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Permanent establishment problem - How do I permanently avoid the problem of a permanent establishment in India
If one maintains - consciously or unconsciously - a permanent establishment in India (Permanent Establishment "PE"), this can have serious consequences. In extreme cases, it can even mean the end of all business activities. The following article looks at different types of permanent establishment in India and provides answers on how to avoid them.
What is a permanent establishment?
A permanent establishment is defined by the tax laws of a country or by international (trade) agreements between countries. It occurs primarily when a company creates value in a foreign country, but is not registered as a legal entity there and has no other tax obligations.
Praveen Singhal, CFO of Maier + Vidorno India as well as Thomas Breitinger, branch manager of Maier + Vidorno Germany, know many examples from their practice in which companies unintentionally had a branch in India. The way out of the permanent establishment trap was not always easy. According to the two India experts, there are three classic forms of permanent establishment in India:
According to Singhal, one of the most common mistakes made by German companies who start selling their products in India is that they work with a financially dependent agent or "consultant" who is bound by instructions. Although the company does not have a company in India, this construct creates a permanent establishment and the company becomes taxable in India. The same applies to companies that operate a liaison office in India and, for example, actively sell goods or services. A liaison office is only allowed to take on representative tasks in India. Sales and other commercial activities are not included.
Establishment through "location" (Fixed Place PE)
If a foreign company rents a space (office, warehouse) or even just an office space in a shared office in India, this can be considered a permanent establishment. In an emergency, maintaining a simple correspondence address can also be classified as a permanent establishment.
Construction and assembly plant (Project PE)
Construction and assembly facilities arise when construction or assembly services are provided over a period of more than six months. The mere monitoring of the work is also sufficient for the establishment of an operating facility. A German company wins a project to build a new bridge in India. For this purpose, the company exports machines and special materials to an Indian customer. In addition, project managers, engineers and architects are also flown in to oversee the construction. Such a project must be declared as a permanent establishment, unless the company has set up a project office.
What are the consequences of a permanent establishment in India?
“In our experience, the representative permanent establishment stands for the most common type of permanent establishment in India,” says Singhal. “A foreign company hires a sales representative who works exclusively for the German company, possibly from a permanent location. The representative permanent establishment is often discovered through an incorrect or inconclusive income tax return by the representative ”.
Indian law provides for severe sanctions in this case. The tax authorities not only impose a fine on the foreign company, but also calculate the amount of taxes due on the possible income plus interest (1.5% per month). The consequences are financial damage that can far exceed the order value.
"Since the foreign company is not officially registered as a legal entity in India, it does not have to present any accounting," explains Thomas Breitinger. “As a result, the Indian tax authorities make an estimate of the income. Often times, this estimate is well above the actual figures. For example, if the foreign company's agent has been working for the company for five years, it will be classified as a permanent establishment for the last five years. The permanent establishment is then taxed as a branch, which means that the foreign company has to post-tax 42% of the estimated profit. In addition, there are the aforementioned lost interest and a large fine. Some companies received a request for payment that was three times what they had invoiced in India in five years ”.
How can the risk of having an illegal permanent establishment in India be avoided?
“One possibility is to work with dealers who also work for other companies and who are neither bound by instructions nor financially dependent on the principal. However, this must be guaranteed 100%. We see again and again that companies unconsciously take the risk of an illegal permanent establishment because they do not find out in advance whether their agent has other representatives ”.
According to Breitinger, however, the problem with professional agencies is that they are rarely interested in investing the necessary time and work in selling German products. “German companies usually come onto the Indian market with top-quality products. The retailer must be able to sell these products on the basis of their added value and not on the basis of price. In a company that has many products in its range, this is rather the exception. There is a lack of technical understanding and patience here. These companies prefer to work with products that promise quick margins ”. So then again the "expert" who has the appropriate qualifications, is trained in Germany and focuses exclusively on the sale of German products?
Breitinger replies with "Unreservedly yes". However, this expert must be integrated into an organization that ensures that the risk of establishing a permanent establishment does not arise in the first place. Maier + Vidorno does this as part of its incubation program. The employee is hired by Maier + Vidorno and managed locally, while the technical expertise comes from the German company. Two strengths come together: the technical expertise comes from the German parent company and the Indian expertise from M + V in managing employees according to Indian rules.
“The obvious advantages of this partnership are not only that the German company can save both financial and time resources when setting up a company and the associated bureaucratic effort. Rather, this step enables you to initially explore the market with a very manageable risk, to establish your own brand in India and to grow sustainably. ", Says Breitinger and adds:" More than one hundred companies in India are currently working with M + in this way V together. "
“If you are not sure whether there is a risk of having a permanent establishment with your business in India, M + V introduces free screening by. Talk to us. We would be happy to support you in finding a suitable solution so that the adventure in India does not end in a nightmare, ”said Breitinger.
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