Permanent Establishment in International Taxation and Indian Tax Law

Posted by Written by Manah Popli Reading Time: 8 minutes

Understanding permanent establishment (PE) norms remains crucial in international taxation due to its impact on the taxation of multinational entities operating across borders. We discuss PE norms in global frameworks as well as how the concept is treated in India’s tax jurisdiction.

Since the start of 2023, Indian tax authorities have been proactively implementing measures to monitor international business establishments operating in the country. In May 2023, the tax authorities, citing a draft order, attributed an income of approximately INR 552.5 million (US$6.73 million) to Netflix’s permanent establishment in India for the assessment year 2021-22.

Find Business Support
Manage Company Tax and Audit Compliance across Multiple Jurisdictions

Similarly, in October 2023, the Indian Income Tax Department scrutinized around 40 Chinese solar module makers, including industry giants like Longi Green Energy Technology Co. Ltd. and Trina Solar Ltd, along with their Indian distributors, due to suspected tax evasion. This investigation is particularly significant, given that solar modules constitute more than 60 percent of the overall project expenditure.

These cases allude to the concept of permanent establishment, prompting us to compare the provisions of permanent establishment (PE) in international taxation with the domestic provisions governing the same.

What is permanent establishment in international taxation?

The concept of permanent establishment serves as the foundation for the taxation of multinational corporations (MNCs) globally. However, PE norms are not applied uniformly in all international tax jurisdictions.

To understand the full scope of their tax liabilities, it is necessary for MNCs to explore pertinent provisions within the UN Model, OECD Model, applicable Double Taxation Avoidance Agreements (DTAA), as well as domestic tax regulations.

UN Model in international taxation refers to a model taxation convention between developed and developing countries consisting of articles and definitions that can be used between different countries to determine the scope of the tax agreement between them. Similarly, the OECD Model is a soft law taxation guideline for solving issues pertaining to double taxation in international jurisdictions. These two models are among the few conventional guidelines present for solving inter-state tax disputes.

According to Article 7 of the UN Model, the source state (for example, India) has the authority to tax the profits attributable to the PE within its borders. Article 5(1) defines PE as a fixed place of business where the enterprise conducts its activities wholly or partly. This fundamental rule encompasses five key elements:

  • Existence of a place of business: Demonstrating a physical location for business operations.
  • Location criteria: The place of business must have a specific geographic presence.
  • Right to use: The taxpayer must possess the authority to utilize the place of business.
  • Duration of use: The utilization of the place of business must be for unmistakable period of time
  • Business activity: Activities carried out at the place of business must align with treaty or domestic law definitions of business activities.

Each criterion holds its distinct benchmarks for verification.

Article 5(2) stipulates what is meant by a ‘fixed place of business’, to include “a building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only if such site, project or activities last more than six months”. Article 5(3)(b) refers to Supervisory PE, indicating supervisory activities related to construction sites or installations lasting more than six months. Article 5(4) provides the list of establishments that would not account for a PE. Per the UN Model, a service sector PE would involve providing services in the source state through employees or other personnel for a specific period, such as183 days in any 12-month period commencing or ending in the fiscal year concerned, or for related enterprises (per the India-US Treaty).

Find Business Support
De-Risk Your Business with Multi-disciplinary Review and Legal Advisory

Various other articles under the OECD model of international taxation address agency PE. Wherein an enterprise may be considered as a permanent establishment in a country even without a fixed place of establishment in case of an agent action on behalf of the enterprise, to an extent, such agency shall lead to creation of a dependent agency under PE.

Per the OECD, “the work carried under BEPS Action 7 provides changes to the definition of permanent establishment in the OECD Model Tax Convention to address strategies used to avoid having a taxable presence in a jurisdiction under tax treaties.” BEPS Action Plan 7 introduces mechanisms for states dealing with situations where companies artificially create a permanent establishment to evade establishing a taxable presence in a jurisdiction under tax treaties, leading to untaxed or low-taxed cross-border income.

OECD: Why the OECD BEPS Action Plan matters

Tax treaties typically stipulate that the business profits of a foreign enterprise are subject to taxation in a jurisdiction only if the enterprise has a permanent establishment there to which the profits can be attributed. The precise definition of permanent establishment in these treaties is pivotal in determining whether a non-resident enterprise is liable to pay income tax in another jurisdiction.

In response to common tax avoidance strategies, as highlighted in the BEPS Action Plan, a review of the permanent establishment definition was deemed necessary. This was aimed at preventing tactics like replacing traditional distributors with commissionnaire arrangements, allowing for a shift of profits out of the jurisdiction where sales occurred without a substantial change in the functions performed in that jurisdiction.

India’s status under OECD tax convention

Exchange of information on request (EOIR)
Global forum membership

yes

EOIR rating round 1

compliant

EOIR rating round 2

largely compliant

Mutual Administrative Assistance Convention

in force

Automatic exchange of information (AEOI)

Commitment to AEOI (CRS)

2017

CRS MCAA signed

yes

Review of the AEOI legal frameworks

in place but needs improvement

Initial review of effectiveness in practice of AEOI

on track

Mutual Administrative Assistance Convention

in force

BEPS

Inclusive Framework on BEPS membership

yes

Outcome Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (11 July 2023)

participates in agreement

Existence of harmful tax regimes (Action 5)

not harmful (no harmful regime exists)

Exchange of information on tax rulings (Action 5)

reviewed/recommendations made

Preventing treaty abuse (Action 6)

2022 review completed

CbC – Domestic law (Action 13)

legal framework in place

CbC – Information exchange network (Action 13)

activated

Effective dispute resolution (Action 14)

stage 2 reviewed & recommendations made

Multilateral Instrument (Action 15)

in force

Source: OECD BEPS

Relevant provisions of Indian domestic tax law

In Indian domestic tax law, the provisions pertaining to permanent establishment encompass several key sections in the Income-tax Act, 1961. Under the Act, Section 5(2) delves into the total income of non-residents, while Section 9 addresses income deemed to accrue or arise in India. The definition of ‘business connection’ is outlined in Explanation 2 of Section 9(1) of Income-tax Act, 1961, aligning with the Multilateral Instrument of OECD Model (MLI). (The MLI influences the interpretation and application of treaty clauses related to agency business connections.)

Finally, Section 92F(iiia) of the Income-tax Act deals explicitly with the concept of permanent establishment.

Notably, there is a recent consideration of significant economic presence criteria specifically tailored for digital platforms.

Significant Economic Presence (SEP) criteria for digital platforms

The SEP criterion introduces a concept to tax digital businesses based on their significant economic presence in a country, even without a physical presence. It aims to tax income generated from users or activities within the country’s jurisdiction.

Technological advances and digitization have allowed businesses to generate cross-border revenues without physical presence, raising concerns in market jurisdictions where users reside. Outdated tax rules, designed for traditional models, have left these jurisdictions without a fair share of taxes. The international tax debate has focused on adapting to emerging business models, with the OECD proposing interim solutions under the BEPS Action Plan 1, including options like Significant Economic Presence, Withholding Tax on digital transactions, and Equalization Levy. In response, many countries have unilaterally adjusted domestic laws to tax modern businesses.

In 2016, India pioneered the imposition of a 6 percent equalization levy on online advertising and related services. This levy was significantly expanded in 2020 to include the online sale of goods and services within its scope. For more information, read our article, Equalization Levy Compliance Framework for Non-Resident E-Commerce Operators in India.

‘Significant economic presence’ is defined as:

  • Any transaction involving goods, services, or property conducted by a non-resident with any person in India, including the provision of downloading data or software in India, if the total payments from such transaction(s) during the previous year surpass INR 20 million; or
  • The systematic and continuous solicitation of business activities or interaction with 300,000 users in India.

  • Section 5(2) of the Income-tax Act, 1961 states that the total income of a non-resident includes income that accrues or arises in India or is deemed to accrue or arise in India.
  • Section 9 deals with various types of income deemed to accrue or arise in India. It includes income arising from business connections, royalties, fees for technical services, capital gains on assets situated in India, and similar scenarios.
  • Explanation 2 of Section 9(1): This explanation within Section 9(1) provides the definition of business connection for taxation purposes, delineating the scope of activities or relationships constituting a business connection in India.
  • Section 92F contains the following definitions explicitly pertaining to permanent establishment:
  • Associated enterprise (AE): This definition pertains to enterprises that are in a position to directly or indirectly control or influence another enterprise’s decision-making process or are under similar control or influence themselves.
  • International transaction: It defines any transaction between two or more associated enterprises, either or both of whom are non-residents, including transactions related to the sale of goods, services, property, loans, etc.
  • Specified domestic transaction: This definition covers transactions or arrangements between related parties that fulfill certain criteria laid out in the Act, attracting transfer pricing regulations even if both parties are Indian residents.
  • Permanent establishment: A PE encompasses a fixed place of business where the taxpayer conducts its operations either wholly or partially.

These definitions under Section 92F primarily aim to establish the scope and nature of transactions and relationships between associated enterprises, enabling the application of transfer pricing (TP) regulations to ensure fair and arm’s length pricing in cross-border and domestic transactions.

READ: Transfer Pricing Regulations in India

When tax authorities assess the existence of a PE, they undertake a multifaceted analysis. This involves evaluating the actual operations, legal provisions, and judicial precedents. They scrutinize various elements, such as business models, transactions, strategies, human resources, physical presence like offices, and warranties. This exhaustive scrutiny aims to establish whether the criteria defining a permanent establishment are met, ensuring compliance within the international taxation framework, and avoiding tax evasion or avoidance.

Furthermore, in a ruling by the Supreme Court in ADIT vs. E-Funds IT Solution Inc. [2017], the court emphasized the pivotal criterion to determine the existence of a fixed place of business: whether the physically located premises were under the enterprise’s control. Simply providing access to a project does not imply that the premises are at the enterprise’s disposal; it requires the enterprise to have the right to use and control them. The responsibility lies with the enterprise to demonstrate effective control over the premises through the revenue it generates.

Key points

International taxation, particularly the concept of permanent establishment, often involves dispute resolution based on treaties between nations for double tax avoidance (DTA/DTAA). India, a party to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (BEPS MLI), ratified it on June 25, 2019, bringing it into force from October 01, 2019.

In case of disputes within Indian jurisdiction, if there’s no specific treaty between the enterprise’s origin country and the host country, and both are signatories to MLI, MLI provisions prevail. However, as MLI applies to “covered tax agreements,” in the absence of such agreements, the Income-tax Act 1961 takes precedence. Notably, investors should be aware that under Indian jurisdiction, the existence of a Dependent Agent PE (DAPE) can potentially trigger PE status, necessitating careful consideration. India has signed double tax avoidance agreements with 94 countries and limited agreements with eight countries, outlining norms for taxable income, conditions of taxation, and exemptions.

READ: India’s Double Taxation Avoidance Agreements

Presently, India, under the OECD model international taxation regime, is not labeled as a harmful taxation regime. Audits targeting Chinese companies for potential tax evasion, which could result in substantial fines, can be contextualized within India’s broader anti-dumping efforts against import dependency.  

In conclusion, given that PE serves as a focal point of contention across international tax jurisdictions, it is strongly recommended that foreign enterprises consult and comply with India’s domestic taxation provisions, and seek local expertise. This will avoid situations of reputational damage and the high costs associated with tax non-compliance.

About Us

India Briefing is produced by Dezan Shira & Associates. The firm assists foreign investors throughout Asia from offices across the world, including in Delhi and Mumbai. Readers may write to india@dezshira.com for more support on doing business in India.

We also maintain offices or have alliance partners assisting foreign investors in Indonesia, Singapore, Vietnam, Philippines, Malaysia, Thailand, Italy, Germany, and the United States, in addition to practices in Bangladesh and Russia.