Some Important Concepts in Permanent Establishment

Since the law governing the concept of PE has not been clearly defined, in order to have a
precise understanding of taxation of a foreign entity operating in
India, some important
concepts used are:
Business Connection
Income tax act has defined the term Business connection, thereby clarifying and restricting
the scope of varied interpretation. Business connection is a long
recognized mode of determining tax liability of non resident. A business connection involves a
relation between a business carried on by a non-resident, which yields profits or gains and
some activity in India that contributes to the earning of these profits or gains. A business
connection may arise between a non-resident and a resident if both of them carry on
business and if the non-resident earns income through such a connection.
The term business connection is of colossal significance in the concept of PE. If there is no
business connection between a non resident entity and a resident entity, the resident entity
may not be a PE of the non-resident entity, and the resident entity would have to be assessed
to income-tax as a separate entity. In such a case, the non-resident entity will not be liable to
tax in India.
Business connection is an expression of wide and indefinite import and is different from the
expression business as defined under the Act .Hence the term was being interpreted
differently by different authorities under different circumstances and had been the subject
matter of judicial interpretations by various authorities.
Some of the illustrative examples of business connection based on decided case
laws are:

Maintaining a branch office in India for the purchase or sale of goods

or transacting other business.

Appointing an agent in India for the systematic and regular purchaseof

raw materials or other commodities, or for sale of the non residents goods, or
business purposes.

Erecting a factory in India where the raw material purchased locally

is worked into a form suitable for export abroad

Forming a local subsidiary company to sell the products of the non

resident parent company

Having financial association between a resident and a non-resident

company.

for other

Attribution of profits
The PE criterion is commonly used in international double taxation conventions to determine
the taxability of an income in the country from which it originates. As per various double

taxation conventions, the 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 PE.
Currently, the international tax principles for attributing profits to a PE are provided in the
OECD Model tax treaty; however a number of bilateral tax treaties adopt features of UN
Model Convention. The models have been briefly discussed in the paragraphs below:
OECD Model------This model provides that only so much of the profits of an enterprise as are
attributable to a PE in a country may be taxed in that country. It also secures taxing rights of
a host country so that profits of a non-resident enterprise that are not attributable to the
permanent establishment cannot be subject to tax. Working Hypothesis is developed as a
preferred approach for the attribution of profits by the OECD. It has examined the feasibility
of treating a PE as a hypothetical distinct and separate enterprise and has reviewed ways in
which transfer pricing principles could be applied in order to attribute profits to a PE in
accordance with the arm's length principle.
UN Model Convention
UN Model generally follows the similar principles, however, the major difference
between the two models is that the UN Model extends source country taxing rights beyond
the strict attribution of profit to a PE and grants a host country the right to tax profits
attributable to sales made by the non-resident enterprise in the countrys territory of goods or
merchandise of the same or similar kind as those sold through that PE.
Conclusion
Even though the concept of PE has been defined extensively in various literatures, still there
are a number of issues which remain unanswered. The distinct nature of each transaction
makes interpretation of the law and case law precedents worth noting. This not only helps in
formulation of the law and providing clarification for various judicial proceedings but also
gives rise to introduction of various concepts to make the interpretation of the law simpler.
Subsidiary PE and Installation/ Construction PE, though do not fall under any specific
classifications but are still treated as PE as a result of the interpretation of such decided case
laws.