Indian court reinforces physical presence as cornerstone of service PE

The ruling excludes vacation and business development days from service PE calculations and confirms virtual services from abroad don’t count, potentially reshaping compliance for multinationals

In a landmark decision offering significant relief to global enterprises, the Delhi High Court ruled that the presence of Clifford Chance personnel in India did not constitute a service permanent establishment in India. 

While affirming the Income-tax Appellate Tribunal’s (‘ITAT’) order, the court firmly established that under the India-Singapore tax treaty, the constitution of service PE is contingent on actual physical presence in India for rendering services. Days spent on vacation or business development are excluded, and critically, virtual service delivery from outside India cannot be counted toward the 90-day threshold stipulated in Article 5(6)(a) of the India-Singapore tax treaty.

This ruling has far-reaching implications. While rendered in the context of the India-Singapore tax treaty, the judgment will influence interpretations under other tax treaties entered into by India, depending on how the service PE clauses are framed.

Controversy and the High Court’s decision

Clifford Chance, a tax resident of Singapore, was rendering legal advisory services to certain Indian clients. Two employees of the taxpayer visited India during the 2019/20 tax year for a total of 120 days. However, this included 36 vacation days, 35 business development days, and five standard working days, leaving only 44 effective days of actual service performance in India. For the tax year 2020/21, no employees were present in India.

The tax officer held that a virtual PE of the taxpayer was established in India on account of the services rendered to the Indian clients, without physical presence. It was also observed that vacation days and business development days cannot be excluded, as the employees were continuously rendering services in India during previous years.

On appeal, the Delhi bench of ITAT observed that physical presence and actual performance of services in India are essential to trigger service PE under the India-Singapore tax treaty. 

The Delhi High Court affirmed the ITAT’s decision and held that Article 5(6)(a) of the India-Singapore tax treaty requires services to be furnished ‘within’ India, which implies physical presence. The court further clarified that the concept of virtual service PE is not mentioned in the tax treaty and cannot be introduced through judicial interpretation.

The court observed that the mere presence of employees in India without services being rendered to the clients during their stay in India would not lead to the constitution of PE in India. Accordingly, the days for which the employees were on vacation and engaged in business development activities in India are to be excluded. Also, when two employees stay for a day, it should be counted as one day.

Acknowledging the revenue’s concerns about digitalisation, the court emphasised that taxability must strictly follow treaty language, which is the result of deliberate bilateral negotiations. It noted that India’s introduction of ‘significant economic presence’ and the OECD’s commentary reflect a separate policy approach to address digital economy challenges. Until Article 5(6) is renegotiated or supplemented, virtual or remote services provided from abroad remain outside the scope of service PE. 

Impact on other businesses

The judgment serves as a welcome step towards providing clarity regarding the taxability of remote services rendered by foreign enterprises in India. 

It is important to note that the court resorted to a strict interpretation of the expression ‘within a contracting state’ that appears in Article 5(6) of the India-Singapore tax treaty while arriving at its conclusion. 

Most of the tax treaties entered into by India (such as with the US, UK, Australia, Canada and Finland) employ a similar expression in relation to service PE. As a result, the decision of the High Court shall equally apply to these tax treaties, and it shall provide much-needed clarity to global firms providing services remotely from said countries.

There also exist certain tax treaties wherein the service PE clause is framed differently. For instance, the India-United Arab Emirates (UAE) and India-Kuwait tax treaties employ the expression ‘in the other contracting state’ instead of ‘within a contracting state’.

Another example is the India-Mauritius tax treaty, which merely provides for the furnishing of services through employees or other personnel for a service PE to get triggered in the source state, without the use of either of the above expressions.

Considering that the High Court in Clifford Chance adopted a strict interpretation of the Singapore tax treaty, the applicability of the ruling to the above-mentioned countries is debatable. One could argue that since the above treaties do not use the phrase ‘within a contracting state’, the ambit of service PE is wider in said treaties and covers even virtual service rendition.

The aforesaid interpretation may not appear to be consistent with the substantive principles governing the concept of PE. Traditionally, the constitution of PE necessitates physical presence in the source state. Even the international guidelines introduced by the OECD and UN for service PE require physical presence in the source state.

These principles were also affirmed by the Supreme Court of India in ADIT v. E-Funds IT Solution Inc. In that case, the court, while examining Article 5(2)(l) of the India-USA tax treaty, held that for a service PE to get triggered, a multinational should furnish services within India and such services should be rendered through its employees.

If a country intends to include virtual service periods within the ambit of Service PE, its tax treaty must clearly state this. Where the clause is ambiguous, as seen in treaties with the UAE or Mauritius, virtual presence should not automatically create a service PE, considering the overall concept of PE. 

For example, Kuwait’s domestic law explicitly provides that a service PE is triggered once the day-count threshold is met, regardless of physical presence. 

The Court’s observation on the exclusion of days where an employee is on leave or engaged in business development in India was also interesting. The interpretation will enable many non-residents to visit customer locations to promote their products to Indian customers. 
 

It must, however, be remembered that the above inference is based on the understanding that the employees are developing a market for the non-resident in India and are not negotiating contracts during such development activity. The conclusion regarding PE may be different if the employees are undertaking business development meetings and, in the course of doing so, also play a principal role that leads to the conclusion of a contract. Such cases may warrant examination of the dependent agent PE in India. 
 

Notably, the exclusion of vacation days seems to be premised on the assumption that the employees were not working from India during their vacation. However, if during their presence in India, the employees continue to service clients, albeit those residing outside India, such days could be included in the threshold for the determination of service PE.

Thus, the exclusion of the period is premised on certain assumptions that should be considered by non-residents while determining the tax liability in India.

Final thoughts

This judgment arrives at a pivotal moment, as cross-border service delivery by global enterprises continues to surge. 

PE remains one of the most critical concerns for multinational firms, and this ruling offers much-needed clarity and reassurance. Its significance will be profound where Service PE clauses mirror the India-Singapore tax treaty. 

The clarity regarding the exclusion of certain days helps non-residents to determine their period of presence and their ultimate tax liability in India. 

The coming years will be fascinating as courts navigate through these nuances and interpret service PE provisions in the evolving digital economy.

[The authors are Partner, Associate Partner and Principal Associate, respectively, in Direct Tax practice at Lakshmikumaran & Sridharan Attorneys]