Taxation of international transactions: a critical assessment of permanent establishment concept to convenience

Abstract

In treaty tax law Permanent Establishment (in short PE) is defined as the fixed place of business through which the business of an enterprise is wholly or partly carried on. This concept is very crucial in allocating the taxing rights between two or more countries on business income in cross border transactions. Accordingly, even if business income earned by a non-resident is taxable as per domestic law of a country, it may still be not taxable in that country if income was not earned in a business carried on through the PE in that country. In a number of judgments passed by the Indian Courts, tax could not be levied by Revenue Authorities because the PE was found missing. Therefore, the purpose of this study is to make critical evaluation of PE to know as to whether it has been fair in allocating the taxing rights or it favors the developed countries whose brain child it is. The concept of PE has been studied in all its aspects by reviewing the literature available in this regard. Websites of national and international organizations relevant for this study were referred to. I have discussed the matter with the officers working in Income Tax Department and referred to the record of Non-residents maintained in their Office. I attended seminars on International Conference in Mumbai and Chennai held in 2009-10. I have also discussed PE with experts like CAs, Professors, and Authors of some books on International Taxation. I also sent the questionnaire to know the views of the experts on PE. The finding in respect to PE is that it is not fair in allocation of taxing rights between nations. It favors developed countries who have kept the concept of PE alive by including PE fictions in the PE definition. World over in fast changing business scenarios, especially due to advancement in communication technology, business can be done of any volume without having physical presence in other country; hence no tax. This has posed a threat to the tax base of developing countries by residents of developed countries who do business in developing countries using their public services, resources and markets. Income must be taxed in the source country as their resources have been used and public services utilized. Their right should not be taken away on the ground that in absence of physical presence of business in source country administrative convenience demands that it should be taxed by the resident country. Therefore it is recommended that PE should be abandoned as changes in methods of doing business have made the condition of physical presence redundant. Instead, tax international transactions and introduce the system of withholding tax at low rate on outgoing payments if it is tax deductable in the hands of a taxpayer in the source country.