Can employment or consulting create a Permanent Establishment in India? Legal Framework and Key Considerations

Introduction

Permanent Establishment (PE) is a critical concept in international tax law, determining the tax liability of a foreign entity in a host country. In India, the notion of PE is primarily governed by the Income Tax Act, 1961, and various Double Taxation Avoidance Agreements (DTAAs) that India has entered with other countries. Understanding what constitutes a PE is essential for foreign companies engaging in business activities in India, whether through hiring resident employees or engaging consultants.

Indian Law on Permanent Establishment

The concept of PE in Indian tax law is derived from Section 9 of the Income Tax Act, 1961, which deals with the income deemed to accrue or arise in India. According to Section 9, all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situated in India, shall be deemed to accrue or arise in India.

Definition of Permanent Establishment (PE):

The Income Tax Act, 1961, does not explicitly define PE. However, the DTAAs India has signed with other countries often provide detailed definitions and conditions for what constitutes a PE. Typically, under Article 5 of the OECD Model Tax Convention, which many DTAAs follow, a PE is defined as a fixed place of business through which the business of an enterprise is wholly or partly carried on. This includes:

• A place of management.
• A branch.
• An office.
• A factory.
• A workshop.
• A mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

Additionally, the definition of PE may extend to include:

• Service PE: Arises when services are furnished in India for more than a specified duration, typically 90 days within any 12-month period.
• Agency PE: Established if a person, other than an independent agent, is acting on behalf of the enterprise and has the authority to conclude contracts in the name of the enterprise.
• Construction PE: Arises when a building site, construction, installation, or assembly project continues for more than six months.

Hiring of Indian Resident Employees

When a foreign company hires Indian resident employees, the risk of creating a PE depends on the nature and extent of activities performed by these employees in India. Simply having employees in India does not automatically create a PE; however, if these employees carry out substantial business activities on behalf of the foreign company, it could lead to the establishment of a PE.

Factors Considered for PE:

1. Nature of Activities: The primary consideration is whether the activities conducted by the employees are of a preparatory or auxiliary nature. Activities such as market research, promotional activities, or back-office operations typically do not create a PE if they are ancillary to the main business operations conducted outside India.

2. Extent of Activities: If the employees are involved in core business functions like concluding contracts, managing substantial business operations, or providing key managerial services, these activities may lead to the creation of a PE.

3. Control and Supervision: The degree of control exercised by the foreign company over these activities is another critical factor. If the foreign company directly controls and supervises the business activities in India, it is more likely to be deemed as having a PE.

Relevant Case Law:

In the case of Morgan Stanley & Co. Inc. v. DIT (2007)[1], the Supreme Court of India ruled that outsourcing back-office operations to India does not create a PE, provided these activities are of a preparatory or auxiliary nature. However, if there is a supervisory office for quality control and management purposes, it may constitute a PE as it represents a fixed place of business in India

Engaging with Indian Consultants

Engaging Indian consultants involves similar considerations as hiring employees, particularly regarding the authority and independence of the consultants. The determination of PE depends on whether the consultants act independently or as agents of the foreign company.

Dependent vs. Independent Agents:

1. Dependent Agent: A consultant who acts as a dependent agent may create a PE if they habitually exercise the authority to negotiate and conclude contracts on behalf of the foreign company. This is particularly relevant if the consultant’s activities are not of a preparatory or auxiliary character.

2. Independent Agent: An independent agent operating in the ordinary course of business typically does not create a PE. An independent agent is someone who is legally and economically independent and acts in the ordinary course of their business. However, if the independent agent is fully controlled by the foreign enterprise or if the activities performed by the agent are not of an independent nature, this may lead to the creation of a PE.

Relevant Case Law:

In the case of DIT v. E-Funds IT Solution Inc. (2017)[2], the Supreme Court of India held that the presence of a subsidiary in India does not automatically create a PE for the foreign parent company unless it can be shown that the subsidiary acts as an agent or conducts business activities on behalf of the parent company. The court emphasized the need to demonstrate that the subsidiary was not independent and was habitually exercising authority to conclude contracts on behalf of the parent company.

What Amounts to Creation of Permanent Establishment in India

The creation of a PE in India involves an analysis of various factors as outlined in the Income Tax Act, 1961, and DTAAs. The key types of PE include:

1. Fixed Place PE: This is the most common form of PE and involves having a fixed place of business through which the enterprise’s business is wholly or partly carried on. This includes offices, branches, factories, workshops, warehouses, and any other premises where business activities are conducted regularly.

2. Service PE: Service PE is created when services are provided in India for a specified duration. For instance, if a foreign company provides services in India for more than 90 days within any 12-month period, it may constitute a PE under many DTAAs. This type of PE often applies to consultancy services, technical services, and management services.

3. Agency PE: Agency PE arises when a dependent agent in India habitually exercises the authority to conclude contracts on behalf of the foreign company. The agent must have the authority to bind the company in a manner that is legally enforceable. The activities of the agent must be more than preparatory or auxiliary to establish a PE.

4. Construction PE: This type of PE is relevant for foreign companies involved in construction, installation, or assembly projects in India. If such projects last for more than six months, they typically create a PE. The duration threshold may vary depending on the specific provisions of the applicable DTAA.

Case Laws on Permanent Establishment

1. Formula One World Championship Ltd. v. CIT (2017)[3]

In this case, the Supreme Court held that the presence of a racetrack used for hosting the Formula One Grand Prix in India constituted a PE. The court reasoned that the racetrack, though utilized for a few days, was a fixed place of business due to its regular and continuous use for significant commercial activities. This case highlighted that even temporary business activities could establish a PE if conducted with regularity and continuity.

2. GE Energy Parts Inc. v. ADIT (2018)[4]

The Authority for Advance Rulings (AAR) addressed whether a liaison office could create a PE in India. The AAR ruled that a liaison office engaged in auxiliary activities such as communication and support does not create a PE. However, if the liaison office undertakes core business activities like contract negotiations, it could lead to the establishment of a PE.

Conclusion

Understanding the nuances of what constitutes a Permanent Establishment in India is essential for foreign companies to manage their tax obligations effectively. Hiring resident employees or engaging consultants requires careful structuring to avoid inadvertent creation of a PE. By comprehending the statutory provisions and judicial precedents, foreign companies can navigate the complexities of Indian tax law and ensure compliance while optimizing their business operations in India.

[1] [Morgan Stanley & Co. Inc. v. DIT, (2007) 292 ITR 416 (SC)].

[2] [DIT v. E-Funds IT Solution Inc., (2017) 399 ITR 34 (SC)].

[3] [Formula One World Championship Ltd. v. CIT, (2017) 394 ITR 80 (SC)].

[4] [GE Energy Parts Inc. v. ADIT, (2018) 402 ITR 119 (AAR)].

Contributed by Prithiviraj Senthil Nathan