Understanding Permanent Establishment in International Taxation: Key Concepts and Implications

Recent years have seen India become one of the fastest developing nations in the world, with increased economic activity brought about by significant inflows of foreign investment and technology cooperation. All of this has made taxing foreign corporations more difficult.

India levies taxes on foreign entities based on a number of factors, including the entity’s presence in India and its place of income and source. Therefore, the idea of PE has become more significant as international businesses become more prevalent in India.

A company’s profits are liable to Indian taxes if it is incorporated in India. India has the right to apply the “residential base” of taxation on a company’s worldwide income. Insofar as the foreign company’s income originates in India, India also has the authority to tax that income.

 The Indian Income Tax Act states that income of a foreign company is considered to have its source in India if it is accrued, arisen, or deemed to have arisen in India. India is therefore entitled to tax such income using the “source base” taxation principle.

If a foreign firm establishes a long-term presence in India with the intention of conducting business there, whatever income the company receives that is directly attributable to their presence there is subject to Indian taxation. This reasoning is where the idea of a Permanent Establishment (PE) originates.

Permanent establish are following types ;

Construction permanent establishment

For installation or building projects, a foreign enterprise’s activity in India must constitute a “construction PE” for there to be a taxable event in India. A construction site or installation project is called a Construction PE if it takes longer to complete beyond the time allotted by the relevant tax treaty with that nation.

Service Permanent Establishment

A Service PE exists if a foreign business provides services (apart from fees for technical services) in India through employees or other individuals for a duration longer than a predetermined amount of time.

Dependant Agency Permanent Establishment

In the event that an individual living in India represents or functions on behalf of a foreign company, the establishment of a PE in India may be triggered by the individual’s presence in India being interpreted as the foreign enterprise’s presence in India.

Subsidiary Permanent Establishment

A subsidiary company is not always a PE of the parent company just because it exists in India. According to the other PE regulations, a subsidiary cannot be considered a PE unless the parent company’s operations are carried out through it.

Permanent establishment and Income Tax Act

Generally speaking, unless a non-resident taxpayer has a Permanent Establishment in the source country and the earnings are derived from it, the non-resident taxpayer is exempt from paying income tax on its business profits.

According to Section 90(2) of the Income Tax Act, the terms of the DTAA and the Income Tax Act are often taken into account when determining a non-resident tax burden, with the more advantageous of the two being used.

Referring to Section 92F(iiia) read in conjunction with Section 92F(iii) of the Income Tax Act,1961  one can define the phrase “Permanent Establishment.” Enterprise is defined in Section 92F(iii), which also includes the definition of PE. Section 92F(iiia)1 elaborates on this definition by stating that PE includes a fixed place of business where the enterprise’s business is conducted entirely or in part.

Explanation 2 of Section 9(1)(i) of the Income Tax Act recognizes business connections under Indian domestic law. It must be read in accordance with Section 5 of the Income Tax Act, which stipulates that a non-resident company must pay tax in India on income that is accrued through a business connection in India, whether it is received in India or is presumed to be received there.

Under Section 115JB of the IT Act, international businesses having a place of business or PE in India are required to pay Minimum Alternate Tax (MAT). A foreign company is exempt from paying MAT if it is an independent agency and does not have a place of business or PE in India.

Implications of PE’s formation in India

Profits related to a foreign company’s operations in India shall be taxed as “Business Income” in line with Article 7 of the treaties after it is established that the foreign company has a PE in India.

• The earnings that a PE would have earned if it had operated independently in the same or similar activities under the same or comparable conditions as the remainder of the firm are known as the PE’s profits.
• They are required to keep official records of accounts.
• They need to register in accordance with indirect tax legislation and submit applications for PANs and TANs.
• Whether they are spent in India or anywhere else, costs incurred for the PE’s company are permitted as tax-deductible costs for calculating the PE’s earnings.
• After that, the Net Profits will be liable to taxes in India, just like a foreign firm would.
• obligatory With-Holding Tax (WTH) compliance.

Interpretation of the UN and OECD Conventions regarding Permanent Establishment

Part of the ongoing global initiatives to end double taxation is the United Nations Model Convention on Double Taxation between Developed and Developing Countries, or UN Model Convention. These initiatives, which were started by the League of Nations and continued by the United Nations and the Organization for Economic Co-operation and Development (OECD), have largely found tangible expression in a number of model or draft model bilateral tax treaties.

PE is defined in Article 5 of the OECD Model Convention12. Article 5 is not a substantial provision as a result. It is a definitive provision instead. A fixed place of business where an enterprise conducts all or part of its activity is referred to as a “permanent establishment” for the purposes of this Convention.

The following are some key distinctions between the OECD Model and the definition of PE as it is covered by the United Nations Model Convention: –

• Rather than the twelve-month test under the OECD Model Convention, there is a six-month test for a building or construction site that constitutes a permanent establishment. This test specifically covers assembly projects as well as supervisory activities related to building sites and construction, assembly, or installation projects.
• When a business uses workers or other persons to provide services, it is considered a permanent establishment if such operations take place for a total of more than 183 days throughout any 12-month period that starts or ends during that fiscal year.
• While Article 5 of the OECD Model Convention handles cases that were previously examined under the “fixed base” criteria of that Article, Article 14 (Independent Personal Services) has been kept. Article 14 of the United Nations Model Convention has been kept, however the current Commentary offers advice to nations that do not want to include it in their bilateral tax agreements;
• In accordance with the United Nations Model Convention, a delivery activity may lead to a permanent establishment, but not in accordance with the OECD Model Convention;
• When a “dependent agent” maintains a stock of goods or merchandise and routinely makes deliveries from it, their actions may be considered a permanent establishment even if they do not possess or regularly exercise the authority to enter into contracts in the name of the business.
• A permanent establishment is therefore more likely to exist under the United Nations Model Convention method since there is a unique provision defining when a permanent establishment is constituted in the case of an insurance firm.

One of the key ideas in international taxation is the concept of permanent establishment. The exposure to domestic tax liability in the nation of source would typically depend on the existence of a Permanent Establishment or not. Therefore, before starting to structure activities in another jurisdiction, it is essential to completely understand the notion. One of the main concerns for taxpayers and tax advisors alike has been the allocation of profits to a Permanent Establishment.

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