MC EXCLUSIVE CBDT may not provide tax relief to foreign-owned data centres

Data centres by virtue of Digital Personal Data Protection (DPDP) Act impose significant obligations on non-residents (foreign entities) to host data in India on Indian servers.

The current tax treatment of data centre operations relies heavily on judicial interpretations, which may vary from case to case, experts said.

To foster predictability and uniform application of the law, CBDT should consider issuing comprehensive guidelines or a circular addressing the “permanent establishment” (PE) implications of digital infrastructure models, including data centres, they said.

"The threshold could be prescribed in accordance with the jurisprudence and the OECD guidelines as to what part of activities could be considered as the core activities or preparatory and auxiliary activities, which would help standardise the tax treatment and would go a long way in reducing litigation," Sandeep Sehgal, partner-tax, AKM Global, said.

'Permanent establishment' conundrum

The Indian threshold for a taxable presence for digital transactions is very low, which makes it "virtually impossible" for a non-resident to escape taxation/litigation of having a taxable presence through a “permanent establishment”, experts said.

Under the income tax act, permanent establishment determines whether a foreign enterprise has a sufficient business presence in a country to be subjected to it’s I-T laws.

If a foreign enterprise has physical presence in the source country, which is India, with employees, then income earned by that business is taxable in India. Otherwise, the enterprise is generally not taxed.

In the case of foreign digital service providers operating through Indian data centres, the degree of actual control over the infrastructure is often limited and exercised usually by Indian service providers. However, given the rise of digital footprints and the ability to manage services remotely, there is increasing uncertainty as to whether such relationships may be construed as creating a permanent establishment, experts said.

While OECD has not yet recognised the concept of a “virtual PE” and continues to emphasis on physical control, Indian tax authorities may still seek to characterise remote access or virtual configuration rights over data centres as sufficient to establish a taxable presence, they said.

If the argument is accepted, the consequence could be that any income attributable to India would be taxed in India, at a possible rate of 35 percent.

'Consistency in taxation required'

"This uncertainty raises significant concerns for foreign companies looking to invest in India’s expanding data centre ecosystem," said Hitesh Sawhney, partner, Price Waterhouse & Co. "These enterprises seek clear and consistent assurance that once the local Indian DC operator is taxed on its functional and risk-based role in accordance with arm’s length principles, there should be no further attribution of profits to the foreign entity merely due to the use of such infrastructure," he said.

India has made encouraging progress in shaping a supportive policy environment for data centres. As the industry continues to grow, greater alignment across taxation norms, approval processes, and power infrastructure at both central and state levels would further streamline development, said Anbu Shanmugam, COO, Digital Connexion, a JV between Brookfield, Jio, and Digital Realty.

Aravind Srivatsan, Partner and Tax Leader, Nangia Andersen said that consistent with the scale of DCs which can come up in India including from possibly GIFT city for financial services, it would be useful to have a timely circular from CBDT with illustrations on taxation of data centers.

India is fast emerging as a data centre hub, with projections indicating a substantial increase by 2030. India’s data centre capacity is expected to exceed 4,500 MW by 2030, attracting investments of $20-25 billion over the next five to six years. Increased digitalisation of the economy, data localisation efforts and the rise of artificial intelligence (AI) are expected to power this growth.