PROJECT instances, machinery or equipment; – ii. this





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The concept of permanent establishment (hereinafter
“PE”) has gained considerable importance with the growing trend of
globalization. The concept of a PE is important for several Articles of the
and the concept or its cognate, also appears in the domestic laws of some
countries. In India we have the concept of ‘business connection’
(“BC”). Further, where a tax treaty is in operation, the crucial
question is whether a foreign enterprise is carrying on business through a PE
in the country where the profits are earned. If the enterprise does not have a
PE then it can be taxed only in the country where it is a resident. However,
where the enterprise operates through a PE, the profits attributable to it, may
be taxed by the country where the PE is located, leaving the country of
residence to give relief from double taxation. Thus it may be possible for an
enterprise with overseas trading operations to avoid foreign taxes by carefully
structuring its operations to come below the PE threshold. Where a PE is in
existence, the country where it is located may also tax its capital gains,
dividends, interest and royalties that are effectively connected to such PE. The
PE concept marks the dividing line for businesses between merely trading with a
country and trading in that country.2
Thus, a legal concept, PE is a compromise
between source state and residence state for purposes of taxation of business



1.1   Definition in Art 5 (1): The general rule: the PE must be a fixed place of business at the
disposal of the enterprise through which the business of the enterprise is
carried on. The official commentary 3on
the OECD Model explains the basic criteria for the existence of a PE as follows:

existence of a ‘place of business’,
i.e., a facility such as premises or, in certain instances, machinery or
equipment; –

place of business must be ‘fixed’, i.e., it must be established at a distinct place with a certain
degree of permanence; –

the ‘carrying on of the business’ of
the enterprise through this fixed place of business. This means usually that
persons who, one way or another, are dependent on the enterprise (personnel)
conduct the business of the enterprise in the State in which the fixed place is

From this definition it can be seen that
there are two types of PE contemplated. First, an establishment which is a part
of the same enterprise and under common ownership and control- an office,
branch, etc. This is covered by Article 5(1) to (4), which can be referred to
as ‘Associated PE’. The second type is an agent who is legally separate from
the enterprise, but is nevertheless dependent on the enterprise to the point of
forming a permanent establishment. This is covered by Article 5(5) and (6),
which can be referred to as ‘Unassociated PE’.

1.2  Specific Inclusion in Art 5(2) –contains a list of places of business,
which prima facie constitute PE, provided they satisfy the requirements of
Article 5(1). hese establishments are: Place
of management, Branch, Office, Factory, Workshop and Mine, oil or gas, quarry
or any other place of extraction of  natural resources. The establishments
mentioned are more by way of illustration. Hence, even an establishment which
is not mentioned therein could well constitute a PE.

It may be noted that merely because an
establishment is of the nature mentioned in Article 5(2), it need not be
treated as PE. For such an establishment to be treated as PE, it should first
have the indicia of a PE that are set out in Article 5(1).

1.3  Special rule for construction &
installation sites Article 5(3) – Article 5(3) specifically includes two kinds of activities, which
together with an establishment would constitute PE. These activities constitute
what are commonly referred to as ‘construction’
and ‘service’ and the rules
which determine the existence of the PE are referred to as ‘construction rule’
and ‘service rule’. Under construction rule, PE if an enterprise has a
building site, a construction, assembly or installation project or supervisory
activities in connection therewith, a PE would come into existence if such
site, project or activities continue for more than six months. Under service
rule, PE if an enterprise furnishes services (including consultancy
services) through employees or other personnel engaged by it for furnishing
such services, a PE would come into existence if such activities continue for a
period or periods aggregating more than six months within any twelve month


1.4  Activities which may be carried on at a fixed
place of business without giving rise to a PE Article 5(4): Art. 5(4) provides that use of the
facilities for certain kinds of activities would not constitute a PE. These are:

Use of facilities
for storage or display of goods(the OECD Model Convention also includes
delivery together with storage and display).

Maintenance of
stock of goods solely for storage or display.

Maintenance of
stock of goods solely for processing by another enterprise.

Maintenance of
fixed place for purchasing merchandise or for collecting information.

Maintenance of
fixed place of business for carrying out activities of preparatory or ancillary

Maintenance of
fixed place of business solely for any combination of above activities provided
the overall activity of fixed place of business resulting from this combination
is of preparatory or ancillary character.  


1.5   Dependent
agents constitute a PE Article 5(5) provides that Under Article
5(5) where an enterprise doesn’t have its own establishment, it could have a PE
through an agent provided the following tests are satisfied:

Tests:- Any person,
whether an individual or a company, could be an agent. It is not necessary that
the agent should be resident of the Source Country. The agent should be
authorised to conclude contracts
on behalf of the principal. The authority may be general or specific or limited. However, it should be such
that the agent’s action would bind
the enterprise. The authority should be with
respect to business of the enterprise. Normally, solicitation of
business and negotiation of contracts that are subject to the approval of the
principal would not constitute agency PE. The authorisation should be construed
in substance and not in form. Thus, if an agent has the authority to negotiate
all parts of the contract in a manner, which is binding on the principal but
the contract is signed outside the Source Country, the agent could be said to
have the authority to conclude contract.

Under Article 5(b), agency PE could come into
existence even if the agent has no authority to conclude contracts but he
habitually maintains stock of goods from which he regularly delivers goods on
behalf of the enterprise. Again, the term ‘habitually’ indicates that the
stocking should be repeated. Also, the term ‘regularly’ indicates that the
delivery should not be on an exceptional basis.

Tests:-  Only agent who
are dependent upon the
principal may constitute a PE. The dependency would, generally, be commercial
dependency. Thus, assurance as regards the agent’s expenses, minimum guaranteed
remuneration, etc. would indicate commercial dependency. Another instance would
be a case where the agent has only one principal and devotes all his time to this


Tests:- The authority to
bind the principal should be for the purposes which are essential and
significant to the principal’s business and not for administrative purposes
such as conclusion of contracts for stationery, rent, office, cleaning or
manpower contracts. Mere fact that the agent has the authority to conclude
contract would result in agency PE. It is also necessary that the agent
habitually exercise such authority. The term ‘habitually’ indicates that the
authority should be used repeatedly and not merely in isolated instances.


1.6  PE in case of Insurance Business Article
5(6)- Article
5(6) identifies certain forms of independent agents who do not constitute a PE.Article
5(6) doesn’t have a corresponding provision under the OECD Model Convention. It
provides that an enterprise carrying on insurance business shall be deemed to
have a PE in the Source Country if: It collects premium in the territory of the
Source Country; or If it insures risks situated in the Source Country through a
person other than an independent agent referred to in Article 5(7).


1.7  An associated company will not necessarily
give rise to a PE Article 5(7) states that – Article 5(7) provides for an exception to agency rule PE.
An enterprise is not deemed to have a PE in the Source Country merely because
it carries on business in that country through a broker, general commission agent or any other agent of an
independent status if such person is acting in the ordinary course of business.

The exception mentioned above would, however, not apply
in a case where the activities of such person are devoted wholly or almost
wholly on behalf of that enterprise and conditions are made or imposed between
that enterprises and the agent in their commercial and financial relation which
differ from those which would have been made between two independent


1.8  No PE by virtue of Relationship: Article
5(8)-  Article 5(8) clarifies that the company which
controls, or is controlled, by another company which is resident of the source
state would, by itself, not constitute either company a PE of the other. Thus,
a subsidiary company would not constitute a PE of the holding company merely
because it is controlled by the holding company or a holding company would not
constitute a PE of the subsidiary company merely because it controls the
subsidiary company.



is the Indian equivalent of PE. It is much wider in connotation and has been
very effectively used by the revenue authorities to tax the income of
non-residents in India. Despite being referred to in the ITA, the term was not
defined till the Finance Act, 2003 inserted a somewhat cryptic explanation to
Section 9 of the Indian Income Tax Act, 1961 (“ITA”).

SC in the landmark judgment of of CIT v. R.D. Aggarwal & Co4
stated that a stray or isolated transaction is not normally regarded as a
business connection. Business connection may take several forms. It may include
carrying on a part of the main business or activity incidental to the main
business of the non-resident through an agent , or it may merely be a relation
between the business of the non-resident and the activity in the taxable
territories which facilitates or assists the carrying on of that business. A
relation to be a business connection must be real and intimate and through or
from some income must accrue or arise directly or indirectly to the
non-resident. The income which accrues or arises through or from the
‘connection’ must arise outside the taxable territories and not within. (This
is because income arising within a taxable territory need not be brought within
the scope of a deeming provision to subject it to tax in the taxable

these principles to the case of the firm, the Supreme Court came to a
conclusion that no business connection existed in that case because the
contracts for the sale of yarn took place outside India, the price was received
by the non-resident exporters outside India and the delivery was also given
outside India. No operation such as procuring raw materials, manufacture of
finished goods, sale of finished goods or delivery of finished goods against
price took place within India.

 The definition of term PE was inserted in
Section 92F(iiia) by the Finance Act, 2002. This definition is relevant only
for the transfer pricing provisions and is an inclusive definition. Definition
The term BC is discussed in Section 9(1)(i) in Explanation 2 of the ITA.
Explanation 2 states that “business connection” shall include any
business activity carried out through a person who, acting on behalf of the

a.       has
and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident, unless his
activities are limited to the purchase of goods or merchandise for the
non-resident; or

b.      has
no such authority, but habitually
maintains in India a stock of goods or merchandise from which he
regularly delivers goods or merchandise on behalf of the non-resident; or

c.       habitually
secures orders in India,
mainly or wholly for the non-resident or for that non-resident and other
non-residents controlling, controlled by, or subject to the same common
control, as that non-resident:

Provided that
such business connection shall not
include any business activity carried out through a broker, general commission
agent or any other agent having an independent status, if such broker, general
commission agent or any other agent having an independent status is acting in
the ordinary course of his business :

further that where such broker, general commission
agent or any other agent works mainly or wholly on behalf of a non-resident
(hereafter in this proviso referred to as the principal non-resident) or on
behalf of such non-resident and other non-residents which are controlled by the
principal non-resident or have a controlling interest in the principal
non-resident or are subject to the same common control as the principal non-resident,
he shall not be deemed to be a broker, general commission agent or an agent of
an independent status.

Bombay High Court in CIT v National
Mutual Life Association of Australia 5 held that all that is necessary for a
BC to exist is that there should be: (i) a business in India; (ii) a connection
between non-resident person or company and that ‘business’; and that the
non-resident person or company has earned an income through such connection.

Section 9(1)(i) provides that income is deemed
to accrue or arise in India if it accrues, directly or indirectly through
or from any business connection
in India or, through or from any property
in India or through or from any asset
or source of income in India, the transfer of a capital asset situate in India

Explanation to section 9(1)(i) provides for
following exemptions.

the  case  of business of which all
the  operations  are not carried  out  in  India, 
only such part  of  the income as  is reasonably 
attributable to the operations carried out in  India would be the income
deemed to accrue or arise in India.

No income
shall be taxable in India if the operations of the non-resident  is confined to the purchase of goods
in India for  the purpose of export

In case of
non-resident engaged in the business
of running a news agency or  of publishing newspapers, magazines or
journals, no income  shall be taxable in India if the
activities  confined  to the collection of news and views in India
for transmission out of India

case of non-resident no income shall be taxable in India if the operations are confined to the shooting of any
cinematograph film in India.

in the case of
a foreign company engaged in the business of mining of diamonds, no income
shall be taxable for activities which are confined
to the display of uncut and unassorted diamond in any special zone
notified by the Central Government

Explanation 5 of S.9 which was added after the
nefarious Vodafone Case provides that clarified that an asset or a capital asset
being any share or interest in a company or entity registered or incorporated
outside India shall be deemed to be and shall always be deemed to have been
situated in India, if the share or interest derives, directly or indirectly,
its value substantially from the assets located in India.

However,  in  each  case  the
question whether  there  is  a business connection 
from  or through which income arises or accrues  must  be
determined  upon the facts and circumstances of that case. 6



In the cases of Motorola Communication Inc(‘Motorola’),
Ericsson Radio Systems AB (‘Ericsson’) and Nokia Networks OY(‘Nokia’) (2005)
95-ITD-269 (SB), the ITAT ruled on the cases of three
telecommunication companies in the light of three different sets of facts.

The decision deals with a number of issues,
which mainly affect taxation of non-resident in India. One such issue is
whether the activities of the non-residents, in the facts of the case, result
into a business connection/ Permanent Establishment (‘PE’) in India, merely
because the non-residents had wholly owned subsidiary in India.

In this context, the following significant
observations of the Tribunal are relevant:

income is deemed to accrue in India to a non-resident from the sale of hardware
and software if such sale is effected outside India to an Indian purchaser even
tough the non-resident supplier, along with other group companies, has entered
into a turnkey contract for supply and installation of equipment in India and
the non-resident supplier assumes overall responsibility for the proper
execution of said turnkey contract. In such a situation, as the sale of the
equipment is effected outside India and the title and the risk therein passes
to the Indian purchaser outside India, there is no business connection in terms
of domestic tax law between the Non-resident supplier and the Indian purchaser.

PE i.e., a fixed place of business of a non-resident would exist in India if
one is able to point to a physical location at the disposal of the non-resident
through which its business is carried on in India. Employees of the
non-resident supplier having use of its Indian subsidiary’s office as a matter
of right would constitute a PE of the non-resident supplier in India. The
existence of a liaison office in India, of a non-resident does not, in itself,
constitute its PE in India.

wholly owned subsidiary of a non-resident in India would constitute its PE in
India if, their mutual relationship leads to the distinction between these two
corporate entities becoming blurred and a reasonable inference can be drawn
that the subsidiary was a virtual projection of the supplier in India.

In the case of Ericsson, the special bench held that it did not have
a PE in India on account of there being no ‘fixed place of business’. Also,
there was no ‘Agency PE’ as the subsidiary of Ericsson’s group company could
not be said to be a ‘dependent agent’ of Ericsson as it had no authority to
conclude contracts on Ericsson’s behalf. Also, as the profits in respect of the
installation had already been taxed in the hands of the Indian subsidiary, the
same could not be taxed once again in the hands of supplier (i.e. Ericsson).

In case of Motorola, the facts of the case showed that the
employees of the Motorola was using the premises of the subsidiary not only for
the work of Motorola but were also working for Motorola’s Indian subsidiary.
While Motorola paid salaries to these employees, its Indian subsidiary provided
them perquisites, which Motorola reimbursed to the subsidiary with a mark up.
The special bench held without discussion that this led to a perception of the
subsidiary being a projection of the activities of Motorola in India and hence
a PE of Motorola could be said to be constituted in India. On facts it was
however established that the activities carried on by the employees (the PE)
were preparatory and auxiliary in character and because, as per Article 5(3)
(e) of the DTAA between India and USA, there was a specific exclusion from the
constitution of a PE by the carrying on of such activities, the Special Bench
held that no PE of Motorola was constituted in India.

In case of Nokia, the Special Bench held that its liaison
office would not constitute its PE in India as it was not carrying on
commercial activities. In fact it was specifically barred by the Reserve Bank
of India from doing so. The case of its subsidiary was different however, as
the facts led to a perception of the subsidiary being a projection of the
activities of Nokia in India.

The Special Bench held that it need not be
established that there was actually a projection of the activities of the
Non-resident in India. It was enough if the facts of the case resulted in a
perception of the subsidiary being a projection of the non-resident in India.
The facts which were found to be relevant in this context by the Special Bench
in Nokia’s case are set out below:

The contracts for the supply of equipment and
software were signed in India by an employee of Nokia’s liaison office. The
same person took up employment with Nokia’s Indian subsidiary the very next day
and signed the contracts for the installation also. Nokia had given an
undertaking to the Indian operators that it would not dilute its stake in the Indian
subsidiary to below 51 percent.



is pertinent to follow the “substance over form” principle for characterization
of a BC. Although law regarding BC is clear, it has been observed that income
tax authorities unnecessarily trouble the non-resident entities by either erring
on the determination of a BC or attributing profits to a BC. Therefore, it is
advisable for the non-resident entities to take a preliminary ruling
concerning their transactions from the Authority of Advance Rulings. Also,
great caution has to be undertaken by the income tax authorities in order to
differentiate between income attributable to a BC due to activities performed
by it through a non-resident entity and income generated by a BC through its
activities in India.

1 The term “Convention”
has been used in the context of the United Nations Double Taxation Avoidance
Agreement (“UN Model”) and the OECD Double Taxation Avoidance
Agreement (“OECD model”)

2 Manual on the OECD Model Tax
Convention on Income and on Capital by Dr. Philip Baker (hereinafter referred
to as “Commentary by Dr Philip Baker”), page 5-2 para 5B.01

3 Para 2 of Article 5(1) of the
commentary to the OECD Model

4 (1965) 56 ITR 20 / TS-6-SC-1964,

5 1933 I ITR 350, 361 (Bom)

6 Blue  Star Engg. Co. (Bom.) P. Ltd. v CIT 73
ITR 283 (Bom.)

7 (2005) 95-ITD-269(SB)