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Are Your Server's Activities Creating a Taxable Presence?
In 2011, Taxand US published a series called "How Is Your Cloud Taxable?" This series discussed, among other things, how many companies are searching for ways to gain a competitive edge while mitigating costs. IT departments have begun using cloud computing as a cost-effective way to grow their infrastructure. However, many tax professionals are unsure of the impact that cloud computing could have on a company's tax footprint and effective tax rate. Taxand US investigate the impact that IT is having on overall taxation for multinationals.
Recent developments in India have added more uncertainty to this complicated area of taxation. In a February 7, 2012, decision, the country's Authority for Advance Rulings (AAR) ruled that a foreign company's server constitutes a permanent establishment, or PE, for tax purposes, and the profits arising from it are taxable in India. According to Abhishek Goenka (partner) and Sharath Rao (director) at BMR Advisors in India, "The issue of a server or other IT infrastructure constituting a PE is very fact specific and may impact web hosting companies that have any Indian presence in the form of servers, cargo industries where tracking equipment is placed in India, and telecommunication companies where leased equipment is used to provide continuous connectivity."
In light of these recent developments, this article will discuss the concept of a server as a PE under the Organisation for Economic Co-operation and Development (OECD)'s view and the lack of U.S. guidance on this issue. It will also look at how multinational companies can limit the risk that their servers might create a PE in the countries in which they are located.
Taxand US looks in depth at Permanent Establishments and the OECD's view
The recent developments in India, combined with the lack of direct authority, U.S. or otherwise, in dealing with the server as a PE issue should raise a bit of a red flag for companies that conduct business using servers in various countries. This includes many, if not most, multinational companies. A risk exists for companies with servers in foreign jurisdictions. They may have a taxable presence in those jurisdictions, the U.S. included, and not even know it.
For multinationals using servers in foreign jurisdictions, there are ways to minimize the risks that their servers create a PE, such as the following:
1. Learn your local jurisdiction's rules. As we have seen, the U.S. has issued no official guidance on this issue. However, the local jurisdictions in which your company's servers are located may have done so. Knowing these rules will help your company structure its server's activities in a manner that minimizes the risks that they create a PE.
2. Consider forming a legal entity in the country in which the servers are located. Although there may be some tax leakage associated with having a taxable entity in the country, the income associated with it can be defined, thus limiting other income of the multinational from being subject to tax.
3. Consider utilizing a service provider in the local jurisdiction that owns, controls and services the servers and other hardware, rather than taking ownership of the servers themselves.
The lack of clarity means that there is currently no way of eliminating all potential risk. However, these ideas can start to mitigate some of the concern.