Permanent establishment risk factor: By working with a representative, many German companies inadvertently and unknowingly become taxable in India and fall under Indian jurisdiction.
An Permanent establishment is by definition a fixed facility through which business is carried out in whole or in part. From the perspective of Indian authorities, almost any activity of a foreign company carried out in India can qualify as a permanent establishment.
Creation of a representative permanent establishment
According to the double taxation agreement (DTA) between Germany and India (Article 5, Section 5), a permanent establishment also arises if a person
- for the company in India has a power of attorney to conclude contracts,
- does not have such a power of attorney, but maintains a distribution warehouse for the company in India, or simply
- “Usually orders are acquired exclusively or almost exclusively for the company”.
Accordingly, a “dependent” representative without a power of attorney creates one Permanent establishment!
Settlement against your will
A permanent establishment automatically creates a branch in India. This means that the German “mother” company is suddenly directly at the mercy of Indian jurisdiction - including its arbitrariness and bias, which one encounters almost everywhere, at least in the lower courts. Due to the peculiarities of the Indian system, you are sometimes faced with extremely high demands, tough procedures and, unfortunately, sometimes influence.
Taxes & compliance expenses for permanent establishments
Law & taxes at permanent establishment
Foreign companies are subject to profit taxation in India whenever their activities result in a (tax) permanent establishment arises – see above. Unfortunately for German companies, the scope of taxation under Indian law is also significantly greater than in other countries.
Taxation of foreign companies is governed by the Indian Income Tax Act (ITA). Accordingly, income is taxable if it is directly or indirectly attributable to a business connection in India.
The burden of proof lies exclusively with the company, which must prove to the Indian tax authorities in detail which income is attributable to the (Indian) permanent establishment and which income is not. The effort required for such proof can be quite significant and also associated with high costs. Understandably, most companies want to save effort and costs, especially if the market is initially only to be tested by a local contact person.
In addition, the tax subject, i.e. the German company, is obliged to carry out the following compliance activities:
- Applying for an Indian Tax Number (Permanent Account Number, PAN)
- Managing our own business premises accounting according to Indian principles
- Accounting audit by a chartered accountant
- Annual tax return (Attention Indian financial year ends on March 31st!)
Avoiding a permanent establishment – unless necessary
Market entry through representatives is often common practice for medium-sized businesses in India. However, this means that many companies are already treading on very thin ice at a very early stage and risk – without knowing it – that the Indian authorities will hold them accountable without mercy.
Care, a clear understanding of permitted activities and a clean contractual framework are the only ways to minimize this risk. We would be happy to advise you on how to prevent the “accidental establishment” of a representative office.
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