How to Assess Permanent Establishment Risk Under India's DTAAs for Cross-Border Business

Kaustav Chowdhury
1 day ago
6 min read

Foreign businesses operating in or with India face the critical question of whether their activities create a "permanent establishment" (PE) under India's network of double taxation avoidance agreements. A PE determination has significant consequences: if a foreign enterprise is found to have a PE in India, profits attributable to that PE become taxable in India. This guide provides a step-by-step framework for identifying, evaluating, and mitigating PE risk under the major categories recognised in India's DTAAs, the domestic Income Tax Act, 1961, and relevant judicial precedent.

Step 1: Understand the Distinction Between Business Connection and Treaty PE

The starting point for any PE risk assessment is understanding the interaction between domestic law and treaty law. Under Section 9(1)(i) of the Income Tax Act, 1961, income is deemed to accrue or arise in India if it arises through or from any "business connection" in India. The concept of business connection is broad: it encompasses any relationship between a non-resident's business and activity in India that contributes, directly or indirectly, to the earning of profits. Explanation 2 to Section 9(1)(i) further clarifies that a non-resident has a business connection in India if it has a PE here.

However, where a DTAA applies, the narrower treaty definition of "permanent establishment" under Article 5 prevails over the wider domestic concept, provided the treaty is more beneficial to the assessee. This is because Section 90(2) of the Income Tax Act allows the assessee to be governed by the DTAA or the Act, whichever are more beneficial. Therefore, the first step is to identify which DTAA applies and examine its specific PE provisions.

Step 2: Evaluate Fixed Place PE Risk (Article 5(1))

Article 5(1) of most DTAAs defines a PE as a "fixed place of business through which the business of an enterprise is wholly or partly carried on." A fixed place PE typically includes an office, branch, factory, workshop, mine, quarry, or any other place of extraction of natural resources.

India applies a "disposal test": if the foreign enterprise has the right to use premises in India to carry on its own business activities (whether owned, rented, or otherwise at its disposal), that location may constitute a PE. The key factors are:

Permanence: The place of business must have a degree of permanence; purely temporary arrangements generally do not qualify
Business activity: The enterprise must carry on its business through that fixed place, not merely maintain the premises
Control or right to use: The enterprise must exercise control over the location or have the right to use it for business purposes

Article 5(4) of most treaties lists activities excluded from PE status even if conducted from a fixed place, including the use of facilities solely for storage, display, or delivery of goods, or the maintenance of a fixed place solely for purchasing goods or collecting information. If the activity is "preparatory or auxiliary" in character, it will not create a PE.

Step 3: Assess Service PE Exposure

A "service PE" arises when a foreign enterprise furnishes services in India through employees or other personnel present beyond a specified number of days. The threshold varies by treaty: the India-US DTAA sets 90 days in any taxable year, while many other treaties (following the UN Model) prescribe 183 days within any twelve-month period for the same or a connected project.

The Delhi High Court's ruling in Commissioner of Income Tax v. Clifford Chance Pte Ltd (decided 4 December 2025) is particularly instructive. The Court held that a service PE under the India-Singapore DTAA requires actual physical presence of employees furnishing services "within India." Virtual or remote service delivery does not create a service PE. The Court clarified that only days on which services were actually rendered to clients should be counted toward the threshold, excluding vacation days, business development days, and overlapping days.

Action item: Track the number of days employees spend in India rendering services, verify the specific threshold in the applicable DTAA, and maintain records distinguishing actual service delivery from other presence.

Step 4: Evaluate Agency PE Risk

An agency PE under Article 5(5) arises when a person (other than an independent agent) acts in India on behalf of the foreign enterprise and habitually exercises authority to conclude contracts in its name. The key conditions are:

Dependence: The agent must be "dependent" on the foreign enterprise, not an independent agent acting in the ordinary course of its own business
Habitual authority: The agent must habitually exercise contract-concluding authority, not merely negotiate terms
Binding contracts: The contracts concluded must be in the name of, or binding upon, the foreign enterprise

The UN Model Tax Convention expands this concept. Under Article 5(5)(b), an agency PE can also arise if the agent maintains a stock of goods from which it regularly delivers on behalf of the enterprise, even without contract-concluding authority. India's treaties with developing nations frequently adopt this broader formulation. Indian courts have emphasised that mere dependency is insufficient; the specific conditions under Article 5(5) must be met.

Action item: Review the role and authority of any local distributors, representatives, or agents. Determine whether they exercise contract-concluding authority on behalf of the foreign enterprise.

Step 5: Review Construction PE Thresholds (Article 5(3))

A construction PE arises when a building site, construction project, or installation project exceeds the duration threshold in the applicable DTAA. The OECD Model sets this at twelve months, but India's treaties frequently adopt shorter periods:

India-US DTAA: 120 days within any twelve-month period
India-UK DTAA: More than six months
India-UAE DTAA: Nine months
India-Singapore DTAA: 183 days

When computing duration, days contributed by all employees, subcontractors, and personnel working on the project are typically aggregated. The OECD Commentary recognises that subcontractor time should be included in calculating the principal contractor's presence.

Step 6: Map the Applicable DTAA and Compare OECD and UN Model Provisions

India has DTAAs with over 90 countries. Each treaty may vary from the standard OECD or UN Model. The key differences relevant to PE assessment are:

Taxation philosophy: The OECD Model favours residence-based taxation with a narrower PE definition; the UN Model favours source-based taxation with broader PE triggers
Service PE: The UN Model includes a specific service PE provision in Article 5(3)(b); the OECD Model has no equivalent
Agency PE: The UN Model's Article 5(5)(b) treats stock-maintaining agents as creating a PE; the OECD Model does not
Exclusions: The UN Model omits "delivery" from the Article 5(4) list of excluded activities, making delivery operations more likely to constitute a PE

The 2025 Update to the OECD Model Tax Convention, approved on 18 November 2025, introduced new guidance on remote work and PE, including a 50% working time benchmark and a commercial reason test for home office PE. Businesses should monitor whether India's DTAAs incorporate these updated principles.

Step 7: Implement Mitigation Strategies

Once PE risk has been identified, businesses can take practical steps to mitigate exposure:

Rely on Article 5(4) exclusions: Structure activities in India to fall within the preparatory or auxiliary exclusion, such as market research, liaison, or information-gathering
Monitor service PE thresholds: Limit cumulative employee deputation to remain below the applicable threshold in the relevant DTAA
Ensure agent independence: If using local agents, ensure they operate as genuinely independent agents bearing their own commercial risk
Maintain documentation: Keep contemporaneous records of the nature, duration, and location of all activities in India
Seek advance rulings: Apply to the Authority for Advance Rulings under Section 245Q of the Income Tax Act to obtain certainty on PE status
Review intercompany agreements: Ensure contracts and secondment agreements do not inadvertently create PE exposure

Common Pitfalls in PE Risk Assessment

Businesses frequently encounter the following issues:

Assuming no office means no PE: Service PE and agency PE can arise without fixed physical premises in India
Relying on OECD Model thresholds: India's treaties frequently adopt different (often lower) thresholds; always check the specific DTAA
Failing to aggregate days: For service PE, days of all employees rendering services must be aggregated, not counted individually
Treating dependent agents as independent: Distributors who regularly conclude contracts on behalf of the enterprise may create an agency PE regardless of labelling
Ignoring domestic law: Even if a DTAA PE threshold is not crossed, the broader "business connection" under Section 9(1)(i) may still apply

Conclusion

Permanent establishment risk is a multifaceted challenge that requires careful analysis of treaty provisions, domestic law, and specific business facts. By systematically working through each PE category (fixed place, service, agency, and construction), mapping the applicable DTAA, and implementing targeted mitigation strategies, foreign businesses can manage their PE exposure and avoid unexpected tax liabilities in India. Given the evolving judicial landscape, including the Delhi High Court's December 2025 ruling in Clifford Chance rejecting virtual service PE, and the 2025 updates to the OECD Model Tax Convention, regular PE risk review should be integral to cross-border tax planning for any business with operations or clients in India.