In this specialist article you will learn how you can avoid a tax permanent establishment and withholding tax - without setting up a company in India.
Numerous companies contact us with the specific desire to set up a company in India. In the first conversations we find out which problem is primarily intended to be solved: You need your own Personnel for sales and/or service activities in India.
In order to be active on site, it is necessary per se Weder a local branch, or a Office Liaison.
Own staff – external agency
For medium-sized companies (with manageable sales in India), setting up their own subsidiary often makes no economic sense at all. Managing them involves significant time and monetary expenditure (keyword: Compliance).
Of course it is not possible to pay Indian employees directly from Europe. This would clearly immediately create a tax permanent establishment, to name just one problem.
In order to employ your own workforce in India (indirectly), the Collaboration with an independent service provider probably the best and most financially/administratively attractive solution. About our Indian subsidiary WB Trade and Services Pvt. Ltd. (WBTS) We offer our customers exactly this option.
Using a hosting or service model, we provide the legally necessary framework to hire staff, pay them and properly pay all taxes and duties. Although employed by WBTS, the employees clearly work exclusively for our customers. In order to exclude a permanent establishment for tax purposes, our company – and not our customer – acts as a contractual partner in India.
Tax risks when providing services in India
The topic tax permanent establishment the novel here already discussed in detail. The Indian legislature (or the double taxation agreement) always recognizes a permanent establishment for tax purposes if services last longer than six months.
This regulation may also apply under certain circumstances Service (Level) Agreements – and in the worst case also (legally binding) warranty – below and would therefore be taxable in India.
However, since it is rarely possible to clearly separate the service component from the delivery of goods financially, the service also “infects” the delivery of goods. This means that the entire business in India becomes taxable (see also specialist article “Monday workshop for mechanical engineers”).
Therefore - regardless of your own local structures - when drafting contracts between India and Europe, careful attention must be paid to separating any type of service from the delivery of goods. The service may only be provided by an Indian company and cannot be attributed to the European exporter. This not only prevents a permanent establishment for tax purposes, but also the withholding of the tax Withholding tax:
Withholding tax when exporting services (Tax Deduction at Source – TDS)
Based on the double taxation agreement (DTA). Fees etc. for (technical) services taxed in the recipient country. However, the country from which the payment is made - i.e. India - has the right to withhold a withholding tax of 10 percent. The paying Indian “person” is responsible and liable for tax withholding.
Accordingly, when purchasing a service from abroad, the Indian company retains 10 to 20 percent of the order amount (in order to pay this share to the tax office). However, if it cannot be clearly ruled out that the payee has a permanent establishment for tax purposes in India, the company will pay up to 42 percent of the invoice amount (corresponds to the Indian tax rate) retained.
Regardless of whether it is legal or arbitrary, this legal situation massively shifts the negotiating power in favor of the Indian customer and sometimes puts the exporter in massive distress. We have seen it more than once that European companies also get into existential economic problems as a result of Indian companies.
Conclusion: Contract splitting and collaboration with agencies
The following applies both when employing staff on site in India and when providing services: appropriate care and foresight is necessary when drafting contracts between suppliers and customers. Only if the delivery of goods and services (assembly, service, etc.) are clearly separated from each other, and the service is provided by an independent Indian company, can they tax permanent establishment and Withholding tax be avoided.
It is therefore essential for direct exporters to work with independent service providers who provide services as service agencies in India - with or without their own employees.
Attention: Even having your own Indian subsidiary does NOT protect you from the creation of a tax permanent establishment (of the parent company) in India. The same principles of contract splitting apply here too (see above).
If you have any further questions, please contact the experts in our department.
