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CONCEPT OF PERMANENT
ESTABLISHMENT

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CA Darpan Mehta

Concept of Permanent Establishment | 1

DISCLAIMER

This presentation provides general information existing at the time of its
preparation. The presentation is meant for general guidance and no
responsibility for loss arising to any person acting or refraining from acting as a
result of any material contained in this publication will be accepted by BMR
Advisors. It is recommended that professional advice be taken based on the
specific facts and circumstances. This presentation does not substitute the
need to refer to the original pronouncements


1

CONTENTS

Permanent Establishment (‘PE’)
History and Origin
Types of PE
Fixed Place PE
Specific PE
Exclusions
Installation PE
Service PE
Agency PE
Challenges to PE concept


PERMANENT
ESTABLISHMENT

- History and Origin
- Types of PE


2

HISTORY AND ORIGIN

“International taxation should be based on either political, residential or
economic allegiance between the taxpayer and the taxing state.”
PE as a concept originated in Prussia in 1845 in the Industrial Code
The primary use of the PE concept is to determine the right of a state to tax
the profits of an enterprise of another state
No definitive tests; facts based determination


TYPES OF PE

Types of PE

Fixed Place PE Agency PE Installation PE Service PE

An office is a
Dependent Independent Building site,
fixed place Service by
Agent Construction,
Agent employee or
Installation or other
assembly project personnel

Preparatory and Income generating
auxiliary activities activities PE if lasts PE if
NO PE
greater services

than 6/12 last
PE (if certain
months beyond
conditions are
satisfied) specified
NO PE PE time

Concept of Permanent Establishment Tax Update – India | 6

3

FIXED PLACE PE


FIXED PLACE PE - CONCEPT

There must be a fixed place of business (situs test);
The fixed place of business must be located [in a] certain territorial area
(locus test);
The use of the fixed place of business must last for a certain period of time
(tempus test);
The taxpayer must have a certain right of use [over] the fixed place of
business (ius test);
The activities performed through the fixed place of business must be of a
business character (business activity test)


4

FIXED PLACE PE – LOCUS TEST

All three tests (locus, situs and business activity) must be satisfied
Presence to be ‘visible’ in the other contracting state
Usually linked to a geographical location
Covers premises as well as tangible assets used for carrying on business
Movable places of business with a temporary fixed location meet the locus
test
Activities carried out within a defined geographical location could constitute
a PE; eg, a diving offshore vessel functioning within a defined area, dealer
selling merchandise from a mobile van


FIXED PLACE PE – EXAMPLES

Fishing boat operated within the territorial waters
Streets in a city? E.g. Milkman case and Taxicab in Hamburg
Circus or a carnival performing at different places in a city
Concert tours, music shows etc.
Restaurants and shops on-board ships in international traffic?
Home offices
Partner’s premises – a PE for Partnership?


5

FIXED PLACE PE – OECD POSITION AND INDIA’S
OBSERVATIONS/COMMENTS
OECD Position:
Both geographical and commercial coherence would be necessary to
construe a fixed place of business for the purpose of establishing a PE
OECD does not consider tangible or intangible property leased out by an
enterprise without maintaining a place of business to constitute a PE

India’s Position:
Both the conditions ie geographical and commercial coherence in isolation,
may construe a fixed place of business; work under a series of unrelated
contracts for different clients in a large building may trigger a PE
Even tangible and intangible properties could, in certain circumstances,
constitute a PE of the lessor in the source country

It is necessary to determine who actually exercises control over the
property and whose business is being carried out through such leased asset


FIXED PLACE PE – TEMPUS TEST

No minimum threshold under Indian law
An isolated activity cannot lead to establishment of a fixed base PE as the
ingredients of regularity, continuity and repetitiveness are essentially
missing
If a non-resident is carrying its activities through a place which is exclusively
available to its business in India then that place will be deemed to be its
fixed place PE even if the same is used for a day
Interestingly, in a recent ruling, the AAR has held that conducting of golf
tournament in India for a week’s duration does not lead to existence of a
fixed base PE in India. Golf in Dubai, LLC v. ADIT, In re (2008) 306 ITR 374
(AAR)


6

FIXED PLACE PE – IUS TEST

Place should be at the disposal of the foreign enterprise for the purpose of
its business activities
The foreign enterprise should have the ability to exercise some right or
dominion or control
The place may be owned, rented or leased;
Legal right to use need not be the sole determinant; factual use or exercise
of such right will have a greater bearing
Even illegal occupation could constitute a PE


FIXED PLACE PE – BUSINESS ACTIVITY TEST

The definition of PE requires that the business of the foreign enterprise,
wholly or partly, ought to be carried out through the fixed place
Place of business must ‘serve’ the business activity and not be ‘subject to’ it
The use of the premises by an agent for the purpose of the business of the
principal may lead to the interpretation that such premises are at the
disposal of the principal and therefore constitute a PE (Galileo International
Inc)
Similarly, in ACIT v DHL Operations BV, the office of a local courier
company was considered to constitute a PE for the foreign company
engaged in providing courier services since the foreign company delivered
packages to the local courier company for onward delivery to the addressee


7

SPECIFIC PE


SPECIFIC PE - ILLUSTRATIVE LIST

Article 5(2) provides for an illustrative list of facilities constituting a PE
The term PE includes especially:
A place of management
A branch
An office
A factory
A workshop; and
A mine, an oil or gas well or any other place of extraction of natural resources
OECD considers the satisfaction of conditions prescribed in paragraph 1 of
Article 5 as a prerequisite for examples in paragraph 2 to constitute a PE
India does not agree with the above interpretation and holds that all the
examples provided under paragraph 2 of Article 5 would independently

constitute a PE


8

INDIA’ RESERVATIONS TO OECD – ARTICLE 5

India reserves its right to include a warehouse, a sales outlet and a farm,
plantation or other place where agricultural, forestry, plantation or related
activities are carried on, under paragraph 2 as an example of a PE
India reserves its right to treat an enterprise as having a PE, if a person, in
India, acting on behalf of the enterprise habitually maintains a stock of
goods or merchandise from which it regularly delivers goods or
merchandise on behalf of the enterprise
India reserves its right to provide that an insurance enterprise of a
Contracting State shall, except with respect to re-insurance, be deemed to
have a PE in India if it collects premiums in India or insures risks situated
therein through a person other than an agent of an independent status


EXCLUSIONS


9

EXCLUSIONS

The following are excluded from the definition of PE:
Use of facilities solely for storage or display of merchandise
Maintenance of stock of goods solely for the purpose of processing by another
enterprise

Maintenance of a fixed place of business solely for
Advertising
Supply of information
Scientific research
Other similar activities which have a preparatory or auxiliary character


EXCLUSIONS

According to OECD, a PE could be constituted if a foreign enterprise
maintains an office with employees that are involved in the maintenance of
goods/ machinery supplied to customers
India is of the view that even the maintenance of an office and employees
that are substantially involved in the negotiation of contracts for the import
of products or services will form a PE.
India would not include scientific research in the list of examples of activities
indicative of preparatory or auxiliary nature


10

INSTALLATION PE


INSTALLATION PE - CONCEPT

Building site or construction or installation project including the construction
of buildings, bridges or canals, excavating and dredging and the laying of
pipelines
Installation project means putting together or re-grouping of pre-fabricated
elements such as the erection of steel scaffolding or units of production
Final assembling of moveable objects (eg airplanes) also covered by the
above term
Planning and supervision covered only if carried on by the building
contractor himself
Delivery of materials to a construction or assembly project is not itself a
construction or assembly project


11

INSTALLATION PE – TEMPUS TEST

The permanence element of a PE is replaced by a test of minimum length
of time
The minimum period starts when the enterprise starts to perform business
in connection with the building or construction or installation project
Building works for different ordering parties mark the beginning of new
periods even if they are operated at one and the same place
India’s Position/Observation:
India does not agree with the words “the 12 month test applies to each
individual site or project”. It considers that a series of consecutive short
term sites or projects operated by a contractor would give rise to the
existence of a PE in the country concerned
India has reserved its right to replace construction or installation project
with construction, installation or assembly project or supervisory activities

in connection therewith and reserves its right to negotiate the period of time
for which they should last to be regarded as a PE


SERVICE PE


12

SERVICE PE - CONCEPT

Article 5(2) / (3) of the DTAA - furnishing of services by a non-resident in
India through employees or other personnel may result in creation of
‘Service PE’, provided the duration of such services exceeds the specified
period
Services may be rendered to an associated enterprise of the service
provider or a third party service recipient
The permanence element of a PE is replaced by a test of minimum length
of time in the case of Service PE as in case of Installation PE
It is important to evaluate the requirements of Article 12 before examining
the service PE clause
The number of days calculation is based on man days


STEWARDSHIP

Stewardship services are rendered to protect the interest of the customer/
principal
Stewards are typically not involved in the day-to-day management or in
rendering the services undertaken by the service provider
Their function is essentially of quality control and ensuring confidentiality
Usually, the foreign enterprise does not receive fees from the recipient of
such services and the cost of the personnel performing these services are
also borne by the foreign enterprise
Given the above, stewardship activities do not lead to the constitution of a
service PE


13

SECONDMENT

The typical features of a secondment are:
An employee of enterprise X in State X is seconded to enterprise Y in State Y;
he continues on the payroll of enterprise X
Employee resides and renders services in State Y; he reports to enterprise Y
The employee may continue to be paid by enterprise X who in turn is
reimbursed by enterprise Y

Critical parameters in determining the existence of a PE or otherwise
Commercial justification
Enterprise which exercises control over the employee
Existence or otherwise of a lien on employment with enterprise X for the
employee


PLACE OF PROVISION OF SERVICES

The persons rendering the services and the persons availing the services
may be in different locations
For example:
The employee is present in the state where the services are being rendered (ie,
Enterprise X in State X provides services to Enterprise Y in State Y)
The employee is not present in the state where the services are being rendered
(ie, An employee of Enterprise X in State X is present in State Z for rendering
services to Enterprise Y in State Y
The employee is present neither in the state where the services are being
rendered nor in the state where the services are utilized (ie, an Employee of
Enterprise X in State X who is present in State Z for rendering services to
Enterprise Y of State Y and the services are to be utilized in State Y)


14

OTHER PERSONNEL

According to OECD, the business of an enterprise is carried on mainly by
the entrepreneur or persons who are in paid employment relationship with
the enterprise. These personnel include employees and other persons
receiving instructions from the enterprise
The interpretation of ‘other persons’ referred to above is based on the
principle of noscitur a sociis
Some issues arising in interpreting ‘other persons’ are:
Whether non-individuals are included ?
Whether employees of another enterprise included ?
Should the personnel be dependent on the enterprise ?
Is there an overlap between service PE and agency PE or are they
mutually exclusive ?


AGENCY PE


15

AGENCY

Under Indian contract law, agency can be created in the following ways:
Actual express or implied authority
Ratification
Ostensible authority
Necessity
The primary test for an agency is the legal ability of the agent to bind the
principal to a third party
Origin : The first modern DTA between Prussia and Austria/Hungary, 1899


AGENCY UNDER TREATY

Replaces requirement of fixed place of business
Independent agent – no PE
Legal and economic independence
Only dependent agent constitutes a PE who-
Acts on behalf of enterprise
Has authority to conclude contracts
Has no authority but habitually maintains stock of goods and regularly delivers
goods for the enterprise
No PE if agent acts in ordinary course of business
PE in the State would be only in respect of activities which the agent
undertakes for the enterprise


16

AGENCY PE

Person acting on behalf of NO
an enterprise?

YES

Authority to conclude contract NO
No PE
exercised habitually?

YES

NO
Legally and economically
independent?

YES
PE

NO Ordinary course YES
of business?


OECD AND AGENCY PE

OECD’s position:
The agent is required to conclude contracts relating to operations which
constitute the business proper of the enterprise. The mere fact that a
person has attended or even participated in negotiations will not be
sufficient to conclude that the person has exercised an authority to
conclude contracts


17

AGENCY PE: INDIA’S POSITION

Even if a person has attended or participated in negotiations it can, in
certain circumstances, be sufficient, to conclude that he has exercised an
authority to conclude contracts in the name of the enterprise.
A person, who is authorized to negotiate the essential elements of the
contract, and not necessarily all the elements and details of the contract,
on behalf of a foreign resident, can also be said to exercise the authority to
conclude contracts and hence constitute a PE
India reserves its right to treat an enterprise of a Contracting State as
having a PE in India if a person habitually secures orders in India wholly or
almost wholly for the enterprise
India reserves its right to make it clear that an agent whose activities are
conducted wholly or almost wholly on behalf of a single enterprise will not
be considered an agent of an independent status


CHALLENGES TO PE
CONCEPT


18

CHALLENGES TO FIXED PLACE PE

Website by itself creates a PE for a foreign enterprise?
Location of server to be considered?
Can access in India to a website hosted outside India create a PE ?
Problem area especially for ecommerce portals

Website hosted on server located in India may create a PE
PE could exist even if website not accessed from India
Independent activities completed through a vessel / ship be considered as a
fixed place PE?
Website by itself creates a PE for a foreign enterprise?
Presence of property in the other contracting state can lead to the creation
of a PE?


CHALLENGES TO INSTALLATION PE

Whether series of short term unrelated contracts covered ?
Whether Subcontractor days should be counted towards main contractor
days?
Treatment to be give to temporary gaps?


19

CHALLENGES TO SERVICE PE

The period of six months within a twelve month period :
Month as a calendar month ?
Month as a period of thirty days?
How should the word ‘month’ be interpreted for twelve month calculation?
Should the services be rendered for a continuous period of six months?
Outsourcing of services to any other enterprise- whether service PE ?


CHALLENGES TO AGENCY PE

Dependent agent – Separate for each function ?
Attendance or participation in negotiations - sufficient to create PE ?
Actual concluding of contracts not essential
Minutes of meetings with clients/document trail assume importance
Negotiation of which elements (essential or all) can be considered as
adequate to create PE ?
Processing and subsequent delivery directly by processor to customers -
PE ?


20

DARPAN MEHTA
BMR Advisors
darpan.mehta@bmradvisors.com

Mob: +91 9769249148
Off: +91 022 30217135

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