Bird's-Eye View of the Concept of Permanent Establishment

[Sombir Singh]

1. Introduction

The business profits of an enterprise of other Contracting State can be taxed if it carries a business through a permanent establishment; therefore, whether a foreign company carrying on business operations in another (source) country constitutes a Permanent Establishment (PE) in that country. It is an intriguing question for the tax authorities as well as for the taxpayers for a long time, because a taxpayer is generally taxed on its world-wide income in the country of its residence. It can also be taxed in another country if it has recognised source of income there.

Primarily, the taxability of business profits an enterprise in any country depends upon two distinct factors, viz.,

1. whether it is doing business with that country e.g. where an enterprise does business with a country by exporting goods/services from a place outside India. Or
2. whether it is doing business in that country e.g. where an enterprise carries on business in a country through establishing an office/branch or through an agent.

Business in a country may constitutes a PE and PE would give rise to taxable income attributable to PE. Business with a country would not give to rise to any tax liability under DTAA, although business connection could be established. But as per Section 90(2), the assessee can take benefit of the provisions of DTAA.  Hence the term PE marks a dividing line for carrying on business with that country and doing business in that country and the concept of ‘permanent establishment’ assumes significance as Article 7 of DTAA mandates that the business profits of non-resident shall not be taxable in the source state unless the non-resident has PE in that state.

The concept of "permanent establishment" is also relevance for other articles of the convention such as  Article 14 (Independent Personal Services)- the term "Fixed base" is understood to have a meaning akin to "permanent establishment", Article 10 (Dividends), Article-11 (Interest) and Article 12 ( Royalties) for reduced rates of withholding tax on payments to the residents of the other Contracting State, it is necessary that such income is not effectively connected to a permanent establishment or fixed base of the recipient. Further, the concept is also relevant for Article 13 (Capital gains), Article 21 (Other income), Article 22 (Capital), Article 24 (Non-discrimination). Therefore, the purpose of this article to give overview about the concept of ‘permanent establishment’.

2. Permanent Establishment

The taxation of business income on the basis of source rule requires in the country of source some business presence. Such presence is known as permanent establishment. Thus, the historical origin of the concept of PE is a compromise between the countries that favoured the principle of residence and the countries that favoured the principle of source. The basic rule of the PE is that it represents physical business presence. Article 5 of the UN Model defines the expression PE exhaustively; hence, Article 5 of the UN Model is briefly stated as follows:

Paragraph 1 sets out a general definition, as a fixed place through which business of an enterprise is wholly or partly carried on. It is sometimes referred to as the basic rule or Fixed Place PE.

Paragraph 2 gives an inclusive definition, defining the type or nature of place which prima facie create a PE e.g. An office, workshop, place of management.

Paragraph 3 prescribes threshold of 6 months. It is a further extension of the inclusive definition which is made subject to a qualification based on period of continuance. This does not extend the scope of the definition in the earlier paragraphs. These are known as Construction/Installation or Service PE.

Paragraph 4 outlines a number of exclusions of fixed place of business from the PE concept, which are in the nature of preparatory or auxiliary activities as such activities do not contribute directly to the profits.

Paragraphs 5 stipulates that a dependent agent of an enterprise shall constitute PE if he habitually exercises an authority to conclude contracts on behalf of the enterprise. This is known as Dependent Agency PE.

           Paragraphs 6 contain a special rule for agents of insurance companies

Paragraphs 7 provides that an independent agent acting in the ordinary course of business shall not constitute PE, provided the agent satisfied certain prescribed condition.

Paragraph 8 provides that a controlled company by itself does not constitute a permanent establishment.

3. Basic Rule of Permanent Establishment (Fixed Place PE)

The basic test of a permanent establishment is contained in paragraph 1 of article 5 which defines the expression as a: —

            1.  fixed place of business through which the business of an

             2.  enterprise is

             3.  wholly or partly carried on.

The first part of article 5(1) postulates that the existence of a fixed place of business whereas the second part postulates that the business is carried out through a fixed place. If the second part is not attracted, there is no PE as per the decision of Supreme Court in case of DIRECTOR OF INCOME TAX (INTERNATIONAL TAXATION) VERSUS MORGAN STANLEY AND COMPANY INC. - 2007 (7) TMI 201 - SUPREME COURT. There should be a fixed place of business through which the enterprise must conduct business activity and that activity must be income generating.

The words "fixed place of business through which the business is carried on" postulates three tests for determining whether place of business qualifies as PE:

Business connection test - The enterprise must conduct the business activity through the place of business.

Business activity test - The activity must be an income generating business activity, and not merely preparatory or auxiliary.

Fixed place of business test (location test) - There must be a link between it and a specific geographical point.

4. Permanent Establishment Specific Inclusion Components

Paragraph 2 of Article 5 defines permanent establishment inclusively and it contain illustrative list of which prima facie constitute a PE. Paragraph 1 introduces the definition with the expression "means" defining it rather strictly, while paragraph 2, with "includes", setting out many types of business presence which fall short of the strict standard. However, the OECD commentary says that examples in paragraph 2 are to be seen against the background of general definition given in paragraph 1 and it is assumed that the contracting states interpret the terms listed, "a place of management", "a branch", "a office" etc., in such a way that such places of business constitute permanent establishment only if they meet the requirements of paragraph 1. "This argument" observes the Authority for Advance Ruling in - IN RE: P. NO. 28 OF 1999 - 1997 (8) TMI 517 - AUTHORITY FOR ADVANCE RULINGS, "runs contrary to the well-established principle of statutory interpretation that an inclusive definition is intended to add to the primary meaning so as to bring within its scope items which may or may not fall within the scope of the primary definition. Hence, an "office" a "factory", a "workshop", or a "mine" are the places of business and not the PE. They would be PE if business is carried through them. Thus, the general definition is supplemented by a list of illustrative examples, including a place of management, a branch, an office, a factory, a workshop, a mine, quarry or other place of extraction of natural resources, and, a building site or assembly project. The qualifying restriction as set out in paragraph 1 is not applicable as regards "permanency". With respect to them, permanency is presumed. They need not be permanent in actuality, in the sense as paragraph 1 insists. The period for which they should exist is not relevant. But what is not include in Article 5(2) is not automatically exclude from Article 5(1).

5. Permanent Establishment -Construction/Installation PE

Paragraph 3 (a) of Article 5 prescribes a limitation of period for building site, a construction, assembly or installation project or supervisory activities in connection therewith constitutes permanent establishment if it exists for more than a specified period. In this paragraph, permanence test is replaced by duration test. A site, project or activities is taken PE "only" if it lasts for six months (twelve months OECD Model). For other places falling under paras 1 and 2, it may be of shorter period; no rigidity about the duration of their existence. But building sites etc. do not enjoy flexibility. The period of existence has to be more than six (twelve) months. Hence Paragraph 3 does not extend the scope of the general or inclusive definition. It sets out a different criterion, the permanence test replaced by duration test. It is intended to apply in respect to cases falling under paragraphs 1 and 2 and to provide that in a class of such cases, the definition is not to apply unless the requirement regarding the period of continuance is fulfilled, though its wording being ambiguous cannot be precisely correlated to one or the other items mentioned in paragraph 1 or paragraph 2. In neither of these the word "site" or "project" is used. Even for such absence, a site or project could be PE in terms of the general definition or fall within the ambit of the listed items of the inclusive definition. But it could not be so taken if such site or project continues for a less than the prescribed period. The element of permanency in relation to site or project or the activities would be attracted if it continues for a period more than the specified.

6. Permanent Establishment-Service PE

The concept of a service PE finds place in paragraph 3(b) of Article 5 of the UN Model. OECD Model does not include a service PE clause; however, a suggested service PE Clause is included in the OECD Commentary on Article 5. Service PE is constituted if the enterprise renders services through its employees or other personnel for a period or periods aggregating more than six months within any 12 months period and the nature of the services should relate to the same project or a connected project. The block of 12-month period may not coincide with the fiscal year or the calendar year. The block comprises of twelve months commencing from the date of furnishing services. It is pertinent to mention here that Sub-paragraph (b) of paragraph 3 of the UN Model is not an independent paragraph it is extension of general definition therefore, some physical presence (personnel and/or assets) of the non-resident is necessary. This view has been supported by OECD in its commentary in connection with suggested Service PE clause has emphasized upon 'performance' of services in the source state as a necessary ingredient for formation of Service PE. However, a contrary view has been taken by Bengaluru bench of the ITAT in case ABB FZ-LLC VERSUS DEPUTY COMMISSIONER OF INCOME-TAX, (INTERNATIONAL TAXATION) , CIRCLE- 1 (1) , BENGALURU - 2017 (6) TMI 1174 - ITAT BANGALORE where it held that a UAE company ('the taxpayer') had a Service PE in India since the tax payer has been furnishing services to the Indian company even without any substantial physical presence of its employees in India (in this case the physical presence of employee was only 25 days in the previous year). But one may refer to the decision of the Kolkata Tribunal in the case of INCOME-TAX OFFICER, WARD 12 (2) , KOLKATA VERSUS RIGHT FLORISTS (P.) LTD. - 2013 (4) TMI 338 - ITAT KOLKATA where the Tribunal has dealt with an issue of taxability of payment made for online advertisement on the search engines of foreign company. The Tribunal observed that a search engine which has its presence only through its website cannot be held as a PE unless its web servers are also located in the same jurisdiction and hence the search engines of the foreign company did not constitute a PE in India.

To constitute a service PE, an important ingredient is the services need to be performed by the employees or other personnel under direct instructions or direct supervisions and control of the foreign enterprises and foreign enterprises should be responsible for their performance.

This aspect is the key criteria for determining the existence of a Service PE of a foreign enterprise in following situations:

•  Deputation of employees/ personnel.
•  Cases where the foreign enterprise uses the employees of its group company in    India for rendering services in India.
•  Supply of personnel to India by the foreign enterprise.

In case of deputation and secondment of employees, if an employee of a multinational enterprise renders services in the host country beyond a specified period of time and where such employee deputed continues to be on the payroll of the home country or continues to have the lien on its employment with the multinational enterprise only, a service PE emerges. However, the suggested Service PE clause in the OECD Commentary specifically excludes from its scope the performance of services on behalf of the foreign enterprise by the individuals who are employees of another enterprise who are not acting under direct supervision and control of foreign enterprise.

7. Activities which are not taken as Permanent Establishment

Paragraph 4 of Article 5 provides certain exclusions from the scope of the PE. Therefore, even if a place of business of an enterprise may fulfill the conditions of fixed place PE as per Article 5(1)/(2) or construction PE as per Article 5(3) or dependent agency PE as per Article 5(5), it would not constitute PE if the enterprise solely carries on the activities listed under Article 5(4). The following are the list of exclusions provided under Article 5(4):

1. The use of facilities solely for the purpose of storage or display of goods or merchandise belonging to the enterprise.
2. The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage or display.
3. The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise.
4. The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information for the enterprise.
5. The maintenance of the fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character.
6. The maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs (a) to (e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

Sub-paragraph (e) and (f) provides the general list of activities which are not specifically covered by sub-paragraph (a) to (d) provided they have preparatory or auxiliary character.

The term 'preparatory’ and 'auxiliary' have not defined in the Convention. 'Preparatory’ means carrying out the preliminary activities. OECD BEPS Action Plan 7 provides that an activity that has a preparatory character is one that is carried on in contemplation of the carrying on of what constitutes the essential and significant part of the activity of the enterprise as a whole. The preparatory activities are carried out before the core activity of an enterprise commence.

The term 'auxiliary' implies supplementary or additional help and support in the main activities of earning income. OECD BEPS Action Plan 7 provides that auxiliary activity generally corresponds to an activity that is carried on to support, without being part of, the essential and significant part of the activity of the enterprise as a whole.

These preparatory and auxiliary activities do not lead to earning of income and therefore cannot be termed as profit center. Although such place of business may contribute to the productivity of the enterprise, but the services it performs are so remote from the actual realization of profits that it is difficult to allocate any profit.

The important point to be analysed here is to identify whether the activities carried out are contributing to the income or whether they are merely elementary, introductory or preparatory or are merely supportive in aid to the participatory/contributory activities. In other words, they do not result in actual realization of profits but aid in earning of profits.

8. Project office

Project Office ('PO') means a place of business to represent the interests of the MNCs executing a project in India as a support office but excludes a Liaison Office. There is a view that a project office fall within purview of Article 5(4)(e). However, in some case ITAT has found project office to be outside the purview of Article 5(4)(e) but in the Samsung Case, the Apex Court has re-examined the facts about the activities of the PO and gone beyond the principles of considering ITAT as final fact-finding authority. It has reinforced the basic principle of substance over the form after perusal of factual documents. It held that

"28. Though it was pointed out to the ITAT that there were only two persons working in the Mumbai office, neither of whom was qualified to perform any core activity of the Assessee, the ITAT chose to ignore the same. This being the case, it is clear, therefore, that no permanent establishment has been set up within the meaning of Article 5(1) of the DTAA, as the Mumbai Project Office cannot be said to be a fixed place of business through which the core business of the Assessee was wholly or partly carried on. Also, as correctly argued by Shri Ganesh, the Mumbai Project Office, on the facts of the present case, would fall within Article 5(4)(e) of the DTAA, inasmuch as the office is solely an auxiliary office, meant to act as a liaison office between the Assessee and ONGC…."

Hence, it depends on the overall facts of each case that whether the project office constitute a PE or not.

9. Liaison Office

Multi-national Companies can set up their offices in India subject to the relevant regulations in the form of liaison office. Such offices are set up by MNCs to understand the Indian market and to carry out certain predefined limited activities or execution of certain projects. There is also a diversion view regarding liaison constitute a PE: -

In UAE EXCHANGE CENTRE LLC, IN RE - 2004 (5) TMI 60 - AUTHORITY FOR ADVANCE RULINGS, the AAR held that an Indian liaison office of a foreign enterprises engaged in remittance service, perform a essential activity and thus fall outside Article 5(4)(e) when such liaison office download information (such as name and address of beneficiaries, amount to be remitted, etc.) prints cheques/draft and dispatches them to addresses of beneficiaries through courier. However, in case of COMMISSIONER OF INCOME-TAX, AP -I VERSUS VISAKHAPATNAM PORT TRUST - 1983 (6) TMI 31 - ANDHRA PRADESH HIGH COURT, it was held that the liaison/representative office was not a PE where no violation was reported by the RBI, the activities of the liaison office were presumed of preparatory and auxiliary character.

The fact whether a liaison office constitutes a PE will thus have to be examined based on fact and circumstance of each case and it cannot be presumed that a liaison office will always be excluded from the purview of Article 5.

10. Permanent Establishment - -Agency PE

Paragraphs 5 to 7 of article 5 of UN Model Convention deal with special cases where the foreign enterprise functions not directly but through some other agency. An enterprise is treated as having a PE if there is under certain conditions a person acting for it, even though the enterprise may not have a fixed place of business within the meaning of paragraphs 1 and 2. A considerable part of the international trade is conducted through agents. One type of agent is deemed to create a permanent establishment, who has the authority to conclude contracts (other than purchase contracts) on behalf of the enterprise or who habitually exercises this authority. Such are dependent agents. Agents of independent status acting in the ordinary course of their business are excluded. So, let us first comprehend dependent agent and then independent agent.

10.1     Dependent Agent

            Article 5(5) of the UN Model Convention states that: -

“Notwithstanding the provisions of paragraphs 1 and 2, where a person— other than an agent of an independent status to whom paragraph 7 applies— is acting, in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned Contracting State in respect of any activities which that person undertakes for the enterprise, if such a person:

(a)  has and habitually exercises in the State an authority to conclude contracts in the name of the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph; or

(b)  has no such authority, but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise.”

To understand whether an agent may constitute dependent agency PE or not a question has to be asked whether the agent is of independent status as defined in paragraph 7, and if the answer is in the negative, then another question, whether he has, and exercises, the authority to conclude contracts in the name of the enterprise, and if the answer is in the affirmative, then another question, whether he is a mere agent with respect to goods or merchandise for storage or display or, for processing by another enterprise or, for the purpose of the purchase or, for the purpose of carrying any other activity (for the enterprise) of preparatory or auxiliary character. The negative answer to the last question will render him PE. Even if he has no such authority, he is still deemed to be PE if he habitually maintains a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise. Thus, for being a PE an agent may not require any authority. He can act without it. Thus, an agent is deemed to be permanent establishment, if he is not independent and the conditions in either sub-paragraph (a) or (b) of Article 5(5) are satisfied.

Therefore, it is pertinent to note that the primary requirement of creating dependent agency PE is that the agent should have an authority to conclude the contracts in the name of the non-resident enterprise so as to legally bind that enterprise in the source state. Accordingly, if an agent has been authorized by a non-resident enterprise to negotiate substantial elements and details of contract which are binding on such enterprise, he may be considered as a dependent agent of the non-resident enterprise

10.2     Independent Agent

            Article 5(7) of the UN Model Convention states that: -

“An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise, and the conditions are made or imposed between the enterprise and the agent in their commercial and financial relations which differ from those which would have been made between independent enterprises; he will not be considered an agent of an independent status within the meaning of this paragraph.”

The exception provide in UN MC to an independent agent is not present under the OECD MC. It states that:

"….However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise, and conditions are made or imposed between that enterprise and the agent in their commercial and financial relations which differ from those which would have been made between independent enterprises, he will not be considered an agent of an independent status within the meaning of this paragraph."

Independent agent according to paragraph 7 of Article 5 of the UN Model Convention is a broker, general commission agent or any other agent of an independent status, provided such a person is acting in the ordinary course of his business. An independent agent generally means one who, exercising an independent employment, contracts to do a piece of work according to his own methods and without being subject to control of his employer except as to the result of the work. A broker or commission agent generally falls in that category and therefore, specifically mentioned to be independent.

Agent whether independent or not the following consideration to be taken into account

1. An independent agent should be legally and economically independent.
2. An independent agent will be responsible to his principal for the results of his work but not subject to significant control with respect the manner in which that work is carried out or detailed instruction as to the conduct of the work. The principal relying on the special skill and knowledge of the agent is an indication of independence.
3. Dependency is determined by consideration of the extent to which the agent exercises freedom in the conduct of business on behalf of the principal within the scope of the authority conferred by the agreement and not by the limitations on the scale of business which may be conducted by him.
4. Providing information to the principal in connection with the conduct of business is not a sign of dependence, but to ensure smooth running of the agreement. It, however, would be so if it is done in the course of seeking approval for the manner in which the business is to be conducted.
5. Independent status is less likely if the activities are performed wholly or almost wholly on behalf of only one enterprise over the life time of the business or a long period of time. It is, however, to be seen whether the activities constitute an autonomous business conducted by the agent in which he bears risk and receives reward through the use of entrepreneurial skills and knowledge. Where an agent acts for a number of principals, legal dependence may exist if the principals (none being predominant in terms of the agent’s) act in concert to control the acts of the agent business.

  legally and economically independent

An independent agent must satisfy two conditions:

1. The agent must be both legally and economically independent of the enterprise; and
2. He must be acting in the ordinary course of the business in carrying out activities on behalf of the enterprise.

The agent must be both legally and economically independent of the enterprise, and must be acting in the ordinary course of the business in carrying out activities on behalf of the enterprise. Economic independence is determined by the extent to which the agent bears business risk and whether the agent has an exclusive or nearly exclusive relationship with the principal. Exclusivity is only a pointer of lacking independence and is indicative of further investigation. Each case must be decided on its facts.

          In the Ordinary Course of Business

An otherwise independent agent is deemed dependent if while performing acts on behalf of the enterprise he is not acting in the ordinary course of his business. Paragraph 38.7 of the OECD Commentary explains "Persons cannot be said to act in the ordinary course of their own business if, in place of the enterprise, such persons perform activities which, economically, belong to the sphere of the enterprise rather than to their own business operations", and then illustrates, "Where for example, a commission agent not only sells the goods or merchandise of the enterprise in his own name but also habitually acts, in relation to that enterprise, as a permanent agent having an authority to conclude contracts, he would be deemed in respect this particular activity to be permanent establishment, since he is thus acting outside the ordinary course of his own trade or business (namely that of commission agent), unless the activities are limited to those mentioned at the end of paragraph 5 (activities of preparatory or auxiliary nature)”.

10.3     Insurance Agent PE

Paragraphs 6 of Article 5 of UN Model Convention contain a special rule for agents of insurance companies which is read as follow: 

"Notwithstanding the preceding provisions of this article, an insurance enterprise of a Contracting Source state shall, except in regard to reinsurance, be deemed to have a permanent establishment in the other Contracting State if it collects premiums in the territory of that other State or insures risks situated therein through a person other than an agent of an independent status to whom paragraph 7 applies." 

           Article 5(6) does not correspond to any provision of the OECD Model.

A PE under Article 5(6) is based on the assumption that the agent through whom premiums are collected and risk insured, is present in the source state where the risk is located.

           There are two exceptions in Article 5(6): 

1. It does not apply to reinsurance. 
2.  If an insurance agent is independent, no PE exists.

11.       Subsidiary Company PE

Paragraph 8 of the UN Model Convention (paragraph 7 of the OECD Model) provides that the fact that a company which is resident of a Contracting State—

• Controls or is controlled by a company which is resident of another Contracting State, or
• Which carries on business in that other State (whether through permanent establishment or otherwise)

         Shall not by itself constitute either company a permanent establishment of the other.

A subsidiary company is a legal entity separate from the parent company and the business carried on by it is its business and not of the parent company. A corporation is a separate taxable entity even if it only has one shareholder. However, a subsidiary would be parent’s PE, like any other entity, if it is a fixed place of business in terms of article 5(1) or acts as its agent in terms of article 5(5) such as: -

• Any space or premises belonging to the subsidiary at the disposal of the parent company meets the requirement of paragraph 1, a fixed place through which the business is done.
• PE agency requirement of paragraph 5 is met if the subsidiary has and habitually exercises the authority to conclude contract in the name of the parent company and does not act in the ordinary course of its business as independent agent.

In both situations subsidiary company constitute PE if the activity should not be of preparatory or auxiliary character

12.       Reference in the Income Tax Act, 1961 and Legal Decision

In India, the concept of PE is similar to 'Business Connection' as provided in the Act. Section 5 of the Income-tax Act (the Act) deals with scope of total income and section 9 of the Act deals with income deemed to accrue or arise in India. Following the path laid by the OECD Model, the term 'business connection' relied heavily on physical presence. However, keeping abreast with growing digital business models and OECD BEPS, the Government of India expanded the definition of business connection vide Finance Act, 2018 to tax digital transactions. 'Significant Economic Presence' of a non-resident in India will also constitute 'business connection' and hence, income attributable to such economic presence will be taxable in India. The scope of significant economic presence of a non-resident in India has been further expand through inserted Explanation 2A in clause (i) of sub-section (1) of section 9 by the Finance Act, 2020.

Further, the concept of business connection was discussed by the Supreme Court ('SC') in COMMISSIONER OF INCOME-TAX, PUNJAB VERSUS RD. AGGARWAL AND COMPANY AND ANOTHER -1964 (10) TMI 9 - SUPREME COURT 'A business connection involves a relation between the business carried on by the non-resident which yields profits or gains and some activity in the taxable territories which contributes directly or indirectly to the earning of such profits or gains. It predicates an element of continuity between the business of the non-resident and the activity in the taxable territories'. Much in tune with value creation, the concept of business connection in India, seems in sync with the guidelines laid by OECD BEPS on PE.

The concept of PE has been also widely explained in varied decided case laws in India. In COMMISSIONER OF INCOME-TAX, AP -I VERSUS VISAKHAPATNAM PORT TRUST - 1983 (6) TMI 31 - ANDHRA PRADESH HIGH COURT, Hon'ble High Court of Andhra Pradesh, after an elaborate survey of the legal precedents available worldwide observed, "the words 'PE' postulate the existence of substantial element of enduring or permanent nature of a foreign enterprise in another country which can be attributed to a fixed place of business in that country." "It should be of such nature that it would amount to a virtual projection of foreign enterprise of one country into the soil of another country."

 Hon'ble SC of India has been instrumental in well analysing the term in two landmark cases. In DIRECTOR OF INCOME TAX (INTERNATIONAL TAXATION) VERSUS MORGAN STANLEY AND COMPANY INC. - 2007 (7) TMI 201 - SUPREME COURT, a special leave petition was filed before the SC by Morgan Stanley and Company against the ruling of the AAR. The AAR Ruling dealt with whether Morgan Stanley USA (MSCo) had a PE in India with respect to the back-office operations it had outsourced in India to Morgan Stanley Advantage Services (MSAS). The SC observed that MSCo was not carrying out any business activity in India. MSAS was rendering back-office services in India; such functions were considered as "preparatory or auxiliary" in nature under the Treaty. Thus, no fixed place of business existed to establish PE status in India.

 The SC, in another case i.e. FORMULA ONE WORLD CHAMPIONSHIP LTD. VERSUS COMMISSIONER OF INCOME TAX, INTERNATIONAL TAXATION – 3, DELHI & ANR. - 2017 (4) TMI 1109 - SUPREME COURT explained requisites for establishment of PE at length. The case concerned the taxability of a three-day event in India involving a motor racing championship. The issue before the SC was whether the taxpayer, Formula One World Championship Limited ('FOWC'), a UK tax resident, had a PE in India. The SC held under the facts and circumstances that FOWC did constitute PE in India basing its decision on the following:

• Presence of FOWC's business in India by way of holding exclusive commercial rights in relation to F1 Championship and exploiting the same in India.
• FOWC played a major role in conducting F1 Championship in India and hence, it was assessed that FOWC had the right to use and control over the circuit.

It is pertinent to mention that time period was not a significant consideration in the present case. The SC held that the High Court ('HC') rightly concluded that even though it was for limited three days, FOWC had full and exclusive access to the circuit for the entire duration of the event; thus, number of days for which the access was there would not make any difference, in coming to the conclusion that FOWC had the circuit to its disposal. Lastly, FOWC undertook business of exploitation of commercial rights in India through the F1 championship. To conclude, FOWC was taxable on receipts in India by means of establishment of PE in India. 

13.       Supremacy of DTAA over Income-Tax Act

The Apex Court has reinforced the supremacy of the DTAA over the Income-tax Act, 1961. It has held that in case DTAA is apply to any issue in a matter, the issue will have to be answered on the basis of the stipulations in DTAA notified in exercise of powers conferred under Section 90 of the Act. The court has gone to observe that the position is no more res integra in view of the dictum in UNION OF INDIA AND ANOTHER VERSUS AZADI BACHAO ANDOLAN AND ANOTHER - 2003 (10) TMI 5 - SUPREME COURT. It quoted the paragraph 28 of the case, as follows:

"28. A survey of the aforesaid cases makes it clear that the judicial consensus in India has been that Section 90 is specifically intended to enable and empower the Central Government to issue a notification for implementation of the terms of a Double Taxation Avoidance Agreement. When that happens, the provisions of such an agreement, with respect to cases to which they apply, would operate even if inconsistent with the provisions of the Income Tax Act."

14.       Burden of proving the fact that a Foreign Enterprise has a PE in India

In the DIRECTOR OF INCOME TAX-II (INTERNATIONAL TAXATION) NEW DELHI & ANR. VERSUS M/S SAMSUNG HEAVY INDUSTRIES CO. LTD. - 2020 (7) TMI 545 - SUPREME COURT, the Apex Court has held that the onus is on the Tax Authorities and not on the taxpayer to establish the construction of PE of the foreign enterprise in India. It referred the case of ASSISTANT DIRECTOR OF INCOME TAX-I, NEW DELHI VERSUS M/S E-FUNDS IT SOLUTION INC. - 2017 (10) TMI 1011 - SUPREME COURT, where the Apex Court has held in the Para 16 that

"16. …. The burden of proving the fact that a foreign assessee has a PE in India and must, therefore, suffer tax from the business generated from such PE is initially on the Revenue. With these prefatory remarks, let us analyze whether the respondents can be brought within any of the sub-clauses of Article 5."

15.       Conclusion: -

A crucial step in international taxation is determining whether a non-resident has a PE or not in a state. A PE is a fixed place of business through which a non-resident carries out its business activities, and it creates a taxable presence in the state. The presence of a PE triggers the obligation to pay taxes in the state, and failure to comply with this obligation may result in penalties and legal consequences. Therefore, it is essential to accurately determine whether a non-resident has a PE in a state to ensure that they meet their tax obligations and avoid any negative consequences. Therefore, in order to decide whether a PE is constituted, one has to undertake a functional and factual analysis of each of the activity undertaken by the establishment. Further while deciding whether a PE exists or not, Article 5 has to be read as a whole.