Permanent Establishment in India
As business entities started expanding their activities globally and began to have an economic presence outside the state of their residence, the problem of double incidence of taxation arose. The source state wished to tax income derived in its jurisdiction basis the source principle while, the resident state wished to continue taxing foreign income of the entity owing to its residence in that state. The concept of permanent establishment (“PE”) in India and the rest of the world came into existence to avoid double taxation of the income earned by an entity outside the state of its residence.
Over the years, it has become a crucial determinant of an entity’s taxable presence outside its home jurisdiction and has constituted the focal point in the treaty based international fiscal law. All the three model conventions namely, UN (United Nations) Model, OECD (Organisation for Economic Co-operation and Development) Model and US (United States of America) Model use PE as the decisive instrument for the same.
Fundamentally, the concept of PE states that the profits of an enterprise residing in one state and contracting with another state (India in our case) are taxable in the latter state (India) only if the enterprise has a Permanent establishment in India. Further, even when it is established that the enterprise has a PE in India, profits shall be taxable in the latter state only to the extent that they are derived therefrom. The international tax treaties have defined a PE to exist in various scenarios according to the nature of business activities. Respective double tax treaties between nations include different types of PE as per the consensus reached by the respective states on the model tax convention being followed and its specific articles to be adopted.
With respect to the tax treaties entered by India with various nations, a PE in India can be established in the following scenarios:
Fixed Place PE
A fixed place PE in India has been defined to mean a fixed geographical location of the entity in India from which the business of the enterprise is wholly or partly carried on. Through the international jurisprudence that has arisen over the course of the past years, the following requisites arise from this definition:
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The entity should have a fixed place of business in the other contracting state: This could include among others, a factory, branch, workshop, any place of management, a premises used as a sales outlet for soliciting or receiving orders, a warehouse where a person provides storage facility, a farm or plantation where agricultural activities are carried on or even a structure used for the exploration or exploitation of natural resources if used for a designated time period or more in a fiscal year (mostly 120 days)
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The fixed place should be at the disposal of the entity: The entity should have reasonable control over the ownership and management of such fixed place of business. For example, where an entity simply hires a third party manufacturer in the other contracting state to manufacture goods on its behalf and such manufacturer uses its own premises with no control of the entity, such a place would not be at the disposal of the entity.
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The entity should carry on its business through such fixed place: Activities involving some ‘commercial substance’ must be undertaken from such fixed place of business. In other words, activities which assist or directly contribute to generation of revenue must be carried on from such fixed place.
Further, it has been stated that a building site or construction or installation project constitutes a PE in India only if it lasts more than twelve months.
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Dependent Agent PE
A person conducting business activities on behalf of a foreign entity in India shall be considered to be a dependent agent of such entity and shall constitute a Permanent establishment in India ,if the following two conditions are satisfied:
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Such person is not an independent agent: The person shall be considered to be an independent agent if he is not performing such activities solely and exclusively for the said entity and the performance of such activities is within the usual course of such person’s business/profession.
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Such person performs either of the following activities (as per the direction and control of the entity, whilst not bearing any entrepreneurial risk):
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Concludes contracts on behalf of the entity in the other state (not limited to the purchase of goods or merchandise for the entity), that is, he has the power to bind the entity’s participation in business activities or,
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Habitually maintains stock of the entity in the other state from where he regularly fulfils orders to customers.
Do you have any distributor or sales person in India? Please reach out if you want to know if you have a dependent agent PE risk. Contact us now.
Service PE
A service PE is said to exist where a foreign entity provides services in India either through its own employees or through other personnel and such services continue for a designated period or more in a financial year (usually 90 days). However, such time limit shall be reduced (usually 30 days) if the services are performed for a related entity, that is, an entity that participates in the control or management of the other entity, whether directly or indirectly.
It is to be noted that most tax treaties have clearly stated that in the case of holding and subsidiary companies that are located in different tax jurisdictions, the latter does not become a PE of the former in the other jurisdiction merely by virtue of the control and power exercised by the former over it. In other words, the requirements of the provisions as stated above, viz Fixed Place PE, Dependent Agent PE etc. shall have to be applied independently in each scenario in order to determine whether a subsidiary company constitutes a PE of the holding company in the other state.
Are any of your employees or contractors servicing customers in India and worried out Service PE risk? Please reach out.
Conclusion:
While the concept of PE has been extensively used to establish taxing jurisdiction over several years, the same has been proven to be insufficient in wake of the growing digital economies that have made it much easier for businesses to locate many productive activities in geographic locations that are distant from the physical location of their customers. In order to bridge this impediment and in congruence with BEPS Action Plan 1, Equalization levy (“EL”) was introduced in India vide the Finance Act 2016, on the recommendation of the “Committee on Taxation of E-commerce” set-up by CBDT. It’s scope was further expanded vide the Finance Act, 2020. Whether it practically suffices in bridging the insufficiency in the definition of PE remains to be seen.
Frequently Asked Questions (FAQs):
What is no PE in India?
Ans: In case activities of a foreign entity carried out in India do not satisfy the definition of either fixed place PE, dependent agent PE or service PE or any other type of PE specified in the tax treaty between India and the respective nation to which the entity belongs, there would be no PE of such entity in India.
What is no PE Certificate India?
Ans: A no PE certificate in India is a declaration form furnished by a non-resident person (individual/entity) to the Indian Tax Authorities when such person obtains income from any source in India. The form states that the person’s activities do not constitute a PE in India. It usually contains the tax identification number of the person in the foreign state, reference to specific clauses of the respective DTAA being applied for determination of no PE and the place of business in India, if any. Need help in no PE Certificate? Contact us now.
What are examples of permanent establishments?
Ans: A warehouse maintained by an entity in a foreign state to supply goods to customers, a commercial space rented-out to carry out administrative business work or a farm where agricultural produce is harvested and sold to customers, are all examples of permanent establishment.
How is permanent establishment determined/caused in India?
Ans: When a foreign entity carries out business activities in India, they shall be required to apply the definition of PE (including all types: fixed place, dependent agent, service PE or any other type of PE specified in the tax treaty between India and the respective nation to which the foreign entity belongs). If such activities satisfy the definition of any such type of PE, the foreign entity shall be said to constitute a PE in India. Resultantly, the income of the foreign entity attributable to such activities shall be subject to tax levy in India.
What is the importance of permanent establishment?
Ans: Permanent establishment is the decisive factor to establish tax incidence over the activities of an entity in a foreign state, that is, in the source state.
What is the difference between permanent establishment and branch?
Ans: Simply put, a branch of an entity in a foreign state shall always constitute a PE in the foreign state provided such a branch is at the disposal of the entity and the business activities of the entity are carried on from such branch, whether wholly or in part. On the other hand, a permanent establishment can take many forms and may or may not be a branch of the entity in a foreign state.
Is a permanent establishment a company?
Ans: Permanent establishment need not necessarily be a company. It can also be a branch, warehouse or any fixed place of business of the entity in a foreign state. Further, it could also be a dependent agent acting on behalf of the entity in a foreign state or simply provision of services by the entity in a foreign state either through its own personnel or otherwise. Refer to the types of PE discussed above for more details.
What is permanent establishment risk?
Ans: Permanent establishment risk is the risk of certain activities carried out by an entity in a foreign state that could result in a PE, thereby, subjecting the entity to tax levy in such foreign state.