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Substance over Form: Supreme Court Clarification on Creation of Permanent Establishment in Cross-Border Services

The question of whether cross-border services rendered by foreign entities would establish a taxable presence in India has been subject to nuanced scrutiny. In a recent ruling,[1] the Hon’ble Supreme Court of India (“SC”) has reaffirmed that economic substance (not legal form) is the crucial factor for determining whether a foreign entity exercises substantive control over Indian operations to constitute a permanent establishment (“PE”) in India.

FACTS

Hyatt International Southwest Asia Ltd (“Hyatt”), a company incorporated in the UAE, entered Strategic Oversight Services Agreements (“SOSA”) with an Indian hotel owner to provide strategic planning services and “know-how” to ensure efficient operation of such hotels as high-quality international full-service hotels. Pursuant to SOSA, Hyatt was entitled to receive a fee linked to the revenues generated by the hotels.

For the relevant assessment years, Hyatt filed income tax returns in India declaring ‘Nil’ income. During the assessment proceedings, the tax officer concluded that Hyatt’s activities resulted in the establishment of a taxable presence in India, i.e., a PE under Article 5 of the India–UAE Double Taxation Avoidance Agreement (“Tax Treaty”) and accordingly raised a tax demand against Hyatt.

Hyatt’s appeals before the Income Tax Appellate Tribunal (“ITAT”) and the Delhi High Court were unsuccessful. Aggrieved, it appealed before the SC.

ISSUE

The primary issue before the SC was whether Hyatt had a fixed place of business as a PE in India under Article 5(1) of the Tax Treaty and, consequently, whether Hyatt’s business profits attributable to the PE would be taxable in India under the Tax Treaty.

JUDGMENT

The SC extensively analysed Article 5(1) of the Tax Treaty, which defines “PE” as a “fixed place of business through which the business of an enterprise is wholly or partly carried on”. The SC, relying on its earlier decision in the case of Formula One World Championship Ltd,[2]held that the principal test for determining the establishment of a fixed place of business is whether the physically located premises are “at the disposal” of the enterprise, i.e., the enterprise must have the right to use and control over the place. Applying these principles to the given case, the SC noted that pursuant to SOSA, Hyatt exercised “pervasive and enforceable control” over the hotel’s operations through strategic control (appointment of General Manager and key personnel), operational control (HR policies, procurement, pricing, branding), financial control (management of operational bank accounts), and personnel control (assignment without owner’s consent). Thus, SC held that the hotel premises were at the disposal of Hyatt, pursuant to such full and effective control exercised by it.

The SC further noted that Hyatt’s functions were not merely “auxiliary” but “core and essential,” as they extended beyond advisory to administrative roles, involved control over day-to-day operations, and were to be continuously performed over 20 years with revenue sharing. The SC also noted that certain employees of Hyatt also visited the hotel premises. It held that even though the length of their individual stay was not sufficient to breach the PE threshold, the fact that there was a continuous and a coordinated engagement establishes the continuity of business operation, which is necessary for establishing a fixed PE.

Thus, the SC held that the core attributes of establishing a fixed-place PE, namely, stability (i.e., distinct place with certain degree of permanence), productivity (i.e., business activity generating revenue), and dependence (i.e., reliance on a fixed place for business operations) were duly satisfied in this case. Accordingly, the SC found that Hyatt had established a PE in India and was liable to pay taxes on the income attributable to it, regardless of global losses incurred by Hyatt.

The SC distinguished its decision in E-Funds,[3] where it had held that the Indian subsidiary of a foreign entity would not constitute a PE, despite some workflow integrations. It noted that in E-Funds (supra), the Indian subsidiary merely provided back-office support with no involvement in core business functions, whereas in this case, the hotel itself was the location of Hyatt’s primary business operations, carried out under its direct supervision.

TAKEAWAYS

This decision is a significant development in the manner in which India interprets PE provisions. The key principles emanating from this decision are as follows:

  • The disposal test goes beyond a mere physical presence and mandates a probe into a foreign entity’s authority to use, manage, and control the Indian premises in a way that forms the basis for its profit-making activities. Thus, disposal test requires a fact-specific inquiry to ascertain if the facilities are leveraged for substantive business functions, and the metric may differ depending on the type of activities undertaken.
  • Exclusive possession of a fixed place is not essential for establishing a fixed-place PE. Temporary or shared use is sufficient if business is carried on through the fixed place.
  • The period of stay of a foreign entity’s employees in India would not be relevant, if continuity of business operation can be established, including through continuous and a coordinated engagement by such employees.

This decision serves as a clear reminder to foreign entities operating in India to ensure that their Indian businesses are allowed to function independently, without undue control exerted by foreign stakeholders. Given that this ruling has been delivered by the Apex Court, it is imperative for all foreign entities, regardless of the structure through which they conduct operations in India, to revisit their agreements, organisational frameworks, and modus operandi to assess the implications of this judgment.

[1] Hyatt International Southwest Asia Ltd v. Additional Director of Income Tax, Civil Appeal No. 9766 of 2025 (SC).

[2] Formula One World Championship Ltd v. Commissioner of Income Tax, (2017) 15 SCC 602.

[3] Assistant Director of Income Tax v. M/s. E-Funds IT Solutions Inc., (2018) 13 SCC 294.