A guide to Business Connection under Indian Domestic Tax Laws

Introduction

All earnings generated or arising in India, whether directly or indirectly earned, from any business link in India, will be regarded to generate or arise in India itself, according to the domestic tax rules of India. If a non-resident has a business link in India, all income they get from their firm is subject to the business connection under Indian domestic tax laws in India.

What is Business Connection?

A Business Connection is an ongoing, strong association between two companies that generates income for a non-resident organization. It cannot be claimed that a non-resident business entity’s profit is taxable in India until such a business connection is proven.

What is Domestic Tax?

Domestic taxation is imposed on revenues or profits according to the laws of the nation where a business is established or where a person is a resident. Domestic tax occur in the category of direct and indirect taxes. Direct tax is meant to be paid by the individual or a company against whom or which it is really imposed, with both the impact and incidence occurring on the same person or organization.

What is Business Connection under the Income tax Act, 1961 (or the Act)?

The domestic tax laws consider some income to accumulate or arise in India even if it may actually arise outside India. Income obtained through or resulting from a business connection in India is just one of the cases that are covered. It maybe compared to having a physical presence in a business.

Although there was no definition of a business connection in the Act when it first went into effect, the idea has always existed. According to the particular facts and circumstances, this has been defined in several court decisions, including by the Supreme Court. A business connection is a relationship between an Indian activity that assists in the generation of profits from a non-business resident’s and that activity’s conduct outside India. If both individuals participate in business and the non-resident receives revenue through the connection, there may a business connection between them.

The term “business connection” implies a genuine and close relationship between trading activities conducted outside of India and within India. That connection helps the non-resident trader in generating income. Also it has been defined to cover any commercial activity carried out through a person (dependent agent), acting on behalf of the non-resident.

There is also a provision which says that if an agent’s actions are restricted to buying products or commodities for a non-resident, those activities are not considered to be under the definition of a business connection.

Amendments in Permanent Establishment Rule

The Permanent Establishment Rule as revised by the Base erosion and Profit Shifting (BEPS) Action Plan 7 and Multilateral Instrument (MLI) has expanded the scope of a business connection, according to the Indian Government, also the idea of an agent regularly playing a substantial role leading to the completion of a contract has been introduced. The contracts are as follows in this situation:

• On behalf of the Non-Resident.
• For the transfer of ownership or for providing the right to use a property that the non-resident owns or has a right to use.
• Or for the services that Non-Resident provided.

To make the DTAA’s provisions effective, changes are made to India’s tax laws that are aligned with its provision as modified by the MLI. It should be emphasized, that the provisions of the DTAAs, which are much more advantageous than the Indian domestic tax rules, will remain applicable to a Non-Resident until the MLI laws enter into force because the present definition of the PE under the DTAAs is narrower than the above mentioned revised definition under the Indian tax laws.

Significant Economical Presence

The definition of Business Connection has been expanded by the Indian government to include Significant Economic Presence as of April 1,2018. Significant Economic Presence shall be defined as follows in this context:

• Any transaction involving any goods, services, or property that is carried out by a non-resident in India, including the provision of downloading data or software in India, if the total of payments resulting from such transactions during the previous year exceeds the amount as prescribed; or
• Its commercial activities involve participating in digital connection with the designated digitized users in India.

Conclusion

The Finance Bill 2018 has proposed two changes that expanded the applicability of the “business connection” criteria. The first modification is to align the definition of a dependent agent under the domestic tax law’s “business relationship” provision with the BEPS Action Plan 7 and Multilateral Instrument (MLI). The second amendment adds a “substantial economic presence criteria” to determine the business connection for the companies in digital business.