Travel restrictions for foreign nationals and tax effects of the corona virus on assembly projects in India

published on 30 March 2020 | reading time approx. 3 minutes

In order to protect against the spread of the new corona virus (Covid-19), the Indian government like many other countries has banned the entry of foreign nationals businesses have to stop. These travel restrictions certainly have an impact on turnkey projects of foreign companies currently ongoing in India.

  
Foreign companies are taxed in India, if they have a Permanent Establishment (‘PE’) in India. A PE gets constituted by assembly / installation of plants or machinery or supervision activities in India for a period exceeding the prescribed threshold as specified in respective Indian tax treaties. 6 months for the treaty with Germany. Foreign companies are then taxed on the basis of profits attributable to the PE in India. In such situation, comprehensive tax compliance is to be undertaken in India by such foreign company, foreign employees deployed on site become liable to tax in India, any payments by the foreign company having a PE in India would also be subject to withholding tax  (‘TDS’) compliance in India.

 
Whether the 6-month period is exceeded is decided by the duration of the project. It is not the duration of individual stays of employees aggregated for this purpose. Time spent by subcontractors is included in the calculation of the period. The project only ends, when all the activities are accomplished and no further work is to be done on site.

 
The current situation in India and the imposed entry restrictions can force a stoppage of the installation/ assembly activities in India. If the installation/ assembly resumes after the end of the crisis, the period of 6 months may be crossed. A project that would have ordinarily been completed in 3 months can easily exceed the 6 month limit. It thus needs to be answered whether the clock is halted while the project is stopped for the coronavirus pandemic.

Position of the Indian Tax Authorities

Usually, the India tax authorities do not assume that interruptions of works at site are to be excluded from the project period. They tend to refer to an example given by the OECD in its comment to the OECD Model Tax Commentary (“OECD MTC”) (e.g. in the Krupp Uhde case, ITAT Mumbai, 2009). In this case, a construction company interrupts work on a road for 3 months due to bad weather. In total, the work lasts for 13 months (including the interruption), which exceeds the limit of 12 months (threshold as per OECD MTC) for establishing a construction site PE. According to Art. 5 Para. 3 OECD MTC, the OECD believes there is a permanent establishment here.

 
However, it seems questionable whether this case can be applied to the current situation. The corona virus was simply unpredictable. It is a natural event, but not seasonal. It is not even predictable with a sufficient probability like bad weather. It is simply not calculable, it is classic force majeure. In addition, bad weather in road construction is an event that specifically affects the way the construction is carried out, i.e. under the open sky. Installation in a factory building would certainly not be negatively affected by bad weather.

 
In contrast, the corona virus affects every type of business activity, from small shops and businesses to assembly companies and even social life.  This is evidenced by the measures globally. The World Health Organisation (‘WHO’) has classified this disease as a “Pandemic” after assessing the extent of outbreak and alarming levels of spread and severity. In India as well, the government has taken several measures to encourage social distancing and in turn contain the spread of virus in addition to the visa and travel advisory discussed earlier. It has classified this infection as a “National Disaster”. Some states in India have directed closure of schools and colleges, shopping malls, gymnasiums, swimming pools etc. to avoid gathering of crowds. All this goes on to show the gravity of the situation.  All these factors suggest that the situation of coronavirus is an extra ordinary event which has shaken up, the manner in which the world operates, albeit in short term.

 
There no guidance can be inferred from the official comment of the OECD MTC to the current crisis. Whether the virus-induced duration of interruption would be included in the deadline in individual cases will depend on the specific circumstances. The prerequisite certainly is that all people have been removed from the construction site and that no subcontractors continue to work (e.g. even at a reduced speed). For instance, where the project may have commenced, but had to be stalled for want of specialised individuals and experts. The following points are also essential:

• How long was the interruption compared to the entire assembly?
• Was there any official travel restrictions or was the work interrupted voluntarily?

 
The reason for interruptions should be well documented. For example, through communication with clients and subcontractors. Emails to show that the foreign company had to interrupt work completely due to the corona virus and remove all staff.

Position of the German Tax Authorities

As per the German academic literature and case law (Federal Court of Finance - BFH), temporary interruptions based on operational issues do not end a construction or an assembly. Seasonal or other temporary interruptions, e.g. due to bad weather, strike and interruptions based on operational issues, e.g. caused by lack of material or other constructional reasons, therefore have to be taken into account when calculating the project period. In case the interruption is not caused by operational reasons, the period in which the constructions or assembly works stopped, have to be excluded from the project period. This means that interruptions that are not due to reasons within the sphere of risks to be borne by the company should be excluded when calculating the project period. Thus, according to the case law, the project stops, if employees have to leave the project site and the interruption lasts for more than 14 days. As a result, from the German tax perspective, there are strong reasons to assume that interruptions caused by the corona virus shall be excluded from the project period.

Way Forward

The reasons as to why the project is interrupted shall be recorded properly. This can be done by saving minutes and correspondence with the customer and sub-contractors which show that works had to be stopped and the employees had to leave the country due to the corona virus.

 
Beside the question whether a PE may get created due to corona virus interruptions, another question arises: can additional costs occurring from the interruption be deducted from the taxable profit of the PE or do they have to be borne by the head office in Germany. Considering that the event is closely linked to the construction, there are strong arguments to attribute costs caused by a corona virus interruption to the PE. These topics will, however, certainly spark discussions with the Indian tax authority.