Where non-resident enterprises establish business connections or permanent establishments, their profits will be taxable in India to the extent that they are reasonably attributable to operations carried out in India. For this purpose, taxpayers must maintain accounting books. In cases where such books are not maintained or fail to set out the enterprise's actual profits, the tax officer can determine such profits as per Rule 10 of the Income Tax (IT) Rules 1962.

There have been concerns regarding the uncertainty and unpredictability resulting from the application of Rule 10. In order to provide greater clarity and predictability in this regard, the Central Board of Direct Taxes (CBDT) formed a committee to examine the existing profit attribution scheme.

The committee reviewed the profit attribution approaches suggested in the Organisation for Economic Cooperation and Development's model commentary, which advocates for a function, asset and risk analysis. The committee observed that such an analysis represents supply-side factors and excludes sales. Thus, the contribution of the market jurisdiction (a demand-side factor) to profits derived by an enterprise from that jurisdiction is ignored.

The committee recently issued a report on this issue and is seeking comments from stakeholders.(1) Broadly speaking, the report suggests amending Rule 10 of the IT Rules to adopt a three-factor method to attribute profits with equal weight to sales (a demand-side factor) and manpower and assets (supply-side factors). Further, where a business connection is established through a user beyond the prescribed threshold, the committee has recommended that a four-factor formula be used (with 'user' being the fourth factor).

Endnotes

(1) CBDT Press Release F 500/33/2017-FTD.I, 18 April 2019.

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