Permanent Establishment (PE) is a significant feature of bilateral tax treaties and is a key threshold adopted by source countries to tax profits earned by non-resident entities from the business activities carried out by the non-resident in the source country.

A ‘Fixed Place PE’ relates to a non-resident entity having a fixed place of business in the source country. But certain tax treaties also provide for a ‘Service PE’. A Service PE is established if: (i) the non-resident delivers services for longer than the prescribed threshold; and (ii) the said services are furnished in the source country through the employees or other personnel of the non-resident.

Traditionally, a Service PE required the physical presence of employees of the non-resident in the source country. However, in the present digital economy, this understanding is being challenged as more and more jurisdictions are doing away with this requirement.

The governments of Saudi Arabia and Israel, for example, have passed internal guidelines that suggest a non-resident would have a Service PE if it furnished services, including consultancy services, through employees or other personnel who are offshore and not physically present in the Source State. This would only be the case, however, if the activities continue (for the same or connected projects) within the Source State for more than 183 days in any 12-month period.

The Kuwait government has also adopted this new approach according to which services performed by a non-resident for a period longer than the tax treaty threshold pursuant to a contract with a Kuwaiti customer will, prima facie, create a Service PE in Kuwait. This is even if the employees of the non-resident are not physically present in Kuwait and services are performed entirely offshore.

Decision of the ITAT in ABB FZ-LLC Case

The Bangalore Income Tax Appellate Tribunal (ITAT) examined this issue in the recent case of ABB FZ – LLC. The ITAT, taking a note of the recent developments in other jurisdictions, held that the foreign entity (i.e. ABB FZ LLC) would establish a Service PE in India under the India-UAE tax treaty as long as its employees render services to an Indian entity for a significant period, even if they are not physically present in India.

The ITAT also held that the Service PE clause under the India-UAE tax treaty is an independent clause and the condition of having a fixed or permanent place of business in of Fixed Place PE is not required to be met in case of Service PE. It also observed that Article 5(2) provides for an inclusive definition of a PE and enlarges the definition given under Article 5(1) of the tax treaty and, therefore, Article 5(2) is not required to fulfil the requirement laid under Article 5(1) of the tax treaty. It further observed that this reasoning is in line with the various prior decisions of the Indian judiciary including those of the Hon’ble Supreme Court. Accordingly, it was held that Article 5(2) is an independent clause and the condition of having a fixed or permanent place of business under article 5(1) is not a pre-requisite to constitute a PE under Article 5(2).

The ITAT further elaborated its view by observing that in the present age of technology where services, information, consultancy, management etc., can be provided via various virtual modes, the taxpayer’s argument of a fixed place of business cannot be sustained as such services can now easily be rendered without necessitating the physical presence of taxpayer employees.

Lastly, the ITAT also held that for the constitution of a Service PE under India’s UAE tax treaty, is not dependent on whether the employees stayed in India for the threshold period, but upon the fact that services or activities have been rendered/performed over a period of more than nine months within any 12 months period.


The consequences of this new development would mean that any work or service performed as a non-resident under a cross-border agreement, which continues for a period longer than the threshold provided under the tax treaty threshold (e.g.183 days), could potentially lead to a Service PE exposure in India. Such an interpretation is extremely draconian in nature and could have far reaching implications on the global business operations of Multinational Enterprises operating in multiple jurisdictions.

It is also pertinent to note that for the constitution of a Service PE under Article 5(2)(i) of the tax treaty, it is imperative that services are “furnished through the employees or other personnel in the other contracting state”. Ordinarily, in English the preposition ‘in’ denotes a physical location – for example, in the house or in the lake. Therefore, in order to furnish services in the host country, the presence of such employees in that host country is mandatory. Such a presence could either be in the form of physical presence of the employees or if services have been rendered by the employees offshore then through the non-resident’s fixed server in India[1]. However, the interpretation adopted by the ITAT seems implausible as it enlarges the scope of Service PE to include every long-term cross-border transaction whereby a non-resident renders services to a customer in the source country beyond the stipulated threshold period under the tax treaty.

Further, the OECD Commentary also contemplates the physical presence of the employees / personnel in the source country for the constitution of a Service PE.

Pending the examination of the ITAT ruling before the higher courts, it is recommended that parties entering into cross-border transactions maintain detailed documentation setting out the intention of the parties in order to be able to mitigate Service PE exposure.

* The author was assisted by Jyoti Anumolu, Associate

[1] Income Tax Officer v. Right Florists, [2013] 25 ITR(T) 639 (Kol. – Trib.)