Expert verified As a foreign company doing business, you must understand PE taxation in India to avoid unexpected tax liabilities.
Explore with us exactly when a Permanent Establishment (PE) is triggered, how it affects your tax liability, including digital business and how treaties or business type affects your PE status.
What is a Permanent Establishment (PE)?
A Permanent Establishment (PE) refers to a fixed place of business in a country (the “host country”) where a foreign company carries out significant business activities.
This makes the foreign business liable to pay taxes on the profits earned from those activities in the host country.
So, essentially a foreign company carrying out substantial business activities in a country, either directly or through an agent, may be considered to have a PE there and must pay taxes on the profits earned locally.
Key Features of a Permanent Establishment (PE)
- Fixed Place: A physical, lasting location like an office, branch, or factory.
- Business Activity: Core business is carried out from this place and not just support tasks.
- Sufficient Duration: The setup must have continuity (e.g., projects lasting over 6–12 months).
- Income Source: Profits are earned from activities or customers in the host country.
- Dependent Agent: A local agent who regularly signs contracts on behalf of the foreign company can create a PE.
- Not Just Auxiliary Work: Prep work (like storage or info gathering) alone doesn’t trigger a PE.
- Taxable Profits: Only profits linked to the PE are taxed locally, based on fair value (arm’s length principle).
Common Examples of PE in India:
- A U.S. tech company sets up a liaison or branch office in India to manage operations, marketing, or communication.
- A UK company hires an agent in India who negotiates or signs contracts regularly on its behalf
- Foreign companies engaged in mining, oil exploration, or other resource-based activities in India may create a PE.
- Even using a dedicated space within another company’s premises can lead to PE if business activities are carried out there regularly
What is Not a PE? (Common Exceptions)
The following activities do not create a PE:
- Using facilities solely for storage, display, or delivery of goods
- Maintaining a stock of goods solely for processing by another enterprise
- Maintaining a place of business for purchasing, collecting information, advertising, or scientific research
How PE Status Triggers Taxation in India?
Having a permanent establishment (PE) status in India is the critical trigger for taxation of a business’s profits in India.
- Only profits attributable to the PE’s Indian activities are taxed.
- Without PE, trading income isn’t taxed
- Passive income may still be taxable under Indian law and treaties.
Tax Implications of PE
- Profit Attribution: PE treated as a separate entity; profits allocated based on arm’s length principles using sales, assets, manpower.
- Tax Rates: Corporate tax (around 40%), possible branch profit tax, and withholding taxes apply.
- Compliance: PE must register, file returns, maintain transfer pricing docs, and may face audits.
- Penalties: Non-compliance leads to heavy fines, interest, and prosecution.
PE Funds Taxation in India
- Residency: Based on physical presence (individuals) or Place of Effective Management (POEM) for funds, affecting global tax liability.
- Investment Triggers: Tax depends on share source, holding period (short-term vs long-term), and acquisition type.
- Capital Gains: Short-term gains taxed at 30%; long-term gains get concessional rates.
- Income Source: Non-resident funds taxed only on India income; resident funds taxed globally.
- AIF Status: Fund-level taxation or pass-through depending on AIF category.
- Compliance: Includes filing, transfer pricing, advance tax, and TDS.
- Tax Rates & Treaties: Rates vary by residency and entity; treaty benefits depend on ownership and LOB clauses.
- Recent Changes: Stricter POEM rules, revised AIF taxes, and enhanced anti-avoidance measures.
Legal Framework for PE Taxation
PE taxation in India is governed by a combination of domestic law, international tax treaties, and administrative guidance. Here’s a quick overview:
1. Income Tax Act, 1961
- Section 9: Treats income as arising in India if there is a “business connection” in the country, including direct operations or activities through agents. This aligns with the concept of a Permanent Establishment (PE).
- Section 92F(iiia): Defines a PE for transfer pricing as a fixed place of business through which a company carries out its operations, fully or partly.
- Section 5(2): Specifies when income earned by non-residents is taxable in India, including income deemed to accrue or arise in India.
- Significant Economic Presence (SEP): A provision to tax foreign digital businesses with no physical presence in India but significant user interaction, data collection, or digital transactions within the country.
2. Double Taxation Avoidance Agreements (DTAAs)
- India has signed 90+ DTAAs with other countries.
- Article 5 of most treaties defines “Permanent Establishment” (based on OECD/UN Models).
- Article 7 governs profit attribution, stating only profits attributable to the PE can be taxed in India.
- DTAAs override domestic law if more beneficial to the taxpayer (per Section 90 of the Income Tax Act).
3. CBDT Guidelines and Judicial Interpretation
- The CBDT gives guidelines and clarifications, especially useful for digital business and the equalisation levy.
- Court Clarifications:
- A PE is treated like a separate business when calculating its profits, even if the foreign company as a whole is loss-making globally
- Just having access to a place isn’t enough, you need control or the right to use it for it to count as a PE.
4. OECD and UN Models:
- OECD Model: Mostly used by developed countries. It gives a stricter, narrower definition of PE. usually needing a fixed physical place of business.
- UN Model: Favours source countries (like India) and gives them more rights to tax income from foreign companies. It allows a broader definition of PE.
Types of PEs in India With Tax Implications & Example Scenario
India recognizes different types of PEs including:
1. Fixed Place Permanent Establishment (Fixed Place PE)
This arises when a foreign enterprise maintains a fixed, physical location in India through which it wholly or partly conducts business activities.
Key Features:
- Location must be permanent or semi-permanent, not temporary.
- Foreign enterprises must control or manage the premises.
- Examples: offices, branches, factories, warehouses, workshops, mines, plantations.
- Place must be used regularly, not occasionally.
- Ownership alone doesn’t create a PE without business activity.
Examples: A UK-based IT firm rents an office in Hyderabad where Indian employees develop software and manage projects. This rented office qualifies as a Fixed Place PE.
Court Ruling: In the Buddh International Circuit (Formula One) case: The circuit was considered a Fixed Place PE because F1 controlled the venue during races, even though it was temporary.
Tax Implication:
- Profits attributable to business activities at this fixed place are taxable in India
- The foreign enterprise must comply with Indian tax filing, transfer pricing, and withholding requirements.
2. Construction Permanent Establishment (Construction PE)
Arises when a foreign company undertakes construction, installation, or assembly projects in India that exceed a specific duration threshold.
This is usually 6 to 12 months, as defined by the applicable Double Taxation Avoidance Agreement (DTAA).
Key Features:
- Time threshold depends on DTAA (e.g., 6–12 months).
- Covers building sites, pipelines, roads, factories, power plants, or any assembly/installation work
- Work must be substantial, not just brief or preparatory
Examples: A UK infrastructure company constructs a bridge in Karnataka, and the project lasts for over 9 months.
Tax Implication:
- India can tax the income attributable to the construction project once the time threshold is exceeded.
- Profit attribution rules under transfer pricing apply to compute taxable profits.
3. Service Permanent Establishment (Service PE)
It is triggered when a foreign company provides services in India through its employees or other personnel for a continuous or cumulative duration exceeding a specified period.
This is usually 90 to 183 days within 12 months. Applies even without having a physical fixed place of business.
Key Features:
- The threshold period varies by DTAA (e.g., 90–183 days).
- Applies even without a fixed office.
- Covers professional services (e.g., consulting, IT)
- Cumulative short stays can qualify.
Example: A German consulting firm sends engineers to India for 120 days to assist a client
Tax Implication:
- Income attributable to services rendered in India is taxable.
- Foreign enterprises must comply with Indian tax and reporting requirements related to the PE.
4. Agency Permanent Establishment (Agency PE)
This type of PE is created when a foreign company operates in India through an agent who negotiates or concludes contracts on its behalf.
Also, the agent is dependent on the foreign enterprise (i.e., not independent in legal or economic terms).
Key Features:
- Agent must act exclusively or almost exclusively for the foreign company.
- Agent must have authority to bind the company contractually.
- Independent agents (e.g., brokers operating at arm’s length) don’t create PEs.
- Key test is control and dependence, not just activity level.
Examples: A Taiwanese electronics firm appoints an Indian agent who regularly concludes sales contracts with Indian retailers on its behalf.
Tax Implication:
- Profits attributable to the activities of the dependent agent are taxable in India.
- The foreign company must comply with Indian tax rules, including transfer pricing and withholding tax provisions.
5. Digital PE (Significant Economic Presence, SEP)
This was introduced to capture revenue from digital businesses operating without a physical presence.
Key Features:
- Based on economic activity, not physical presence.
- Criteria include annual revenue and number of users serving in a year
- Targets digital businesses like online marketplaces, OTT platforms, and app providers.
Examples: Netflix, Amazon, and other digital platforms with large Indian customer bases.
Tax Implication: Income attributed to Digital PE is taxable in India despite no physical office.
6. Subsidiary or Place of Management PE
While subsidiaries are separate legal entities, a PE can arise if the subsidiary acts as a dependent agent or if the foreign company’s place of effective management is in India.
Key Features:
- Foreign parent company exercises substantial control or management over the Indian subsidiary’s business activities.
- Place of Management PE recognized where key management decisions are made in India
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How Tax Treaties Affect PE Taxation in India
India’s tax treaties, mainly Double Taxation Avoidance Agreements (DTAAs), impact how foreign businesses are taxed when they operate in India through a PE.
Here’s what you need to know:
Treaty Override and Beneficial Provisions
Under Section 90(2) of the Income Tax Act, treaty provisions apply and override domestic tax laws if they are more favorable to the taxpayer.
Profit Attribution
Under treaties (e.g., Article 7 of OECD Model), India can tax only the profits attributable to the PE, not the foreign company’s global income.
Profits must be calculated using the arm’s length principle, treating the PE as a separate business.
Varying Thresholds by Treaty
Each DTAA may define its own thresholds for when a PE arises:
- Construction PE: India-Canada: 120 days; India-Germany: 6 months
- Service PE: India-UAE: 183 days; India-US: 90 days
Anti-Avoidance and Digital Economy
The Multilateral Instrument (MLI) expands DAPE and addresses digital presence (e.g., Significant Economic Presence), though treaty limitations may restrict India’s ability to tax digital businesses.
Avoiding Double Taxation
If India taxes the income, the foreign company can usually claim a tax credit in its home country. Treaties may also lower tax rates for items like royalties or technical fees.
Compliance
Businesses must submit a Tax Residency Certificate and Form 10F.
Most treaties also offer dispute resolution via Mutual Agreement Procedures (MAP) and contain non-discrimination clauses.
Reduce Tax Rates
Many treaties reduce Indian tax rates on royalties, fees for Technical Services (FTS) and interest payments.
If a foreign company has a PE, these income types might still apply—but the DTAA caps the rates (e.g., 10%-15%).
Example: US Tech Company – “TechX” Branch in India
A US-based tech company, TechX opens a branch office in India to support its sales and service operations.
The India branch has a physical office, employs staff, and concludes contracts with local customers.
| Steps | Action |
| Identify PE | US company with Indian office triggers PE under DTAA |
| Compute Attributable Profits | Only profits related to Indian branch activities are considered |
| Taxation in India | Only attributed profits are taxed, not global turnover |
| DTAA Benefits | If it also pays taxes in the US on same profits, DTAA credits allows it to be offset |
Impact of PE on E-commerce & Digital Businesses
Digital companies earn revenue from Indian users without a physical presence, which challenges the traditional definitions of PE.
As a response, India has expanding concept of PE for digital businesses:
1. Significant Economic Presence (SEP) Rule (2018): India now deems a PE exists without physical presence if a foreign company:
- Earns over ₹20 million (~$240,000) from Indian users, or
- Engages 300,000+ users annually
Impact: India can tax profits attributed to Indian operations, even without traditional PE.
2. Equalization Levy: A digital tax on non-resident e-commerce players:
- 2016 (6%): On digital ad payments
- 2020 (2%): On gross e-commerce revenues (now withdrawn as of Aug 1, 2024 to align with OECD norms)
3. Treaty Limitations: Most Indian tax treaties still require physical presence. SEP-based taxation under Indian law may be overridden if treaties don’t recognize virtual PEs, though treaty updates under BEPS/OECD are underway.
4. Compliance for Digital Companies: Even without PE, digital firms must register for GST, withhold taxes where applicable, track SEP thresholds and maintain transfer pricing records
FAQs about PE Taxation in India
1. When does a foreign company create a PE in India?
A PE arises when a company has a physical location, provides services for extended periods, or operates through dependent agents in India. Digital businesses may also trigger PE under Significant Economic Presence (SEP) rules.
2. What is the tax rate for foreign companies with PE in India?
The corporate tax rate for foreign companies with a PE is 40% plus surcharge and cess. The effective rate can vary depending on the income type and applicable DTAA.
3. Can a liaison office create a PE in India?
Generally, a liaison office performing only preparatory or auxiliary activities does not create a PE. However, if it performs core business functions, PE status may be triggered.
4. How do DTAAs affect PE taxation in India?
DTAAs can override Indian law and provide more favorable PE definitions, thresholds, or tax rates. They help avoid double taxation and reduce disputes.
5. Can a server or website create a PE in India?
Yes, in some cases. If the server is located in India and plays a core business role, it may lead to PE under certain treaty interpretations.
