Permanent Establishment

Taxation of international digital transactions has been a perplexing issue. As per the international tax rules, where an enterprise is a resident in one state with income originating in another state (source country), international tax rules provide that the source country will have the taxing rights over such income only if it is established that the enterprise has a permanent establishment (PE) in the source country. Thus, for the source country to be able to tax profits arising from the digital economy, some physical presence of the non-resident enterprise is required in the source state.

However, today a non-resident can carry out a large amount of internet transactions in the source state without having any significant physical presence there. A website can be launched from anywhere and made available to users anywhere in the world. There is no central point, or physical location, for such a transaction and thus, it may not fall within any country’s jurisdiction for taxation purposes.

This opens up two possibilities: double taxation or non-taxation. The concerned people could be even further creative, and actually set up an online business at a place where none of the founders / promoters are present, thereby making it even more difficult to tax them.

Continue Reading Taxing the Digital Economy: The Rule of ‘Significant Economic Presence’

Multinational enterprises often outsource back-office support operations to their captive subsidiaries in India. Additionally, foreign parent companies second their employees to provide guidance to the Indian subsidiary in the provision of back-office functions. A contentious question has for some time arisen, however. Should such arrangements constitute a fixed place Permanent Establishment (PE), a service PE or a Dependant Agent PE (DAPE) for the foreign company in India?

In the 2007 case of Morgan Stanley[i], the Supreme Court (SC), while dealing with the issue of PE, held that back office functions performed by the Indian subsidiary were preparatory and auxiliary in nature and, therefore, did not constitute a fixed place PE. The SC also held that if the foreign company had deputed its employees to the Indian company to render stewardship services, then no service PE would be constituted in India.

In contrast, however, in the case of Centrica Offshore[ii] in 2014, the Delhi High Court (Del HC), held that if the terms of employment of the employees seconded to India continued to be controlled by the foreign company, it would be regarded as having constituted a service PE in India.

In the ensuing paragraphs, we discuss the recent decision of the SC in the instant case of e-Funds Corporation and its implications for resolving this long-standing issue.

Continue Reading Outsourcing of Back Office Support Functions Does Not Create a Permanent Establishment

Permanent Establishment (PE) is a significant feature of bilateral tax treaties and is a key threshold adopted by source countries to tax profits earned by non-resident entities from the business activities carried out by the non-resident in the source country.

A ‘Fixed Place PE’ relates to a non-resident entity having a fixed place of business in the source country. But certain tax treaties also provide for a ‘Service PE’. A Service PE is established if: (i) the non-resident delivers services for longer than the prescribed threshold; and (ii) the said services are furnished in the source country through the employees or other personnel of the non-resident.

Traditionally, a Service PE required the physical presence of employees of the non-resident in the source country. However, in the present digital economy, this understanding is being challenged as more and more jurisdictions are doing away with this requirement.

The governments of Saudi Arabia and Israel, for example, have passed internal guidelines that suggest a non-resident would have a Service PE if it furnished services, including consultancy services, through employees or other personnel who are offshore and not physically present in the Source State. This would only be the case, however, if the activities continue (for the same or connected projects) within the Source State for more than 183 days in any 12-month period.

Continue Reading Service PE Does Not Require Physical Presence of Employees

With globalisation spreading economic activities across jurisdictions, enterprises nowadays have a presence in several jurisdictions. The taxability of activities undertaken by companies on foreign soil is closely linked to whether they are conducted through a permanent establishment (PE). This is a concept widely used in the context of international taxation wherein a particular business transaction leaves its footprint in multiple jurisdictions. Under the terms of various tax treaties, existence of a PE in the source State is a pre-requisite to hold a non-resident liable to pay taxes on business profits. The term PE is generally defined in the tax treaties as “a fixed place of business through which the business of a foreign enterprise is carried on wholly or in part”.

Under the various tax treaties executed with other countries, India imposes tax on any business income accruing or arising to a non-resident, whether directly or indirectly through or from any PE in India.

Continue Reading Formula One: SC Lays Down the Formula for Permanent Establishment