Business Connection vis-à-vis Permanent Establishment

This blog is inscribed by Rhea R Seth.


A business connection involves the concept of control, supervision or continuous activity in nature. This expression has, however, not been defined in the Act.[1]

In more general terms in the concept of business connection prior to its definition by the Finance Act, 2003 in concept, primarily explained what constitutes “nexus”, further explained by Explanations 2 and 3 of section 9(1)(i) of the Act.

The concept of permanent establishment similarly constitutes the nexus to justify taxing of income of a resident of one country in the other country. Such a comparison was attempted by the Authority for Advance Ruling in the following passage.[2]

Questions Raised

The law in the context of between business connection and permanent establishment was posed before it were answered as under:

Question A: In view of the continuous process in respect of the series of purchase and sale transactions undertaken by the applicant and its subsidiary in India, there exists an intimate and continuous relationship which constitutes a business connection for the purpose of Section 9(1)(i) of the Income-tax Act, 1961. In addition, the subsidiary amounts to a permanent establishment in view of Article 5.2(1) read with Articles 5.5 and 5.6 of the DTA.

Question B: The extent of the income deemed to accrue or arise in India will depend on the actual working of the applicant and the subsidiary.

Thus, this question cannot be answered in a hypothetical manner.”[3]

Judicial Deliberations

The Supreme Court held that “Business connection” under Income-tax Act is different from “permanent establishment” and under DTAA[4]. There may be situation, wherein business connection is present, but not be permanent establishment, hence, no liability under Double Tax Avoidance Agreement, even when liability would arise under the domestic law.

In a case of a turnkey project, where both in supply and installation, the income attributable to permanent establishment cannot include the profit on supply of machinery.[5] The Tribunal reasoned, that supply precedes the execution of the project, therefore, it cannot form part of the income of permanent establishment. The Tribunal invoked the “force of attraction rule” observing that, presence of permanent establishment does not imply that the entire income of the non-resident becomes taxable.

Though the decision was rendered, Supreme Court decision in Ishikawajima-Harima Heavy Industries Ltd v. DIT[6], accorded with the principle decided therein. Even the amendment apparently intended to nullify the decision in section 9 (Explanation) by the Finance Act, 2007 which would limit the application of the decision in respect of income from interest, royalty and technical fees, making it taxable.   

In the case before the Tribunal, supply of machinery was a transaction disjunctive from its business undertaken in India, hence accorded with the decision of Supreme Court.

Where the payment is for a contract for designing, fabrication, linkage and commissioning of a platform on Bombay High through a Korean company for a project in the business of exploration etc., of mineral oil, the issue arose whether section 44B had application and, if not, whether there is a permanent establishment to render the assessee liable to tax in India and what would be the estimated tax on income.

The Assessing Officer held that section 44BB would have no application as the assessee was not directly involved in exploration of mineral oil. He inferred permanent establishment, since the work was carried on in India for about nine months.

The estimated income attributable to the activities in India through the permanent establishment was presumed at 2% of the total receipts relating to the activities in India. The first appellate authority confirmed that there was a permanent establishment, but estimated the receipts pertaining to the Indian activities alone by excluding the payments received abroad and inferred 10% of the balance amount as income attributable to Indian activities.

The Tribunal upheld the finding of the first appellate authority, but reduced the income from 10 to 3%. It was argued on behalf of revenue before the High Court that in an instruction from the Central Board of Direct Taxes[7] required 10% to be adopted in such cases.

In CIT v Hyundai Heavy Industries Co Ltd[8] it was found that, the requirement under Article 5(2) for an estimate of income attributable to the permanent establishment, which included six locations in India as found by the Tribunal, its decision including the estimate of income could not be faulted. In fact, it was found that there was no substantial question of law arising out of the order of the Tribunal.

The Supreme Court in CIT v Hyundai Heavy Industries Co Ltd[9] disregarded that there was no question of law involved. While upholding the view that only the income that is attributable to the permanent establishment in India would be taxable, it held that the profit on supply of fabricated platform could not be attributable to the permanent establishment.

It was observed that even assuming some profit arose in such supply, it cannot be assessed, unless the supplies were not at arm’s length. Since the price for the supplies was not challenged, there cannot be an element of profit on such supplies. Apparently, arm’s length price was referred to ensure that there is no overloading of the non-taxable receipts, so as to minimize liability on taxable receipts.

As regards receipts relating to Indian operations, an estimate of income is unavoidable in the absence of acceptable accounts from the assessee. Since the estimated turnover by CIT (Appeals) and upheld by the Tribunal was not challenged, but only the estimate of income from such receipts at 3% was challenged, it was held that the CIT was right in adoption of 10% on the basis of the Board’s instruction and that the Tribunal was not justified in reducing such estimate adopted by the Commissioner. The Departmental appeal was, therefore, allowed. There is nothing sacrosanct in such estimates, so that it is always open to the assessee to prove a lesser income with reference to its accounts.

Decision and Analysis

In the following cases, the decisions ultimately were rendered with reference to the meaning of “permanent establishment” under Double Tax Avoidance Agreement, so that the concept of “business connection” became irrelevant:

  • It was held that liaison office and agents in India will not constitute permanent establishment in India.[10]
  • Where a resident acted for non-resident for booking orders, collecting parcels/packages forwarded by non-resident, the resident, to be treated as permanent establishment of non-resident under the Double Tax Avoidance Agreement between India and USA. Non-resident is liable to tax on income from transactions with the resident in India both under the domestic law and the Agreement between India and USA.[11]
  • The non-resident was publishing magazines abroad. The Indian company was collecting advertisement charges in Indian currency and remitting it to non- resident. It was held that the Indian company was not a permanent establishment’ of non-resident and income of non-resident is not taxable in India based on the Agreement between India and UK and section 9(1) (i).[12]


Domestic law in India is based upon the inference of business connection.[13]

Permanent Establishment under Double Tax Avoidance Agreement is to be understood with reference to the definition of permanent establishment in the relevant Double Tax Avoidance Agreement. Nexus is the basis of inference of business connection as is for permanent establishment but in both the cases, mere existence of business connection does not attract tax liability, since there should be income attributable to the activities in India. In Booz and Company (Australia) P Ltd, In re[14], the AAR adverted to the disposal test, which requires that the place of business from which the business is carried on should be at the disposal of the assessee. Where there is no place of business in India, there can be no liability.

Where for example, a profession understood as personal service under Double Tax Avoidance Agreement is exercised, there should be a fixed base as pointed out in Seagate Singapore International Headquarters P. Ltd., In re[15].

There is, however, no straight jacket formula for the inference of service permanent establishment. Where the non-resident was regularly deputing personnel for its activities in India, there could be service permanent establishment.

[1] Direct Taxes Administration Enquiry Committee 1958-59 pg. 62, para 3.84.

[2] P. No. 8 of 1995 In re (1997) 223 ITR 416 (AAR).

[3] In Re: Advance Ruling (1997 223 ITR 416 AAR)

[4] Ishikawajima-Harima Heavy Industries Lid v DIT (2007) 288 ITR 408 (SC); DIT(IT) v Ishikawajima Harima Heavy Indus. Co Ltd (2013) 212 Taxman 273 (Bom).

[5] DCIT v Roxon Oy (2007) 291 ITR (AT) 275 (Mum).

[6] (2007) 288 ITR 408 (SC).

[7] Instruction No. 1767, dated 1st July, 1987

[8] (2007) 291 ITR 450 (Uttaranchal).

[9] (2007) 291 ITR 482 (SC).

[10] Western Union Financial Services Inc. v ADIT (2007) 291 ITR (AT) 176 (Del).

[11] A.A.R. No. 542 of 2001, In rc (2005) 274 ITR 301 (AAR)

[12] Speciality Magazines P Ltd, In re (2005) 274 ITR 310 (AAR).

[13] Supra 1

[14] (2014) 362 ITR 134 (AAR)

[15] (2010) 322 ITR 650 (AAR)

Leave a Reply

Your email address will not be published. Required fields are marked *