Oil & gas, infra firms to be hit by PE norms

MNCs sometimes split EPC contracts to stay below PE threshold; PE threshold varies for tax treaties between different countries

Oil and gas, power and other infra sector companies will be the most impacted by the change in norms of permanent establishment (PE), post-India’s recent signing of the multilateral instrument (MLI) as part of measures to prevent base erosion and profit shifting. 

Article 14 of the MLI provides for the criteria to determine whether time thresholds in a tax treaty for construction, installation, supervisory have exceeded the time after which a particular project or an activity will be treated as permanent establishment (PE). Tax is imposed on entities if they have a PE in the operating country.

At present, it is not uncommon to find multinational enterprises split the engineering, procurement, and construction (EPC) contracts to stay below the PE threshold. Over the years, multinational companies (MNCs) have attempted to divide the scope of contracts such that the time taken to perform such services remains below the prescribed threshold. This includes EPC contracts in the oil and gas, power and the infra space. 

The MLI states that the minimum standard on primary purpose test (PPT) should address such situations. However, it does provide flexibility to countries wishing to specifically address the practice of splitting of contracts by introduction of a twofold test. Such test states that the activities carried out by all closely related entities beyond a period of 30 days are to be clubbed for the purpose of determining the PE threshold. 

At present, the PE threshold varies for different tax treaties. For example, the India-Mauritius tax treaty provides for a nine-month threshold whereas under the India-US tax treaty the threshold is 120 days. 

According to experts, the lower cap of 30 days will prevent companies from being able to split their contracts once the MLI comes into force.

“Companies engaged in sectors like oil and gas, power and infra need to revisit their tax position with respect to the sub-contractors. Also, contracts that include grossing up of taxes would need closer scrutiny to determine the tax liability,” said Girish Vanvari, partner and head–tax, KPMG India. 

MNCs will be taxed at the rate of 40 per cent on the profits that are attributable to the activities of the PE. For example, if out of a total net profit of $100, $50 is the profits accruing from India then the entity will have to pay $20 as tax. 

According to state-owned Oil and Natural Gas Corporation (ONGC), there will be no increase in the total tax liability of those overseas contractors which are able to claim credit for any increased Indian income tax liability against their tax liability in their country of tax residence. However, an entity which is not able to claim credit for the increased Indian income tax liability may see its cost of doing business in India increase and it may seek to pass on the increased cost to the Indian entity while bidding. 

“Whether such a bidder will be able to pass on the increased tax cost to the Indian entity or not will also depend on whether the bidder is bidding in a competitive scenario or not and the bidding structure and countries of residence of other bidders. However, at the moment, no significant impact on this account is foreseen in the case of ONGC,” said A K Srinivasan, director-finance, ONGC.  

        Fixed place of business

• MNCs sometimes split EPC contracts to stay below PE threshold
• Scope of contracts are divided such that time taken to perform such services is below PE threshold
• Under Article 14 of multilateral instrument, activities of closely related entities beyond 30 days to be clubbed for determining PE 
• PE threshold varies for tax treaties between different countries 
• MNCs to be taxed at 40% on profits attributable to PE activities

To be sure, prevention of artificial avoidance of PE status is not a common minimum standard and countries signing the MLI may or may not adopt this in their treaty. “Many developed countries such as Canada, Japan, Singapore and the UK have opted out of it. But it is likely that the tax authorities in India will start applying this standard in all cases as everything will be looked at with an anti-avoidance yardstick,” said Shefali Goradia, partner, Deloitte Touche Tohmatsu India.

Countries such as Argentina, Australia, France, India, Indonesia, Ireland, the Netherlands and New Zealand have elected to adopt the rule pertaining to splitting up of contracts. India will apply this standard in all its treaties where other countries have opted for this provision.