Permanent Establishments & Double Taxation Avoidance Agreements VIS-A-VIS The Indian Income Tax Act 1961

Plan & Executive Summary

  • The initial section provides a brief discourse on the twin principles of taxation- residence based and source based taxation- and the international stand on the same.
  • Section 2 is tripartite. It continues from the introduction to a PE and firstly, the relevant Indian legal provisions are discussed therein. Secondly, two terms – business connection and attribution of profits- used in the parlance of DTAAs are elucidated. Finally, the three types of Permanent establishments are elaborated; they are, fixed place PE, agency PE and service PE.
  • The penultimate quadripartite Section 3 includes an in-depth analysis of important case laws. The first part discusses watershed cases, which dealt with ‘what would constitute a PE’. Herein, case relating to the definition of PE and the essential nature of a business connection are briefed.

Part 2 speaks on the question of taxation in royalty fee payments. Therein, six scenarios are exhaustively explained and substantiated with judicial pronouncements. They are:

Computer software in e-commerce

Satellite transponders’ capacity

Usage of servers and portals

Designs & drawings- Copyright transfers

Equipment royalty and

Reimbursement of salary monies to the PE

Part 3 talks about the taxability of interest rates paid to the HO by Indian branches of foreign banks and the interest monies collected by the Indian branch from the other intra-group bank branches.

Finally, the last part dwells upon the question of attributing profits for the purpose of taxation when the PE was remunerated at ALP by the Foreign Company. Herein, the legal fiction in regarding the Indian PE as a separate entity is also discussed with cases.

  • The last section concludes the discussion with a moot point.

SECTION I: Introduction

Generally, two principles are recognised in taxation methods: residence based taxation and source based taxation. They are not mutually exclusive and their operating fields intersect at several junctures creating knots for the taxpayer and the tax collectors to untangle. Hence, the issue of Double taxation arises when the same income is subject to taxation in two different jurisdictions based on either principle. To avoid such a situation, the concept of ‘Permanent Establishment’ was evolved in International Fiscal Law [1] to help establish taxing jurisdiction over a foreigner’s business activities.

‘Permanent Establishments’ is an age-old term used to refer to the taxable presence of a foreign Enterprise in another jurisdiction. When an individual or a natural person makes certain tax gains in another country, he should declare himself as a non-resident of that particular country. There should be a system of information sharing between his home country and the foreign country through which the relevant authorities could be alerted to tax his income, assets or financial transactions. However, a legal person by owning foreign subsidiaries could be simultaneously resident in multiple jurisdictions. Hence, it becomes complicated to control the unreasonable tax avoidance of these institutions through Transfer pricing. A PE also helps shift profits to the home country thereby avoiding domestic taxation in the host country.

It is important to note that a permanent establishment should not be construed in the literal sense and it can be seen that the benchmark has been adjusted and altered through a course of judicial precedents and jurisprudence apart from the institutional interference on part of the OECD through its repeatedly amended Model Tax Convention. Art.5 of the OECD Model Tax Convention elucidates on the threshold of activity that triggers the existence of a PE and such an understanding is reflected in most double tax treaties around the world. Art.7 (1) OECD Model Tax Convention reads that:

“Profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits that are attributable to the permanent establishment in accordance with the other provisions may be taxed in that other State.”

This legal concept reconciles the twin principles of taxation and the profits of an enterprise from one Contracting State can be made taxable in another such State if a PE is maintained in this State, and by the other enterprise. Therefore, the jurisdiction to tax the business profits can be transferred from one State to the other. This can be achieved when either the host country exempts the PE from taxation or awards foreign tax credits to it, to reflect the fact that tax has already been paid.

SECTION II: Permanent Establishment

Relevant Indian Statutory provisions

S.92F iii (a) of the Indian Income Tax Act, 1961 explains the term “Permanent Establishment (PE)” as a fixed place of business through which the business of the enterprise is wholly or partly carried out. S. 5(2) of the Act discusses the scope of ‘taxable income’ based on profits & losses incurred and S.9 deals with business connection. However, the tax treaty can supersede these legal provisions, when the non-resident is residing in a country with which India has entered into a Double Tax Avoidance Agreement (DTAA).

  1. 44DA was inserted by the Finance Act, 2003, with effect from April 1, 2004. It provides for taxation of income in the nature of ‘‘royalty’’ or ‘‘fees for technical services’’, which were effectively connected with the PE of the non-resident in India, on a net basis, where such income was derived in pursuance of an agreement entered on or after April 1, 2003 with an Indian concern or the Government of India. Earlier, S.44BB would apply only in a case where the consideration is for services and other facilities relating to exploration activities. Now, the 2010 amendment (with effect from April 2011) has removed confusion and this provision is applicable only when the former section does not provide jurisdiction

Whereas, S.115A provides the rate of taxation in respect of income of a non-resident, including a foreign company, in the nature of royalty or fee for technical services, other than the income referred to in section 44DA.

Furthermore, Ss. 90 & 91 of the Act provide relief to taxpayers who have already paid up in one jurisdiction and who are being subject to taxation in another jurisdiction. While the scope of the former legal provision is exclusive to those 88 countries with which India has entered into DTAAs (of which 85 have been ratified), S. 91 is concerned with the remaining tax jurisdictions.

Before venturing into a discussion on the legal concept of PE, a brief excursion into the topic of Business connections and attribution of profits is necessitated.


Business Connection & Attribution of Profits

It is a long recognised term in determination of tax liabilities incurred in trans-border business relationships. Such a connection can be said to have been established when a non-resident transacts with a resident and earns an income from such activities. Such an income could be realised in the form of profits or losses. If this business association cannot be established, no question of a PE can arise. Illustrative examples are:

  • Maintaining a branch office in India for the sale of goods.
  • Appointing an agent in India for systematic and regular purchase of raw materials and other commodities.
  • Erection of a factory in India for the conversion of the raw material into an exportable good.
  • Forming a local subsidiary company.
  • A financial association between the resident and the non-resident etc.


A parent company can have a PE in its subsidiary’s state of residence if the general requirements for a PE set out in Art. 5(1) to (5) of the OECD Model are met. The requisites can be studied by typifying three classes of Permanent establishments:

  • Fixed place PE
  • Agency PE &
  • Service PE

Fixed place Permanent Establishment

Facility with premises, and even equipment or machinery in certain instances. Place of business includes any installations and they need not exist solely for the purpose of carrying on the business of the Foreign Holding Company. The persons dependent on the enterprise should conduct the business of the enterprises at the place where the ‘distinct situs’ exists. This place could be rented or owned and it can exist even when no place is required to carry on the business. It could be constituted by a pitch in the market place or by a certain permanently used area in the customs depot (e.g. for the storage of dutiable goods), which is at the constant disposal of the foreign AE in another Contracting State.

No formal legal right of possession in respect of that place is necessary; [2] but mere presence would not suffice to establish that the said place is at the disposal of the enterprise. The employees of the Foreign Enterprise should have usage of the Indian subsidiary’s office as a matter of right, so that they may ‘wholly or partly’ carry on their business activities through that place. [3]

The fixed place of business standard has been replaced by a threefold test: first being the effective power to use the location; second, the extent of actual presence (i.e. duration) and third the nature of the relevant activity. The OECD has further clarified that a foreign MNC periodically sending its employees to visit the office of a local subsidiary would not qualify as a taxable local presence.

Therefore, ‘the fixed place of business’ standard can be summarised in four tests:

  • Place of business test
  • Business activity test
  • Permanence test &
  • Disposition test

Certain miscellaneous concepts should be discussed within fixed place PE:

Place of Management

Management means the possession of actual decision-making power and the place where the person actually makes these decisions is crucial. [4] The permanence rule comes into play here and there is a consensus that the term ‘place of management’ does not include a ‘hotel room or similar place temporarily occupied by officials of an enterprise’. [5] But an abstract idea cannot be constructed to determine when a place of management would qualify as a PE. It is subjective and it is influence by the fact scenario of the case.

Productive character

This refers to the contribution to the profits of the enterprise. But this element has been deemphasised since it was realised that it would be purely axiomatic to assume in the case of a well-run business that every entity which forms a part of it, invariably makes a positive contribution to its overall productivity. This amendment was brought in by way of the 2011 draft and an inclusion has been made through the 2014 update.


Time requirement

The OECD proposals suggest a minimum of six-month duration whilst observing that country practices may differ. However, there are exceptions where the minimum duration becomes immaterial. For instance, when short-term activities are regularly conducted in a State but recurring over a number of years or when the business itself requires a duration of less than six months for its completion. Nevertheless, ambiguity exists in determining when a business conducted solely in the host country might crystallise a PE and the relevance of the time period requirement in this scenario.


Visiting employees & secondments

Normally, cross-border secondment arrangements should not lead to a PE of the seconding vehicle. This is because within MNCs, employees are regularly seconded to the other subsidiaries and these employees carry out the business activities of the other company and not that of the parent enterprise. Hence, such situations cannot create a PE.

Home offices

It is debatable whether the taxing rights should be extended to include home offices as well. Nevertheless, these activities- even if they are classed as business activities- are auxiliary and hence, they cannot constitute a PE.

Agency Permanent Establishment

Agency PE is at contrast to fixed place PE since the place of business is rather moving and not stationery. A dependent agent may constitute a PE of the principal whom he represents in certain transactions with third parties. He can indirectly perform certain activities on behalf of an Enterprise. An agency does not require physical presence and it only necessitates a relationship between the principal and the agent, indicating that it should have a separate legal existence. However, not all agents apart from those of an independent status would constitute a PE; they should satisfy at least one of the following categories:

  • Have a certain contracting power.
  • Secure orders wholly or almost wholly on behalf of the foreign enterprise.
  • Regularly deliver goods from the inventory.

Under Art. 5(5) of the OECD Model, a subsidiary constitutes an agency PE of its parent if the subsidiary has the authority to conclude contracts in the name of its parent and habitually exercises this authority, unless these activities are limited to those referred to in Art. 5(4) or unless the subsidiary acts in the ordinary course of its business as an independent agent within the meaning of Art. 5(6) [like a general commission agent, broker or any other agent of independent status].

Contracting power

If the foreign principal is legally bound by the contracts concluded on its behalf by its agent with independent third party agents, then the local agency may qualify as a PE. Such a situation might arise even if the contract is not concluded expressly in the name of the Foreign Company. This can be illustrated with the example of a common law agent contracting for the sake of an undisclosed principal. Here, the name of the name would not be referred to in the contract and the local agent would not disclose his Principal. Art. 5(5) of the Indo-US DTAA enshrines this principle.

S.9 of Income Tax Act 1961 via explanation 2, recognises the International principle and states that:

Business connection shall include any business activity carried out through a person who, acting on behalf of the non -resident, (a) has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident, unless his activities are limited to the purchase of goods or merchandise for the non-resident”.

Therefore, the standard to constitute an Agency PE can be summarised in two tests:

  • Dependency test
  • Binding test.

While the Dependency rule visualises a relationship of legal and economic dependency, the latter rule hold that there should be a finality in the decisions taken by the agent while contracting on behalf of the Foreign Principal.

Service Permanent Establishment

When a Foreign Enterprise furnishes or performs certain services in India other than the ‘Included services’ and ‘Technical services’ or when it has certain employees or personnel providing such services out of India, then the question of imputing the status of a PE to such a legal entity arises. In India, the royalty fees paid by an Indian concern is disallowable and it shall be computed under the head, ‘profits and gains of business or profession’. ‘Royalty’ has been defined u/s. 9(1) (vi) explanation 2 as a fee or a lump sum considerations in return for:

  • Either the transfer of rights over or the sharing of information related to usage or the grant of license for usage of a patent, invention, model, design, secret formula, model, process or trademarked property;
  • Either imparting information related to scientific, technical, industrial or commercial knowledge or experience or providing the rights to use the same;
  • Or ‘transfer of all or any rights in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films’.

SECTION III: Precedential Study


What constitutes a PE/ business connection?

In the watershed case of CIT v. Vishakhapatnam Port Trust, [6] the AP High Court observed that:

“The words “Permanent Establishment” postulate the existence of a substantial element of an enduring or permanent nature of a foreign enterprise in another, which can be attributed to a fixed place of business in that country. It should be of such a nature that it would amount to a virtual projection of the foreign enterprise of one country onto the soil of another country.”

This viewpoint supplements the UN Model Tax Convention, which essentialises a ‘fixed base’ for ‘professional activities’ or ‘other activities’ of an ‘independent character.’

In the cases of Motorola Communication Inc, Ericsson Radio Systems AB & Nokia Networks OY,[7] the legal issue concerned was whether a ‘wholly owned Indian subsidiary’ by a non-resident, could by itself constitute a business connection amounting to a PE. The Tribunal opined that:

“No income is deemed to accrue in India to a non-resident from the sale of hardware and software if such sale is effected outside India to an Indian purchaser even though the non-resident supplier, along with other group companies, has entered into a turnkey contract for supply and installation of equipment in India and the non-resident supplier assumes overall responsibility for the proper execution of said turnkey contract.”

The Tribunal also made some important observations:

  • The existence of a liaison office in India, of a non-resident in itself does not, constitute its PE in India.
  • A wholly owned subsidiary of a non-resident in India would constitute its PE, if their mutual relationship leads to the distinction between these two corporate entities becoming blurred.
  • In the case of Sony Ericsson, the Tribunal found that the ‘group company’ could not be a ‘dependent agent’ of the foreign enterprise since it lacked the authority to conclude contracts on behalf of the parent company. Hence, the business profits were subject to domestic taxation.
  • In the case of Motorola, the employees in the Indian subsidiary were paid by the parent company, which also reimbursed -with a mark-up- the Indian company for the provision of prerequisites to the said employees. Despite being persuaded otherwise, the Tribunal had to hold that a PE was not constituted in India, considering the Indo- US DTAA. The ‘preparatory’ and ‘auxiliary’ activities performed by the Indian subsidiary were excluded from the elements of a PE by Art.5 (3) e of the said DTAA .Therefore, business profits from the Indian subsidiary were liable to local taxation.
  • In the case of Nokia, the Special Bench upheld the specific bar imposed by the RBI and ruled that its liaison office would not constitute its PE in India as it was not carrying on commercial activities.


In the case of DIT v. E Funds Corporation & DIT v. E Funds IT Solutions, the issue to be decided was whether the taxpayers had a permanent establishment in India under Arts. 5(1), 5(2) (1) and 5(4) of the India- US DTAA. Delhi HC held that Indian Subsidiary of a foreign company providing back office support operations does not constitute a PE in India. The High court has rightly observed that a wholly owned Indian company of a foreign company would not create a permanent establishment for the Assessee, despite the MAP [Mutual Agreement Procedure] finding to the contrary. There was no authority with the Indian Subsidiary to take any decisions or conclude contracts, etc. on behalf of its Foreign Holding Company and hence such Indian subsidiary cannot be termed as agency PE of its Foreign Holding Company.


Birla Corporation Ltd. v. ACIT is another landmark case where the Jabalpur Tribunal held that part of the consideration, which can be attributed to installation, commissioning or assembly of the plant and machinery, or any supervision activity in connection thereto, had an income embedded in it, which was taxable under the Income Tax Act, 1961. The Tribunal reasoned that the said income accrues and arises in India and is thereby taxable here since the related economic activity was performed in India. Further, the India-Belgium and the India-U.K. tax treaties provide an additional condition of value of such installation/commissioning services to be more than 10 per cent of the sale value. This condition was also not fulfilled in the present case and accordingly, an installation PE was not created under the relevant tax treaties.

Furthermore, the Court ruled that such services would constitute ‘technical services’ and therefore result in a conflict of laws since a general provision exists for FTS & FIS apart the specific provision dealing with installation PE. Relying on earlier judgments, the Jabalpur Tribunal held that a specific provision would prevail over any number of general provisions in law, in case of apparent conflicts. [8]

The Tribunal rejected the in arguendo argument that upon the failure of the PE test for installation/commissioning, the general FTS legal provision should apply. It opined that such a scenario would render the PE test ‘meaningless’. Therefore, the receipts in the hands of the parties and the payments towards the same were held to be in the nature of ‘business income’ and the same were not taxable in India in the absence of a PE under the relevant tax treaties. Hence, the taxpayer is under no obligation to deduct tax at source on such payments. The matter was remanded to the AO to verify the existence of a PE of foreign parties. [9]


In the case of Galileo International Inc. v. DCIT, [10] the Court allowed an income greater the entire revenue generated by the Indian Operations when it was paid as commission to its Indian agent. In other words, since the payment made to InterGlobe was greater than the entire income attributable to India, the taxpayer faced no tax liability here. Clearly, Galileo USA falls under the explanation 2(a) of section 9 of the Act, which has been laid down to decide the business connection.

As given in the second proviso to explanation 2 of S.9, the InterGlobe/ Galileo India provided services only to its American counterpart. As mentioned u/s. 9, independent status cannot be attributed to InterGlobe since it functioned mostly/wholly on behalf of Galileo USA. Hence, undoubtedly, it would constitute a business connection.

Further, the conditions laid down by OECD guidelines are also satisfied. Ownership of computer machinery may constitute a PE if it can be associated with a fixed place of business, where the relevant business activities are carried out either in part or in whole. [11] Since Galileo USA also provided all the intangible and tangible assets required for the business, Galileo India can be said to constitute its PE.

Furthermore, the Hon’ble Supreme Court in the case of CIT v. R.D. Agarwal & Co., [12] held thus: “The expression ‘business connection’ undoubtedly means something more than business. Abusiness connection u/s.42 involves a relation between a business carried on by a non-resident that yields profits or gains and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits or gains. It predicates an element of continuity between the business of the non-resident and the activity in the taxable territories and a stray or isolated transaction is normally not to be regarded as a business connection. It may include:

  • Carrying on a part of the main business or activity incidental to the main business of the non-resident through an agent;
  • Any relation between the business of the non-resident and the activity in the taxable territories, which facilitates or assists the carrying on of that business.

In each case, the question whether there is a business connection from or through which income, profits or gains arise or accrue to a non-resident must be determined upon the facts and circumstances of the case.”

The Court further opined that, “A relation to be a business connection must be real and intimate, and through or from which income must accrue or arise whether directly or indirectly to the non-resident. But it must in all cases be remembered that by s.42, income, profit or gain which accrues or arises to a non-resident outside the taxable territories is sought to be brought within the net of the income-tax law, and not income, profit or gain which accrues or arises or is deemed to accrue or arise within the taxable territories. Income received or deemed to be received, or accruing or arising or deemed to be accruing or arising within the taxable territories in the previous year is taxable by s.4(1)(a) & (c) of the Act, whether the person earning is a resident or non-resident. If the agent of a non-resident receives that income or is entitled to receive that income, it may be taxed in the hands of the agent by the machinery provision enacted in s.40 (2). Income not taxable u/s.4 of the Act of a non-resident becomes taxable u/s.42 (1) if there subsists a connection between the activities in the taxable territories.”


Taxation of Royalty Fee Payment

Scenario 1: Is Payment for use of transponder capacity for relaying over a footprint area a royalty fee?

Recently, the Delhi High Court in the case of Asia Satellite Telecommunications Co. Ltd., [13]  held that the payments made for using capacity in a transponder for up linking/down linking data do not constitute ‘royalty’ u/s.44DA. The taxpayer was a Hong Kong based telecom service provider who engaged in telemetry in South East Asia and India was a satellite footprint. Since the signals were received by customers in India the question of considering the payments made to the taxpayer by the service recipients, as a ‘royalty’ arose. If the amount collected from the Indian operators and customers could be termed ‘royalty fee’ as understood u/s.9 (1) (iv) explanation 2, then it would be liable to domestic taxation.

There were three issues to be decided here:

  • Firstly, applicability of Section 9(1) (i) of the Act to the payments received by the taxpayer;

The Tribunal held that even though the taxpayer has a business connection in India, no part of the taxpayer’s income was chargeable to tax in India as no operations to earn the income were carried out in India. The High Court held a similar view and observed that in terms of Explanation (a) to Section 9(1) (i) of the Act only so much of the income as is reasonably attributable to the operations carried out in India can be brought to tax under Section 9(1)(i) of the Act. Here, the programmes are uplinked by the customers outside India; amplification of signals takes place at the satellite, which is not located in Indian airspace; and the amplified programme signals are relayed over the footprint area, which includes India, for the cable operators to downlink the signal and pass on the same for viewing by Indian population. Hence, the Court emphatically held that relay of the programmes in India does not amount to operations being carried in India by the taxpayer. Further, as the taxpayer did not have any facility, assets or presence in India, S. 9 (1) (i) was found to be inapplicable.


  • Secondly, whether payment received by the taxpayer can be regarded as “royalty” under section 9(1) (vi);

Grant of usage or control over the concerned tangible or intangible property is necessary to establish royalty fee payment. The Tribunal held that:  “The customers were using a process as a result of which the signals, after being received in the taxpayers’ satellite were converted to a different frequency and were relayed to the area covered by the footprint, after amplification.” High Court observed that the taxpayer alone was the operator of satellites. Further, the arrangement was only to lease transponder capacity, while the taxpayer enjoyed control over the satellite. The High Court relied heavily on the ruling of the Authority of Advance Rulings (AAR) in the case of ISRO Satellite Centre. [14] In this ruling, the AAR had held that in case of an agreement for lease of transponder capacity, if no control over parts of satellite/ transponder has been given to the customers, then the payments for use of transponder capacity would not qualify as royalty under the Act.  By applying the ratio of this case, the HC held that the transponder is an in-severable part of the satellite which cannot function without the continuous support of various systems and components of the satellite. Thereby, the Court opined that it is wrong to assume that the control and constructive possession of the transponder can be handed over by the satellite operator to its customers. Therefore, no question of royalty fee payment for usage of an equipment or a process should arise.


  • Thirdly, whether the payment by the taxpayer can be regarded as Fee for technical Services under section 9(1) (vii).

Taxability of the payments as Fee for technical Services was admitted as an additional ground before the Tribunal. However, the Tribunal did not decide on the issue because it held that the income was taxable under Section 9(1)(vi) as royalty.  Since no argument was advanced by the tax department on this ground before the High Court, the High Court did not adjudicate on this matter.

However, the High Court followed Ishikawajima-Harima Heavy Industries Company Ltd. [15] case in which it was held that sufficient territorial nexus with India was sine qua non for attracting taxation. Therefore, payments from TV channels could not be taxed in India as there was insufficient territorial nexus with India.

The High Court has settled a long-standing controversy and aligned India’s position with various international forums such as OECD after the unfavourable decree in the Special Bench ruling of the Delhi Tribunal in New Skies BV case. [16] However, the new judgment affirms the earliest case that considered this issue, i.e. the Raj Television Networks case (Chennai Tribunal) (2001), which held that since the payments are not for use of any specified intellectual property rights or imparting any industrial, commercial or scientific information, the same cannot be said to be ‘royalties’ under the Act.


Scenario 2: Is the reimbursement by the Foreign Enterprise of the salaries paid by the Indian PE taxable?

This question was considered by the court in the famous Morgan Stanley Int’l Inc. case. [17] The Court rendered clarity on the tension between Arts. 7 & 12 of the Indo-US DTAA. Art.7 was held to be applicable here and therefore the profits attributable to the PE were capable of being taxed in the US.  Art. 12 was found to be inapplicable in cases relating to a PE.

The Court held that reimbursement of salary paid to deputed employees by a foreign company having Service PE in India is not liable to withholding tax since it’s a business profit and that it is not FIS under the India-USA tax treaty. Article 12(6) of India-USA tax treaty provides that provisions of Article 12 shall not apply to ‘royalty’ and FIS arising through PE situated in India. In this case, the Court had entered a frontier in the double taxation issue since the Delhi High Court had not considered this concept in the earlier case of Centrica India Offshore (P.) Ltd v. CIT, which provided for the withholding of tax on reimbursement of salary costs of expatriates, who are seconded in India by foreign MNCs, for working for their Indian subsidiary companies. [18]The Mumbai Tribunal has provided relief to tax payers. It held that:

“The secondees, through their presences in India, constituted “service PE” of MSI. Since the reimbursement of salary costs, even if held as FTS as per the ruling of the Delhi HCt, were obviously effectively connected with such service PE, the same automatically came out of the gross basis form of taxation envisaged under the Article dealing with FTS. They were to be considered as business profits, subjected to net basis form of taxation under Art.7; and there being no element of net profit involved in the instant case, MSI had no tax liability in India”.

Scenario 3: Taxation in E-commerce- Computer Software

According to a technical advisory report published by the OECD, out of the twenty-eight forms of e-commerce only three are taxable. [19] But the classification of e-commerce is problematic and it complicates matters since despite the huge consequences in terms of the tax treatment services like the sale of computer software continue to remain in the grey area and there isn’t much clarity on whether it is a business income or a royalty payment. As a royalty fee paid to the vendor it would count as a remuneration for the right to use copyrighted material and it would be subject to tax in the source country depending on the tax treaty. [20] However, as a sale or a service income in the course of business it would be treated differently. If there is a PE in the source country, it would only be taxable there as per the relevant Bilateral Tax Treaty. [21]

In Dy. CIT non-resident circle, New Delhi v. Metapath Software Int’l Ltd.,[22] the Delhi HC considered the classification of income concerning computer software. The issue before the Court was whether, in the instant case, there was an acquisition of copyrighted article or whether there was an acquisition of copyright for the article. If it is the former, then it would be a mere purchase price, hence it would fall under business income, and subsequently tax cannot be withheld at source. Nevertheless, if it can be established that there was a purchase of copyrights then the payment would count as a royalty fee for the commercial exploitation of a copyrighted article. In the facts of the case, there was no commercial exploitation and the party did not have any of the rights mentioned inclauses (a) and (b) of S.14 of the Copyright Act 1957. Hence, by following the Motorola Inc v. Dy. CIT, [23] the Court held that it was not a royalty payment neither under the Act nor under the Treaty. Hence, it was not taxable solely in India.


Scenario 4: Place of accrual of the royalty is outside India. Will it be taxable in India?

In the case of Aktiengesellschaft Kuhnle Kopp & Kausch W. Germany [24] the Hon’ble High Court held that though royalty was paid by a resident to non-resident, the royalty was paid out of export sales. The origin or the source of the income was outside India, and therefore not taxable in India. The ruling is basically a reaffirmation of the exclusion of ‘deemed royalty’ as mentioned in Section 9(1) (vi) of the Act. This particular ruling is on Royalty but the same principle holds good for FTS also.


Scenario 5: Equipment royalty- User charges for servers and portals

In the case of Cargo Community Network, the non – resident company based in Singapore hosted a portal and provided access to an air cargo portal. Indian booking agents paid Fees for cargo booking and related services like subscription fee, system connection fees and help desk support fees. Help desk services were provided by the Indian Liaison Office located in India. The payments made by the Cargo Agents in India were in consideration of use of the portal developed by the non-resident company and hosted in its server at Singapore. The portal was displayed in the computer screen of the agent in India. The AAR concluded that server and portal together constitute equipment. The equipment, the Authority observed, was used in India. In the facts of the case, the payment was held as equipment royalty. [25]


Scenario 6: Drawings & Designs- Mere passing of info or did owner part with his right to economic exploitation for a consideration? Was it sale?

In the case of CIT v. Neyvalli Lignite Corporation [26] The assessee was engaged in the mining of lignite. It entered into an agreement with a Hungarian Company in connection with its plan for acquisition of Steam Generating Plans. The foreign company was to design, manufacture and supply necessary equipments and material and supervise the erection, testing and commission of the plant. The consideration for the deliverables was broken up into separate works such as designing, commissioning etc.

The ITO held the amount relating to drawing and design charges to be royalty, and therefore taxable in India. The ruling of the Court, however, was in favour of the assessee. The Court held that:

“Royalty can be deemed to accrue or arise only if the holder of an exclusive right parts with the exclusive right for a consideration and allows the other party to use it; mere passing of information concerning design does not itself constitute royalty”.


In the case of CIT v. Davy Ashmore [27] An essential precondition for determining royalty is that the non-resident owner of such intellectual property should retain the property while allowing the right to use such intellectual property. The assessee made payments to a foreign entity in connection with acquisition of certain designs and drawings. These payments were sought to be taxed by the ITO as royalty under Section 9(1) (vi) of the IT Act. The Court rejected the ITO’s contention and held that it was a case of outright sale and therefore, the consideration could not be referred to as royalty.


In the case of Gmp International GmbH [28] the assessee was engaged as a consultant for drawing and design services for the new Tamil Nadu Legislative Assembly Building. The consultancy service for supply of drawings and designs to the Government of Tamil Nadu was held to be Fees for Technical Service (FTS). The contention of the applicant that the transaction is a transfer of capital asset effected offshore was not found acceptable. The Authorities commented that the mere fact that the sub-contractor was required to perform most of the services connected with the designing of the Complex, and received nearly half of the contact value did not mean that the applicant had not rendered any consultancy services apart from presenting a conceptual architectural design. Therefore, the FTS was taxable here and it was held to have been accrued in India.


Taxability of interest rate paid by Indian branch office of a Foreign Bank to its Head Office

In the case of ABN Amro Bank NV, [29] a question arose as to whether the bank, while computing the income of its Indian Branches (‘PE’), was eligible to claim deduction for amounts debited to the profit and loss account of the Indian branches representing interest payable to overseas offices of the bank.

Facts: The assessee is a Dutch Company and it is an incorporated tax resident in Netherlands. The Indian branch carries out the banking business as a permanent establishment PE, as understood under the relevant provisions of the bilateral tax treaty. In the course of banking activities certain amounts were debited from and credited to the accounts of ABN India in the name of interest payments for which no tax was deducted at source.

The issue to be decided was whether it was allowable or if tax should be deducted u/s. 195. The judiciary’s finding was that a branch is not a separate entity from its Foreign Company. Hence, the HC overruled the Tribunal decision and held:

“The proposition of law is well settled that nobody can make profit out of self nor can trade with self nor earn from self. Further, the local law does not allow any deduction of the payment of expenditure to self. Nor does it assume the interest receipt from self through a branch or PE as its income and charges it to tax.”

Based on this reasoning, the Calcutta High Court ruled that no income chargeable to tax could be attributed to the assessee. Hence, such payments should not be subject to deduction of tax at source (TDS) u/s.195, and therefore, cannot be disallowed under section 40(a)(i) on account of non-deduction of tax at source. Also, the ‘deeming fiction’ under art.7 of the Treaty could not be applied here unless it is for determining the attributable profit, in the opinion of the Tribunal. Therefore, payment made by an Indian branch of a Foreign bank to its Head Office is an allowable deduction. This principle has been upheld in earlier decisions as well. [30]

Antwerp Diamond Bank NV Ltd. [31] followed the Tribunal decision in ABN Amro Case. [32] The taxpayer was Indian branch of a Belgian bank. During the relevant assessment year, the taxpayer had made payments to its Head Office towards interest on subordinate debts and term borrowing and had claimed the interest as an expense of the branch. The said interest was offered for taxation in the hands of the HO in terms of Article 11 of India-Belgium DTTA. However, the income was disallowed in India and it was liable to taxation here.

Sumitomo Mitsui Banking Corpn. v. DDIT [33] followed the High Court ruling in ABN Amro case and held that the income was allowable. This case was in the context of India-Japan DTAA. The Tribunal held that although interest paid to the HO by Indian branch (which constitutes PE in India) is not deductible as expenditure under the domestic law being payment to self, the same is deductible while determining the taxable profit attributable to the PE in India in terms of DTAA. As per the domestic law, the said interest, being payment to self, cannot give rise to taxable income in India in the hands of HO. The same position also applies to payment of Interest by Indian branch of a foreign bank to its sister branch offices abroad.


Can the assessee be taxed if its dependent agent PE has been remunerated at arm’s length?

The case of ANL Singapore Pvt. Ltd. [34] was heard in the Delhi ITAT recently.

Facts: The assessee was a shipping company incorporated in, and a tax resident of, Singapore. It had earned freight and detention receipts during assessment year (AY) 2007-08. After applying section 44B of the Income-tax Act, 1961 (the Act) the assessee computed income at the rate of 7.5% for 178 voyages. It claimed non-taxability under Art.8 of the India-Singapore DTAA for which it furnished a copy of its tax residency certificate. The assessee paid commission to its Indian AE, CMA CGM Global (India) Pvt. Ltd. for availing shipping agency services. The AO denied relief under Art.8 of the tax treaty in respect of freight and detention receipts earned from 98 voyages. The AO also held that the assessee had a dependent agent PE in India i.e. CMA India, according to the agency agreement with CMA India. The assessee challenged the assessment order before the Dispute Resolution Panel (DRP), which directed the AO to allow relief according to Art.8 of the tax treaty after examining fresh evidence in respect of the 98 voyages.

The assessee contended that the commission, container controller fees and detention fees paid to CMA India were accepted at arm’s length price in the transfer pricing proceedings of CMA India. Accordingly, it was argued that the business profits were not taxable under Art.7 of the tax treaty in the hands of the assessee. In this regard, reliance was placed on the High Court’s decision in Set Satellite (Singapore) Pvt. Ltd [35] and Delmas, France [36] wherein it had been held that where the AE, which also constituted the PE of the assessee, had been remunerated at arm’s length price; no further attribution was required to be made to the PE.

The revenue contended that merely because the commission paid (which was one of the assessee’s expenses incurred to earn shipping income) was at arm’s length, it could not be said that the assessee’s business profits (according to Art.7) from shipping income attributable to the PE should be obliterated and not be taxed. They reasoned that the PE is not a separate legal entity so the taxable entity qua the business profits should be the assessee, and not the PE in its individual capacity. Therefore, the income earned by the assessee through a PE was chargeable to tax and the arm’s length remuneration paid to the dependent agent PE could be considered as an adequate compensation.

The tribunal found with the assessee and allowed the income holding that:

“Where the AE that was also the PE had been compensated at arm’s length, nothing further could be attributed to the PE”.

The Bomabay High Court decision in SET Satellite (Singapore) Pvt. Ltd. [37] followed the Supreme Court ruling in Morgan Stanley & Co. [38] Even later cases like BBC Worldwide Ltd. [39] and B4U Int’l Holdings Ltd. [40] upheld that there was no need to attribute further profits in case of ALP remuneration made to a PE.

SET Satellite (Singapore) is a foreign telecasting company based in Singapore and engaged in the business of broadcasting various television channels into India from there, appointed SET India (P) Ltd as an agent to carry on marketing activities in India for sale of advertisement air-time slots (ad airtime) to various advertisers in India on its behalf. The agent appointed by the appellant qualified as a “dependent agent PE” (Dape) and its services were remunerated on an arm’s length basis.

ITAT – relying on the view expressed by the OECD, IFA and the ATO—held that the mere payment of arm’s length remuneration to a dependent agent did not extinguish the tax liability of the appellant in India.

After the Morgan Stanley (SC) case in 2007, Indian position on this issue was in disagreement with the International standard. Therefore, on an appeal heard in 2008, this SC ruling was followed in SET Satellite (Singapore) to reverse the Tribunal decision and hold that no further attribution of profits was required to be made to Dape depending on functions performed, assets used and risks assumed when it was compensated at ALP.


SECTION III: Conclusion

DTAA’s are consensus based treaties where countries agree upon the sharing of tax revenues. Generally, it is agreed that taxation should be residence based regardless of where the income arose. But such a principle could be easily exploited by Corporate persons. For instance, countries like Cyprus and Mauritius do not tax capital gains; hence, in certain cases taxation could be escaped altogether! These are cases where gains accruing from disposal of immovable property held outside the territory and shares in companies, the property whereof consists of immovable property held outside the country, will be exempted from capital gains tax. This provision provides a huge advantage to taxpayers and it could be capitalised upon to avoid tax. This disparity in tax laws only further complicates International Taxation and even more fascinates tax lawyers and taxpayers alike!

[1] The three Model Tax Conventions –UN, US & OECD- determine the international standpoint on this issue and are all in agreement as far as taxability of Permanent Establishments are concerned.

[2] Klaus Vogel, OECD MC Commentary, para.4 p.286 (3rd Ed.).

[3] Ibid.

[4] John Huston & Lee William, Permanent Establishment – A Planning Primer 18.

[5] Bischel, Tax Treaties in International Planning 117 (New York, 1975).

[6] [(1983), 144-ITR-146 (AP)].

[7] [(2005) 95-ITD-269(SB)].

[8] Union of India v. India Fisheries (P) Ltd. [1965] 57 ITR 331 (SC) & ITO v. Titagarh Steels Ltd. [2001] 79 ITD 532 (SC).

[9] Birla Corporation Limited v. ACIT (ITA No. 251 and 252/Jab/13) –

[10] Galileo International Inc. v. DCIT [2008] 19 SOT 257 (Delhi), appeal dismissed 25 February 2009.t

[11] Klaus Vogel, OECD MC Commentary, para 42.4.

[12] [1965] 56 ITR 20.

[13] Asia Satellite Telecommunications Co. Ltd. v. DIT [2011-TII-05-HC-DEL-INTL] (Judgement date: 31 January 2011).

[14] ISRO Satellite Centre [ISAC], In re [2008] 307 ITR 59 (AAR).

[15] Ishikawajima-Harima Heavy Industries Company Limited v. DIT [2007] 288 ITR 408 (SC).

[16] New Skies Satellites NV v. ADIT [2009] 126 TTJ 1 (Del).

[17] Morgan Stanley International Incorporated v. DIT (I .T.A. No.6882/Mum/2011) (Mum) –

[18] [2014] 364 ITR 336 (Del).

[19] CH Lee, Impact of E-commerce on allocation of Tax Revenue between developed and developing countries, 4(1) J. Kor. L. 19 (2004).

[20] A. Forgione, Clicks and Mortars: Taxing Multinational Business Profits in the Digital Age, 26 Seattle Univ. L. R. 733 (2003).

[21] Art.7, OECD Model Convention.

[22] [2006] 9 SOT 305 (High Court).

[23] [2005] 95 ITD 269 (SB) (High Court of Delhi).

[24] BHEL 262 ITR 513 (MAD) [2003].

[25] Cargo Community Network 289 ITR 355 (AAR)[2007].

[26] 243 ITR 459(Mad )[2000].

[27] ( 190 ITR 626)(Cal ) [1991].

[28] (AAR) 229 CTR 133[2010].

[29] [2011 -TII- 09- HC-Kol. -INTL].

[30] Sir Kikabhai Premchand v. CIT [(1953) 24-ITR-506 (SC)]; Betts Hartley Huett & Co. Ltd. [(1978) 116-ITR-425 (Cal)]; Ram Lal Bechai Ram v. CIT [(1946) 14-ITR-1(All.)].

[31] 1798/Mum/2009(AY-2005-06).

[32] ABN AMRO Bank NV vs. ADIT [2005] 97 ITD 89.

[33] [2012] 136 ITD 66 (Mum.) (SB).

[34] ANL Singapore Pvt. Ltd v. DDIT(IT) [TS-194-ITAT-2013(Del)-TP].

[35] Set Satellite (Singapore) Pte. Ltd v. DDIT (IT) [2008] 307 ITR 205 (Bombay).

[36] Delmas, France v. ADIT (IT) [ITA No. 9001/Mum/2010].

[37] Set Satellite (Singapore) Pte Ltd. v. DDIT [2008] 307 ITR 205 (Bombay).

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

[39] DIT v. BBC Worldwide Ltd. [2011] 203 Taxman 554 (Del).

[40] DDIT v. B4U International Holdings Ltd. [(ITA No. 880/Mum/2005) (AY 2001-02)] (2012).





 Lakshana Radhakrishnan is presently an undergraduate student at National Academy of Legal Studies and Research (NALSAR) University of Law, Hyderabad. She will be graduating in 2019. She can be contacted at

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Disclaimer:  The views and opinions expressed in this article are those of the authors. All data and information provided on this site is for informational purposes only. makes no representations as to accuracy, completeness, correctness or validity of any information on this site and will not be liable for any errors, omissions, or delays in this information or any losses, injuries, or damages arising from its display or use.