Placement of computer equipments like servers and routers in India by a
does/ does not amount to Permanent Establishment of the foreign entity in
Countries negotiate bilateral tax treaties to govern the tax treatment
of cross-border transactions. Under most tax treaties, a company that
sells goods and services to foreign markets can have its profits taxed by
the foreign tax authority only if the company maintains a "permanent
establishment (PE)" within the foreign jurisdiction (the "source country")
and profits are attributable to this permanent establishment.
In the absence of any permanent establishment, the source country is not
permitted to levy its income tax on any profits arising from the
international transaction and the country where the business is based (the
"residence country") will generally tax all of the profits.
According to the definition given by the OECD model tax convention Article
5 a "Permanent Establishment" means a fixed place of business through
which the business of an enterprise is wholly or partly carried on.
The term "permanent establishment" typically includes:
a) A place of management;
b) A branch;
c) An office
d) A factory
e) A workshop, and
f) A mine, an oil or gas well, a quarry or any other place of extraction
of natural resources
A non-resident or a foreign company is treated as having a Permanent
Establishment in India under Article 5 of the Double Taxation Avoidance
Agreements, entered into by India with different countries, if the said
non-resident or foreign company carries on business in India through a
branch, sales office etc. or through an agent (other than an independent
agent) who habitually exercises an authority to conclude contracts or
regularly delivers goods or merchandise or habitually secures orders on
behalf of the non-resident principal.
Some primary characteristics of a permanent establishment are as
· A place where the business of the employer is carried out
· Activities occur with a certain degree of regularity either daily,
weekly or monthly
· There is a degree of permanence & continuity even when it is only for a
· There is a person who has authority to authorize contracts or make
decisions respecting the operations
Taken as a whole, the definitions of permanent establishment suggest the
need for some geographic and temporal permanence that enables foreign
businesses to conduct significant business activities within source
countries. In other words, the permanent establishment must have some
tangible physical presence that is not temporary in nature.
Now, the threshold question of whether or not “the placement of computer
equipments like servers and routers in India by a foreign entity does/
does not amount to Permanent Establishment of the foreign entity in India”
can be discussed in context of e-commerce.
E-Commerce is a subset of e-business. It is a commerce of conducting
transactions using network of computers and telecommunication i.e.
The rationale for the permanent establishment concept has historically
rested on two main grounds. Firstly, the permanent establishment concept
was reasonably easy to administrate for tax authorities. Secondly, the
permanent establishment principle arguably represented a balanced rule
from an international equity perspective. This sharing of tax revenues
additionally made sense from an efficiency perspective because residence
countries and source countries were now given an incentive to cooperate in
reducing the chance for international double taxation, hence promoting
The emergence of e-commerce, however, upset this balance because physical
locations are no longer required in foreign markets in order to engage in
significant commercial activities. The issue whether computer equipments
at a given location constitute a permanent establishment firstly depends
on whether it meets the requirement of being “fixed”.
As such a distinction needs to be made between computer equipment, which
may be set up at a location so as to constitute a PE, and the data that is
used by or stored on that equipment. For instance, an Internet website
which is a combination of software and electronic data, does not in itself
constitute a tangible property and neither does it have a “place of
business” as such it cannot constitute a PE.
On the other hand, the Server (tangible machines that are set up within
the source country) are computers networked to the Internet having a
physical location and such location may thus constitute a “fixed place of
business” of the enterprise that operates the server.
Thus if the enterprise carrying on business through a website has the
server at its own disposal for example owns or leases and operates the
server, the place where that server is stored could constitute a PE.
However such server cannot be a PE if merely hosting arrangements exist.
To constitute a fixed place of business the server needs to be located
there for a sufficient period of time to be treated fixed. However some
countries have argued that the e-tailor’s business is carried on not
through servers but enterprise offices warehouses etc. where its income
generating activities take place yet the requirement that an e-tailor must
have affixed place of business is not met by a server.
Preparatory or auxiliary activities can constitute a PE where such
activities provide a communication link hence a router that acts as a
gateway between 2 or more network junctions and buffers and transfers data
among them (for example: the local network is connected to the Internet,
and vice versa.) can constitute a PE provided that such functions are a
core part of the enterprise and the equipment is fixed in the place of
Number of commentators and delegates of the OECD Model Tax Convention
adopted by the Committee on Fiscal Affairs on 22 December 2000 have noted,
it is unlikely that much tax revenues depend on the issue of whether or
not computer equipment at a given location constitutes a permanent
In many cases, the ability to relocate computer equipment reduces the
risks that taxpayers in e-commerce operations have found to have in
permanent establishments, where they did not intend to. It is crucial,
however, that taxpayers and tax authorities know where the borderlines are
and that taxpayers not be put in a position to have a permanent
establishment in a country without knowing that they have a business
presence in that country (a result that is avoided by the conclusion that
a web site cannot, in itself, constitute a permanent establishment).
Thus a server seems, at first glance, to fall within the traditional
definition of permanent establishments. E-commerce importing nations will
be tempted to assert that the server should constitute a permanent
establishment under traditional international tax principles in order to
protect their ability to tax the cross-border transactions.
These changes will result in the removal of physical intermediaries or
dependent agents from foreign markets. These business model shifts will
lead to the erosion of source country income tax revenues as long as
international tax rules emphasize the need for a physical presence within
With the development of the Internet, online retailers can now accomplish
much of their sales and advertising strategies via a website that
transfers transaction costs to customers, including activities such as
The Internet also permits businesses to gather information in foreign
markets without having a physical presence in those markets and enables a
number of administrative tasks to be performed remotely.
Still, a server operated by an e-commerce business that performs most or
all of a business transaction would likely be considered to perform
activities that, taken collectively, form an essential and significant
part of the commercial transaction and therefore will be characterized as
a permanent establishment under the OECD Proposal.
Further, it is suggested that the nature of this type of server-permanent
establishment, especially its lack of personnel, is likely to mean that
tasks performed by the server would likely be conducted under a “contract
service provider” arrangement that would leave all substantial assets and
risks with the head office and attribute to the permanent establishment
the profits associated with the physical operation of the computer server.
Given the need for the permanent establishment to recognize, in computing
profit, the arm’s length value of the tangible and intangible property
that it uses and that were contributed to it by other parts of the
enterprise, the conclusion would be.
The author can be reached at: firstname.lastname@example.org /
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