Issues under U.S.-India Tax Treaty U.S.

-based companies in a broad range of industries are getting hit with tax assessments in India that reflect a failure to properly apply the U.S.-India tax treaty or a failure to follow internationally accepted standards in treaty interpretation and transfer pricing. In many instances, the Indian revenue authorities are raising the same issues and taking the same positions in their audits of many different companies in different industries. Set forth below is a summary of significant tax issues that many companies are facing in India. 1. Independent Agent Permanent Establishment: Article 5(5) of the Treaty provides that an enterprise of one country will not be deemed to have a PE in the other country merely because it carries on business there through an independent agent, unless the activities of the agent are devoted wholly or almost wholly on behalf of the enterprise and the transactions between the agent and the enterprise are not on arms-length terms. The Indian revenue authorities have been very aggressive in applying this rule. They allege that all Indian subsidiaries are economically dependent on the U.S. parent and therefore constitute a PE of the U.S. parent. They reject the taxpayers evidence of lack of economic dependence and ignore the Treatys requirement that there be non-arms-length transactions between the agent and the enterprise in order for this rule to apply. 2. Allocation of Profits to the Permanent Establishment: In addition to taking the position that all Indian subsidiaries constitute PEs of the U.S. parent, the Indian revenue authorities also are very aggressive in allocating profits to the PE. They take the position that a share of the corporate groups entire global profits must be allocated to the deemed PEs, in addition to the arms length fees that the Indian subsidiaries receive for their transactions with the U.S. parent. 3. Transfer Pricing Margins for Related-Party Services: Recently, the Indian revenue authorities have become very aggressive in determining the income that should be earned by an Indian subsidiary that provides back office and other services for other members of the U.S. corporate group. They have made assessments reflecting margins of 35-45% for service entities that operate on a norisk basis. 4. Other Transfer Pricing Issues: The Indian revenue authorities also have employed a variety of other practices that are inconsistent with internationally accepted standards with respect to transfer pricing. They use only Indian comparables and refuse to consider foreign comparables. They apply a segmentation approach to businesses, accepting the transfer pricing for those

segments of the business that are profitable and making assessments for those segments that are not profitable. They cherry-pick among comparables and they refuse to accept as comparables information regarding the taxpayers transactions with third-party Indian service providers involving services of a similar nature. 5. Mutual Agreement: Although there has been improvement in the competent authority process in India over the last few years, it still takes far too long and is expensive to resolve issues in India. These procedural problems are exacerbated by the aggressive substantive position that the Indian revenue authorities have been taking. Institution of a binding arbitration process with India would be very beneficial in terms of resolving issues more expeditiously. A bilateral APA program with India also would be very helpful in terms of eliminating transfer pricing disputes. 6. Other Issues with respect to the Current US-India Treaty: We would also like to note two additional issues that arise under the current text of the Treaty and that could be improved upon in connection with any negotiation of a protocol or other update to the Treaty. Article 4 of the Treaty does not include any special rules to address the treatment of pension funds and tax-exempt organizations as residents for Treaty purposes. The Indian revenue authorities have denied Treaty benefits to U.S. pension funds. Article 5(2)(l)(ii) of the Treaty provides that a PE includes the furnishing of services within a country through employees if the services are performed for a related enterprise. Article 16(2) of the Treaty provides that compensation for employment in a country is not taxable in that country if the employee is present there for not more than 183 days; the employer is not a resident there; and the compensation is not borne by a PE there. These rules can combine to cause a U.S. company to have a PE in India if one employee spends one day in India and also to cause that employee to be taxable in India.