Holding & Subsidiary Company Permanent Establishment Risk
Two parallel frameworks govern the Permanent Establishment (PE) analysis:
- Section 9 of the Income Tax Act 2025 (ITA 2025) the domestic law "business connection" test and
- Article 5 of the Double Taxation Avoidance Agreement ("DTAA") as modified by the Multilateral Instrument ("MLI").
1. Domestic Law: Business connection under Section 11 of the ITA 2025
Section 9 of the ITA 2025 is the basic provision which states that income arising through or from any “business connection” in India to accrue or arise in India. It is wider than the DTAA PE concept and can establish taxability even without physical presence. Courts have consistently interpreted "business connection" to require a real and close relation between a non-resident's business and some activity in India that directly or indirectly contributes to earning profits.
A. Agency PE
Under Section 9 of the ITA 2025, a business connection exists if subsidiary company, acting on behalf of holding company:
- Routinely exercises authority to conclude contracts in the name of holding company, or habitually plays the principal role leading to the conclusion of contracts by holding company;
- Routinely maintains a stock of goods in India and delivers them on behalf of holding company; or
- Routinely secures orders in India, mainly or wholly for holding company.
Critical Risk - If the subsidiary company is exclusively providing services to holding company, the independent agent defence u/s 9 is likely to be questioned. The Indian employees who participate in deal negotiations, client calls or pricing discussions with holding company's customers may trigger Dependent Agency PE.
B. Significant Economic Presence (SEP)
SEP covers digital economy activities and is triggered if holding company:
- Transacts in goods, services or property with any person in India and aggregate payments exceed INR 2 crore in a Tax Year or
- Systematically and continuously solicits business or engages with 3 lakh or more users in India.
Critical Risk - SEP creates a PE risk irrespective of whether holding company has any physical presence, place of business or agent in India. Income attributable to SEP specifically includes income from advertisements targeting Indian customers, sale of data collected from Indian persons and sale of goods/services using such data.
2. Permanent Establishment under Article 5 of the DTAA
The DTAA provisions apply to the extent they are more beneficial to the assessee. This means holding company's business profits may not be taxable in India unless a PE is also established under the DTAA.
A. Fixed Place PE
A Fixed Place PE arises if holding company has a fixed place of business in India through which it wholly or partly carries on its business. Key triggers include If subsidiary company's office premises are "at the disposal" of holding company i.e. holding company personnel regularly use those premises for core business activities (right to use + control thereupon). The Supreme Court in E-Funds IT Solution Inc. (2017) confirmed that an Indian subsidiary does not automatically become a fixed place PE. However, the more recent Supreme Court ruling in Hyatt International Southwest Asia Ltd. (2025) taken a stand that substantial operational control and continuous functional presence. Therefore, even without formal ownership or lease a fixed place PE can be formed provided the holding company's business is carried on through that space.
Preparatory or Auxiliary Exception: The DTAA excludes activities of a preparatory or auxiliary character from the PE definition. However, courts analyses whether the activity is an "essential and significant" part of the enterprise's core business as a whole (GE Energy Parts Inc., Delhi HC 2019). If Subsidiary company performs functions important to holding company's value chain such as technology product development, client servicing etc. the preparatory/auxiliary exception will not hold.
MLI Anti-Fragmentation: The MLI prevents holding company from fragmenting entire operations into separate activities, each claiming preparatory/auxiliary status. If subsidiary company and holding company through another associated enterprise together carry on the complementary functions in India, the above preparatory exception will be denied.
B. Service PE
A Service PE is caused when the holding company furnishes services in India including consultancy services through its employees or personnel for a period exceeding 90 days within any 12 months period. High risk scenarios include:
- Holding company deputing employees to subsidiary company where deputed employees retain a lien on holding company employment and holding company remains responsible for their work in India.
- Holding company personnel visiting India to manage, supervise, or direct subsidiary company's operations.
However, routine stewardship activities (monitoring quality, protecting holding company's interest) do not create a Service PE (E-Funds, SC 2017). However, if visits involve directing, supervising, or controlling operations as opposed to mere oversight, Service PE risk materialises (Convergys, Delhi ITAT 2013).
C. Agency / Dependent Agent PE
A Dependent Agent PE (DAPE) arises if a person (other than an independent agent), acting on behalf of holding company in India:
- Usually concludes contracts or plays the principal role leading to their conclusion in the name of holding company without material modification by holding company or
- Habitually secures orders wholly or almost wholly for holding company.
Profit Attribution
Under both Section 9 of the ITA 2025 and Article 7 (Business Profits) of the DTAA, only income reasonably attributable to Indian operations is taxable in India. A landmark principle confirmed by the Supreme Court in Morgan Stanley (2007) and E-Funds (2017) is that if Subsidiary company is remunerated at arm's length in accordance with its functions, assets and risks, no further profits are attributable to holding company due to PE in India.
Conclusion:
The existence of an Indian subsidiary does not automatically create a Permanent Establishment (PE) for a foreign holding company. However, factors such as the subsidiary's role in contract negotiations, use of office premises by the holding company, employee visits to India, and digital business activities may increase PE exposure under both the Income Tax Act, 2025 and the applicable DTAA.
Foreign companies operating in India should regularly review their business structure, operational arrangements, and intercompany transactions to assess PE risk. For any queries regarding Permanent Establishment (PE) risk, international taxation, or foreign company operations in India, please write to us at enquire@kdpaccountants.com
