The Double Taxation Avoidance Agreement (DTAA) between the US and India provides rules to determine taxability of income arising in either country. A key concept in the treaty is Permanent Establishment (PE), which determines when a business or nonprofit organization has a taxable presence in the other country. Understanding the concept of PE is crucial because it determines the tax obligations of US entities operating in India.
PE is defined under Article 5 of the DTAA as “a fixed place of business through which the business of an enterprise is wholly or partly carried on.” US entities working in India may encounter three types of PE: fixed place PE, services PE, and agency PE.
Fixed Place PE
The most straightforward type of PE, this arises when a US entity has a fixed place of business in India at its disposal, such as a place of management, office, branch, or factory. The key factors are the permanence of the location and the conduct of business activities from that location, and thus physical presence in India is a pre-requisite for this kind of PE. It is important to note that physical presence need not exist for the entire year to establish PE; rather, the test is whether the physical presence in India existed for a time period sufficient to fulfill the foreign entity’s specific business purpose.[1] Moreover, it is not necessary that the physical location be legally owned by the foreign entity, as renting space or having access to space may be sufficient to constitute sufficient control over a physical location.
Services PE
Article 5(2)(l) of the DTAA introduces the concept of a services PE and states that a US entity’s provision of services in India through employees or other personnel may constitute a PE, even in the absence of a physical location in India. Such services must be provided for a period aggregating more than 90 days within any twelve-month period or be performed in India for an entity related to the US company or nonprofit organization.
Agency PE
Article 5(4) of the DTAA provides that a PE may arise where a US entity uses an agent in India who has and habitually exercises the authority to conclude contracts on behalf of the US entity. Agency PE also arises if an agent maintains a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the US company in India or secures orders almost exclusively on behalf of the US company. Such agents are considered “dependent” agents because they are reliant on the US company for their income and thus represent a projection of the US company’s business in India. However, the DTAA clarifies that the mere use of a broker or other agent in India itself will not constitute PE if such persons are acting in the ordinary course of business, especially if such agents are independent and work with numerous foreign entities. Rather, a PE will arise where the activities of an agent are devoted wholly or almost wholly on behalf of the US entity and the transactions between the agent and US company are not made under arm’s-length conditions.
The determination of whether a US entity has a PE in India subjecting it to tax liability is not always straightforward and is not based on mere physical presence. Thus, the tests for determining the existence of the different types of PE must be applied by analyzing the specific facts of each case.
To see if DSA Law can help you understand your India tax liability, contact Jeanny Lee at jlee@devsourcing.com.
[1] In one case, the Supreme Court of India held that a racetrack which was built per the specifications of a foreign corporation and was accessible by such corporation for three weeks in the year constituted a fixed place of business. Formula One World Championship Ltd. Versus Commissioner of Income Tax, International Taxation – 3, Delhi & Anr. [2017] 394 ITR 80.
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