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With the globalization of world economies, the concept of Permanent Establishment (PE) has gained significant magnitude both in India and worldwide due to its direct impact on the tax revenue generated by a Country. The PE concept is a measuring tool to determine the right of a country to tax the profits of an enterprise which is resident of another country and is generally used in parlance of cross border business and taxability of the income generated.


PE may be defined as a fixed place of business through which activities of an organization are wholly or partially carried on. This fixed place of business should be the place of business of foreign entity itself (at the disposal of such foreign entity) and not the local entity. Thus the maintenance of fixed place of business only for preparatory and auxiliary activities has been specifically excluded from the definition of PE.


Types of PE

Even though the basic concept of PE revolves around the fixed place of business, it may also extend to include an agent who is legally separate from an enterprise and also rendering of services in India by a foreign entity. The Double Taxation Avoidance Agreements entered into by India recognizes the following main types of PE for a foreign enterprise in India:

°         Fixed Place PE

°         Agency PE

°         Service PE

In order to determine the type of permanent establishment, the transaction has to be classified within any of the below mentioned requisites:

Type of PE


Fixed Place PE

°        Fixed place of business

°        Business of the foreign enterprise is wholly or partly carried on through such place

°        Degree of permanence


Agency PE

°        Authority to conclude contracts on behalf of Foreign enterprises

°        Secures orders wholly or almost wholly on behalf of foreign enterprise

°        Regularly delivers goods from the stock of good maintained.


Service PE

°        Foreign enterprise furnishes or performs services in India other than included services i.e. royalties and fees for technical services.

°        Through employees or other personnel for specified period.



Even if the transaction can be classified in one of the above requisites, certain peculiar transactions can still not be classified to constitute a PE. For the purpose of removal of such ambiguities, in addition to the requisites stated above, certain qualifying tests have been defined to ascertain the correct type of PE with reasonable finality:


Type of PE

Tests required


Fixed Place PE

Geographic Test

Building, premises, installation in India through which business is carried on and such facility should not be temporary.

Right of usage

The access and usage of place must be at the sole discretion and disposal of the foreign enterprise.




Agency PE

Dependency Test

It includes legal and economic dependence. Legal dependence is the arrangement or the agreement between an agent or foreign entity. Economic dependency signifies business relationship with the foreign enterprise and functioning of the business of the agent.

Binding Test

If the action of an agent who is a dependent agent legally binds the foreign enterprise and the final decision to perform a contract does not lie with such foreign enterprise, the binding test would be satisfied.


Some Important Concepts in Permanent Establishment


Since the law governing the concept of PE has not been clearly defined, in order to have a precise understanding of taxation of a foreign entity operating in India, some important concepts used are:

 Business Connection

 Income tax act has defined the term Business connection, thereby clarifying and restricting the scope of varied interpretation. Business connection is a long recognized mode of determining tax liability of non resident. A business connection involves a relation between a business carried on by a non-resident, which yields profits or gains and some activity in India that contributes to the earning of these profits or gains. A business connection may arise between a non-resident and a resident if both of them carry on business and if the non-resident earns income through such a connection.


The term business connection is of colossal significance in the concept of PE. If there is no business connection between a non resident entity and a resident entity, the resident entity may not be a PE of the non-resident entity, and the resident entity would have to be assessed to income-tax as a separate entity. In such a case, the non-resident entity will not be liable to tax in India.


Business connection is an expression of wide and indefinite import and is different from the expression business as defined under the Act .Hence the term was being interpreted differently by different authorities under different circumstances and had been the subject matter of judicial interpretations by various authorities.


Some of the illustrative examples of business connection based on decided case laws are:

°        Maintaining a branch office in India for the purchase or sale of goods or transacting other business.

°        Appointing an agent in India for the systematic and regular purchaseof raw materials or other commodities, or for sale of the non residents goods, or for other business purposes.

°        Erecting a factory in India where the raw material  purchased locally is worked into a form suitable for export abroad

°        Forming a local subsidiary company to sell the products of the non resident parent company

°        Having financial association between a resident and a non-resident company.


Attribution of profits

 The PE criterion is commonly used in international double taxation conventions to determine the taxability of an income in the country from which it originates.  As per various double taxation conventions, the profits of an enterprise of a Contracting state shall be taxable only in that state unless the enterprise carries on business in the other Contracting State through a PE.


Currently, the international tax principles for attributing profits to a PE are provided in the OECD Model tax treaty; however a number of bilateral tax treaties adopt features of UN Model Convention. The models have been briefly discussed in the paragraphs below:

 OECD Model

This model provides that only so much of the profits of an enterprise as are attributable to a PE in a country may be taxed in that country. It also secures taxing rights of a host country so that profits of a non-resident enterprise that are not attributable to the permanent establishment cannot be subject to tax. Working Hypothesis is developed as a preferred approach for the attribution of profits by the OECD. It has examined the feasibility of treating a PE as a hypothetical distinct and separate enterprise and has reviewed ways in which transfer pricing principles could be applied in order to attribute profits to a PE in accordance with the arm's length principle.

 UN Model Convention

UN Model generally follows the similar principles, however, the major difference between the two models is that the UN Model extends source country taxing rights beyond the strict attribution of profit to a PE and grants a host country the right to tax profits attributable to sales made by the non-resident enterprise in the countrys territory of goods or merchandise of the same or similar kind as those sold through that PE.


 Even though the concept of PE has been defined extensively in various literatures, still there are a number of issues which remain unanswered. The distinct nature of each transaction makes interpretation of the law and case law precedents worth noting. This not only helps in formulation of the law and providing clarification for various judicial proceedings but also gives rise to introduction of various concepts to make the interpretation of the law simpler. Subsidiary PE and Installation/ Construction PE, though do not fall under any specific classifications but are still treated as PE as a result of the interpretation of such decided case laws.

(Kapil Nayyar is a Fellow member of the Institute and a Partner with Nayyar Maniar & Associates. He has more than 8 years of post qualification experience in Direct Taxes and International Taxation. Kapil is also a Lead Advisor to Promaynov (, a firm engaged in providing exclusive practical training programmes to CAs and Lawyers in Direct Tax, Indirect Tax, Audit, M&A and Soft skills.)

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Kapil Nayyar
Category Income Tax   Report

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