agent has been working for the company for five years. It means that you have been a PE for the tax authorities for five years. A PE is always valued as a branch office that is 42% of the total income. They estimate that you have an annual income of one million, of which you have to pay 42%. On top of that, you have to pay interest and a fine. Some companies get a bill on the mat that is triple of what they have earned in 5 years in India”.
Avoid Permanent Establishment in India
“To get out of this tricky situation, we still see European companies paying bribes,” says Breitinger. “You really shouldn’t do that. There’s a greater chance that you’ll end up behind bars in your own country than in India. We strongly advise against taking up 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 of course it is better 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 harder.
There are two ways in which you can safely operate on the Indian market as a starter 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 dependent agency PE. But then you have to be 100% sure that this is the case. We still see too many examples where the company unconsciously runs the risk of permanent establishment. This is because the agent did not honestly tell us 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 with which they enter the Indian market are high end. So you need a well-trained agent who not only understands your product but also the market. Often that’s not someone who takes two other jobs in addition to that, 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 on the payroll with us and the legal liability and responsibility will therefore also lie with us. No more PE risks. In addition, we arrange everything from the back office to performance reviews. 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’s a safe option to explore the market and grow. If you’re unsure whether your company is at PE risk, we’ll do a free screening for you. If that’s really the case, then you and your employees can continue to work in a safe way directly through the incubator”.