For multinational corporations (MNCs) with subsidiaries or branch offices in India, navigating the country’s complex tax environment requires both strategic planning and meticulous execution. India’s tax authorities have ramped up scrutiny on cross-border transactions and international tax compliance, making it essential for MNCs to understand the potential areas of litigation and how to mitigate risks.
Here are the key areas of tax litigation for MNCs in India and precautionary measures to avoid or mitigate disputes:
- Transfer Pricing Disputes
MNCs frequently face challenges related to the pricing of inter-company transactions. Whether it’s for goods, services, or intellectual property, the Indian tax authorities ensure that these transactions meet the arm’s length standard. Disagreements on comparables and adjustments can lead to significant litigation.
Ensure robust transfer pricing documentation that justifies the pricing of related party transactions. Regular benchmarking against suitable comparables and engaging in Advance Pricing Agreements (APAs) can help achieve certainty and avoid disputes.
- Permanent Establishment (PE) Issues
India often seeks to establish that foreign corporations have a “Permanent Establishment” (PE) in the country, which would subject their income to Indian taxation. Disputes arise around what constitutes a PE and how much income should be attributed to it.
Review and structure your activities in India to minimize the risk of triggering a PE. Conduct a PE risk assessment for all operations and contracts in India. Consider how functions, assets, and risks are allocated between the Indian entity and the foreign parent.
- Double Taxation Avoidance Agreements (DTAA)
While DTAAs are meant to prevent double taxation, there are often disputes over the interpretation of treaty provisions, especially regarding the beneficial ownership of income streams such as royalties, dividends, and fees for technical services.
Leverage DTAAs carefully by conducting a proper treaty analysis before making cross-border payments. Ensure that all documentation required to establish treaty benefits, such as Tax Residency Certificates (TRC) and Beneficial Ownership Certificates, is in place.
- Royalty and Fee for Technical Services (FTS)
Payments made to foreign entities are often scrutinized, especially in terms of whether they qualify as royalties or fees for technical services under Indian law or DTAA provisions. The associated withholding tax rates can be a point of contention.
Conduct a legal analysis of contracts and transactions to determine whether payments should be categorized as royalties or FTS. Ensure that withholding tax is deducted at the appropriate rate as per the Income Tax Act or applicable DTAA.
- Base Erosion and Profit Shifting (BEPS) Compliance
With the global implementation of OECD’s BEPS action plans, MNCs in India must ensure compliance with transfer pricing documentation and country-by-country reporting. Discrepancies here can lead to significant disputes.
Ensure compliance with the three-tiered transfer pricing documentation requirements (Master File, Local File, and CbCR). Align your global transfer pricing policy with BEPS guidelines to minimize risk of adjustments and penalties.
- Equalisation Levy & Taxation of the Digital Economy
The introduction of the equalisation levy and the concept of Significant Economic Presence (SEP) for taxing digital transactions has led to several disputes. MNCs providing digital services to Indian customers are often caught up in these issues.
For MNCs in the digital space, ensure detailed compliance with equalisation levy provisions. Monitor evolving rules around SEP to understand how your digital presence might be taxed in India, and structure operations accordingly.
- Indirect Transfer of Assets
The Vodafone case highlighted the tax risks related to the indirect transfer of Indian assets. MNCs must be aware of these provisions when engaging in cross-border mergers or acquisitions.
Undertake a detailed legal review of all M&A transactions to assess whether indirect transfer provisions apply. Plan cross-border transactions carefully to avoid unexpected tax liabilities.
- Withholding Tax (TDS) on Cross-Border Payments
Failure to deduct tax at source (TDS) on payments to non-residents can result in litigation. Indian tax authorities may disallow expenses or impose penalties if the correct procedures aren’t followed.
Conduct a TDS review for all cross-border payments to ensure compliance with Indian withholding tax rules. Keep up-to-date with changes in withholding tax rates and ensure timely payments to avoid interest and penalties.
- Thin Capitalization and Debt Financing
India’s thin capitalization rules limit the amount of interest that can be deducted on loans from associated enterprises. MNCs need to ensure that their financing arrangements comply with these rules to avoid disallowances.
Maintain a reasonable debt-to-equity ratio to ensure compliance with India’s thin capitalization rules. Plan your financing arrangements with a view to limiting interest disallowance and related litigation.
For MNCs operating in India, proactive tax planning, thorough documentation, and an understanding of India’s tax regulations are crucial to avoiding potential litigation. Engaging in Advance Pricing Agreements (APAs) and leveraging the Mutual Agreement Procedure (MAP) can also provide strategic resolutions to tax disputes. India’s tax environment for MNCs is becoming more stringent as global standards tighten and the government focuses on curbing tax avoidance. By taking proactive steps to ensure compliance, MNCs can reduce the risk of litigation and focus on their core business activities in India. If your company is navigating these complexities or has concerns about its tax position in India, it is crucial to seek expert advice to mitigate risks and remain compliant.