A foreign company hires four people in India through a contractor arrangement, gives them company email addresses, has them attend customer calls, and books all the revenue offshore. Eighteen months later an Indian tax officer issues a notice asserting that those four people constituted a Permanent Establishment, and that a share of the group's India-linked profit was taxable in India all along — with interest and penalty. The company's defence, that it never incorporated anything in India, turns out to be irrelevant. Permanent Establishment is a tax concept, not a corporate one. You do not need an Indian entity to have one, and having no entity is often what creates the risk rather than avoiding it.

What the regulation actually says

Permanent Establishment is defined in Article 5 of India's Double Taxation Avoidance Agreements (DTAAs), which broadly follow the OECD and UN Model Conventions. Where a treaty applies, Article 5 governs. Where no treaty applies, or where the taxpayer chooses domestic law because it is more favourable, the equivalent domestic concept is "business connection" under Section 9(1)(i) of the Income-tax Act, 1961. Both lead to the same outcome: if the threshold is crossed, India gets taxing rights over the profits attributable to the Indian presence.

There are four routes to a PE, and foreign companies typically trip on the last two.

Fixed place PE (Article 5(1)). A fixed place of business through which the enterprise's business is wholly or partly carried on. An office, a factory, a workshop. Critically, Indian courts have repeatedly held that a place need not be owned or leased by the foreign enterprise — a space "at the disposal" of the enterprise is enough. A room in an Indian group company's premises used regularly by visiting foreign staff has been held to be a fixed place PE. So has a co-working desk under long-term arrangement. So, in some fact patterns, has an employee's home office where the employee works exclusively for the foreign parent and the parent has no other India location.

Construction/installation PE (Article 5(3)). A building site, construction, assembly, or installation project that lasts longer than a threshold period — commonly 6 months or 183 days, but treaty-specific. Some Indian treaties use 90 days for supervisory activities. The duration test aggregates connected projects, and splitting a contract across group entities to stay under the threshold is routinely disregarded.

Agency PE (Article 5(5)). This is the one that catches sales-led entrants. If a person in India habitually concludes contracts on behalf of the foreign enterprise, or habitually plays the principal role leading to the conclusion of contracts that are routinely signed without material modification by the foreign enterprise, that person creates a PE. The second limb matters enormously. India has adopted the expanded agency PE language through the Multilateral Instrument (MLI), which modified a large number of Indian treaties from 2020 onwards. Under the pre-MLI test, a salesperson who negotiated everything but sent contracts abroad for signature was safe. Under the modified test, they are not. If your India-based commercial lead runs the pricing conversation, agrees terms, and head office merely counter-signs, you likely have an agency PE.

The independent agent exemption in Article 5(6) survives, but it has been narrowed. An agent acting exclusively or almost exclusively for one or more closely related enterprises is not independent. A distributor buying and reselling on its own account remains outside the agency PE net — but only if it genuinely takes title and risk, which transfer pricing documentation must support.

Service PE. Many Indian treaties — the India–US and India–UK treaties among them — contain a service PE clause absent from the OECD Model. If the enterprise furnishes services in India through employees or other personnel for more than a specified aggregate period (commonly 90 days in any twelve-month period, or 30 days where services are furnished to an associated enterprise), a PE arises. Foreign companies sending engineers, implementation consultants, or project managers to Indian customers on repeat short visits accumulate days without noticing.

Two further points. Article 5(4) exempts genuinely preparatory or auxiliary activity — a purchasing office, a storage facility, a market-research liaison. India's MLI position adopted the anti-fragmentation rule, so you cannot split one cohesive business function across several "auxiliary" arrangements and claim each is exempt separately. And Article 5(7) confirms that a subsidiary is not automatically a PE of its parent — but that protection collapses if the parent uses the subsidiary's premises and staff as its own, which is exactly what informal group operating models tend to do.

Separately, Section 9(1)(i) carries the Significant Economic Presence test, which can create a business connection from digital transactions with Indian customers above prescribed thresholds even with no physical presence. Where a treaty applies, treaty PE usually overrides SEP; where it does not, SEP stands.

Practical implications

If a PE is established, the profits attributable to it are taxable in India at the non-resident corporate rate — presently 35% plus applicable surcharge and cess for foreign companies (the rate reduced from 40% with effect from AY 2025-26). Attribution is done under Article 7 on an arm's-length basis, and Rule 10 gives the assessing officer wide latitude where accounts are inadequate.

The compliance consequences are heavier than the headline rate. A foreign company with a PE must obtain a PAN, file an Indian corporate income tax return, undergo tax audit under Section 44AB where turnover thresholds are met, and file Form 3CEB for the transactions between the PE and the rest of the enterprise. It must obtain a Tax Residency Certificate and file Form 10F to claim treaty relief. Because these obligations were not identified contemporaneously, they are almost always discovered late — meaning interest under Sections 234A, 234B, and 234C accrues across every missed year, and penalty exposure under Section 270A for under-reported income can reach 200% where the officer treats it as misreporting.

There is also a customer-side effect that surprises entrants. Indian customers withhold tax at source on payments to non-residents under Section 195. Once a PE is alleged, the customer's own withholding position becomes exposed, and Indian buyers respond by increasing withholding, demanding indemnities, or requiring a Section 197 lower-deduction certificate before releasing payment. PE risk therefore shows up as a commercial problem — stalled receivables — before it shows up as a tax assessment.

Finally, an unmanaged PE complicates exit. Buyers in a later transaction will diligence the India operating model, and an undocumented PE position becomes an escrow item or a price reduction.

Step-by-step: what to do

Map every point of India contact before you hire. List each individual working in or travelling to India for the group, their function, who they contract with, and where their output goes. Include contractors and EOR-employed staff — the tax analysis follows function, not employment paperwork.
Identify the applicable treaty and read Article 5 as written. Do not rely on the OECD Model. Then check India's MLI position and the treaty's MLI matched status on the OECD's MLI database to confirm whether the expanded agency PE and anti-fragmentation rules apply to your treaty. Many do; several do not.
Run a day count and keep it live. For service PE and construction PE, maintain a per-person, per-project India day log from day one. Reconstructing travel records three years later from immigration data — which the department can obtain — is a losing exercise.
Fix contracting authority in writing and in practice. If you want to avoid agency PE, the person in India must not conclude contracts and must not play the principal role leading to conclusion. That means documented pricing approval offshore, real negotiation by the foreign entity, and evidence that head office does more than rubber-stamp. A limitation-of-authority clause in an employment contract, contradicted by email traffic, is worth nothing.
Choose the structure deliberately rather than by default. A limited-risk service subsidiary billing the parent on a cost-plus basis under a written intercompany services agreement is the most defensible common model. It requires a Transfer Pricing study, Form 3CEB filing by 31 October, and an arm's-length markup supported by benchmarking. That is real compliance cost, but it is a known cost, priced upfront.
If you are using an Employer of Record, understand what it does and does not solve. An EOR resolves the employment-law and payroll-withholding question. It does not by itself resolve PE, because the PE test looks at whose business the worker is carrying on and whose contracts they influence. An EOR-hired salesperson closing deals for the foreign parent can create an agency PE.
Separate FEMA from tax deliberately. If you do incorporate, the FDI leg runs on its own track — equity into a Wholly Owned Subsidiary under the automatic route for most sectors, inward remittance through an AD Category-I bank, Advance Reporting, and Form FC-GPR filed on the RBI FIRMS portal within 30 days of share allotment, supported by a valuation certificate. Nothing in the PE analysis changes those obligations, and FEMA compliance does not immunise you against a PE finding.
Where the position is genuinely uncertain, use the available machinery. An Advance Ruling from the Board for Advance Rulings gives a binding determination on the applicant's facts. For withholding certainty, a Section 197 certificate sets the customer's deduction rate. For an existing dispute with treaty-partner double taxation, the Mutual Agreement Procedure under the DTAA is the bilateral route.
Document the conclusion, not just the decision. Keep a dated PE memo setting out the facts, the treaty article applied, and why the threshold is not crossed. Refresh it whenever headcount, roles, or the sales motion changes.

FAQ

Does hiring one employee in India create a Permanent Establishment?
Not automatically. It depends on what that person does. A back-office engineer working on the parent's product, with no customer-facing authority, generally does not create an agency PE — though a home office used exclusively for the parent's business can support a fixed place PE argument in some fact patterns. A single salesperson who habitually drives contracts to conclusion very likely does create one.

Does using an Employer of Record protect against PE?
No. The EOR is the legal employer for payroll and labour-law purposes, but PE analysis follows the substance of the activity and whose business is being carried on. EOR arrangements are useful for a genuinely short bridge period; they are not a PE shield for a customer-facing India team.

If I set up a subsidiary, is the parent automatically taxed in India?
No. Article 5(7) of most treaties confirms that control alone does not make a subsidiary a PE of its parent. The protection fails where the parent operates through the subsidiary's premises and staff as if they were its own, or where the subsidiary concludes contracts binding on the parent. Keep the intercompany services agreement, the transfer pricing markup, and the actual behaviour aligned.

Planning India entry?

Start with a free structure review at makeitlegit.in — we will map your India contact points, identify the applicable treaty position, and tell you which structure fits before you hire anyone.

This article is general information on Indian tax and exchange-control regulation, not advice on any specific transaction. PE outcomes are highly fact-dependent and treaty-specific.

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