In this series, we will explore the multifaceted concept of Permanent Establishment (PE), a cornerstone of international taxation. Understanding PE is critical for determining how and when a foreign enterprise becomes liable for tax in another country. The concept establishes the minimum threshold of business presence that triggers tax obligations in the host jurisdiction, ensuring fair allocation of taxing rights between countries.

The series will be structured to cover the following:

  1. Basics of PE
  2. Home PE
  3. Marketing Support PE
  4. Construction PE
  5. GCC and Secondment PE
  6. E-commerce PE
  7. Other Emerging Types of PEs

Basics Of Permanent Establishment

In this write-up, we will be discussing the basic concepts of a PE. Understanding the basics will help lay the foundation for exploring more complex issues and nuances related to PE. At the same time this will make it easier to follow and appreciate the advanced scenarios as our discussion moves forward.  For ease of understanding this write-up is given in the question and answer mode.

  1. What is international taxation?

International taxation is about how countries decide to tax income and transactions that cross borders. It covers rules to prevent the same income from being taxed twice and agreements (tax treaties) that help countries work together and make international business easier.

Imagine a company based in the United States that provides consulting services to a business in India and receives payment for it. The U.S. seeks to tax this income because the company is a resident there and is taxed on its worldwide income (residence-based taxation). At the same time, India also wants to tax this income since the services were rendered to an Indian client and the value was created within its borders (source-based taxation).

To avoid such overlaps, international tax rules aim to strike a balance between these two principles—the residence rule and the source rule. Tax treaties between countries lay down these principles and specify how different types of income should be taxed. For example, incomes such as royalties or fees for technical services are often covered under specific treaty articles. In contrast, business profits are generally taxable in the source country only if the foreign enterprise has a sufficient presence there, referred to as a PE.

  1. What is a permanent establishment?

The next question that naturally arises is—what exactly is a Permanent Establishment (PE), and when does it come into existence? A PE is a fundamental concept in international taxation that determines when a foreign enterprise’s presence in another country becomes substantial enough to create a taxable connection, or nexus, there. It establishes the threshold at which a business from one country has a sufficient and continuous presence in another to justify taxation in that jurisdiction.

In essence, a PE signifies that the foreign company has a significant and ongoing presence in India—such as an office, an agent, or a major site of operations. Article 5 of most tax treaties typically defines a PE to include:

  • A fixed place of business.
  • An agent who regularly conducts business activities on behalf of the enterprise.
  • A construction, installation, or assembly project lasting beyond a specified duration.
  • The furnishing of services over a prescribed period.

To illustrate, consider a company based in the United Kingdom that sells air conditioners in India. If it operates only through online sales without any physical presence, it is merely doing business with India and is unlikely to be taxed there. However, if the company establishes an office in Mumbai or frequently sends employees to manage operations in India, it creates a fixed place of business. This may establish sufficient economic ties with India, requiring examination of whether the U.K. company has a PE in India.

Thus, the PE concept forms a crucial link between the residence and source rules of taxation. It serves as the bridge that determines when the source country may tax the business profits of a foreign enterprise, even if that enterprise is a resident elsewhere. Simply put, the residence rule means “you pay tax where you live,” while the source rule means “you pay tax where you earn.” The PE principle ensures balance between these two—if a foreign business utilizes a country’s infrastructure, workforce, or market to earn income, that country has the right to tax an equitable share of those profits.

  1. How are tax treaties connected with the income tax law?

Before understanding how a PE interacts with income tax law, it’s important to see how a tax treaty connects with it.

India’s Income-tax Act, 1961 (Act) is the country’s domestic law. It decides who must pay tax in India and on what income. A tax treaty (also called a Double Taxation Avoidance Agreement, or DTAA) is an agreement between two countries—for example, between India and the United Kingdom. The main purpose of such treaties is to ensure fairness: income should not be taxed twice (once in each country) and at the same time should not escape tax altogether.

When a foreign company or individual earns income related to India, both countries may want to tax it—India, because the income was earned here (the source country), and the other country, because the person or company is based there (the residence country).

The Act gives India the right to tax income connected to it. The tax treaty then determines how much of that income India can tax and how much the other country can. In simple terms, the Act sets the basic rule, while the treaty acts as a mutual understanding between countries to divide taxing rights and avoid double taxation.

The authority for entering into tax treaties is derived from Section 90(1) of the Act, which empowers the Indian Government to negotiate and implement agreements with other countries for the avoidance of double taxation. This provision ensures that taxpayers are granted relief—either by way of exemption or by allowing credit for taxes paid abroad—so that the same income is not subjected to tax both in India and overseas. Further, Section 90(2) stipulates that where such a treaty exists, the provisions of the Act or the treaty shall apply, depending on which is more beneficial to the taxpayer.

For instance, consider a U.K. company selling air conditioners to businesses in India. Under India’s domestic law, such income may be liable to tax in India. However, under the India–U.K. tax treaty, India can tax this income only if the U.K. company has a PE in India—such as a branch office or employees carrying on business activities here. If the company has no presence in India, the treaty provisions override the domestic rule, and India has no taxing rights over that income.

  1. How does the concept of PE get married to the domestic tax law?

Let’s look at the example of the UK company selling air conditioners to businesses in India. Since the UK company earns income from India, it’s considered income from an Indian source. This means Indian income tax law can apply—specifically section 9(1)(i), which defines the concept of business connection.

A ‘business connection’ exists when:

  • A non-resident earns income by doing business in India, or through property, assets, or capital assets located in India.
  • The non-resident has a ‘significant economic presence’ in India by:
    • Making transactions or sales over a specific threshold.
    • Frequently interacting with a large number of Indian users (often relevant for digital businesses).

If any of these conditions are met, the non-resident company has a business connection in India, and India can tax its Indian-source income. However, international tax treaties (like the India-UK treaty) are designed to prevent double taxation—so that the same income isn’t taxed twice, in both countries—and to ensure it doesn’t escape tax anywhere. Hence, the Source principle and the Residence principle applies. For this, tax treaties typically set a minimum standard called PE.

Hence, if the UK company does not have a PE in India, India cannot tax its profits—even if there is a ‘business connection’ under Section 9. Only if a PE exists does India get the right to tax the business profits of the foreign company.

  1. How Article 5 which relates to a PE structured in tax treaties?

The concept of a Permanent Establishment (PE) is defined in Article 5 of most bilateral tax treaties—such as the India–U.K. and India–U.S. treaties—as well as in the OECD and U.N. Model Conventions. These provisions, along with their commentaries, provide interpretative guidance on when and how a foreign enterprise’s income becomes taxable in a source country. Article 5 typically follows a structured framework comprising several key paragraphs:

  • Paragraph 1 – Basic Rule: Defines a PE as a fixed place of businessthrough which the enterprise wholly or partly carries on its operations (e.g., an office or factory).
  • Paragraph 2 – Illustrative Examples: Lists common forms of a PE, such as a branch, office, factory, workshop, warehouse, mine, quarry, or oil and gas well.
  • Paragraph 3 – Exceptions: Clarifies that certain activities of a preparatory or auxiliary nature—such as storage, display, advertising, or information collection—do not constitute a PE.
  • Paragraph 4 – Dependent Agent PE: Establishes that a PE arises where a dependent agent habitually concludes contracts, or plays the principal role leading to contract conclusion, on behalf of the foreign enterprise.
  • Paragraph 5 – Independent Agent Exception: Provides that independent agents acting in the ordinary course of their business do not create a PE, unless their activities are devoted exclusively or almost exclusively to one enterprise or under its control.
  • Paragraph 6 – Specific Activity PE: Covers special situations such as construction or installation projects, assembly sites, service activities, and insurance operations, which constitute a PE only if they continue beyond a prescribed duration (usually between 6 and 12 months).

  1. Conclusion

The concept of PE plays a pivotal role in international taxation by determining when a foreign business’s presence in India is substantial enough to create a taxable nexus. Indian domestic law, specifically Section 9(1)(i) of the Income-tax Act, recognizes business connections and allows taxation of income arising from India. However, tax treaties override this domestic provision by requiring the presence of a PE as defined under Article 5 of the treaty for India to tax business profits. This ensures that income is not taxed twice and provides clarity on taxing rights by balancing the source and residence principles. Ultimately, the PE concept acts as a fair and clear standard to decide when India can rightfully tax the profits of foreign enterprises operating within its jurisdiction.