When a Subsidiary Becomes a Permanent Establishment of Its Foreign Parent

 A subsidiary company is not automatically a Permanent Establishment (PE) of its foreign parent under tax treaties. However, depending on the functions it performs, it can cross the threshold and become a PE under Article 5 of the OECD/UN Model Convention.

Three Ways a Subsidiary Can Become a PE

1. Fixed Place PE – When the foreign parent effectively uses the subsidiary’s premises as its own place of business. This occurs if the parent has control over a specific office space, uses subsidiary facilities for its core operations, or has its employees working from the subsidiary’s premises. Indian courts (e.g., Formula One v. CIT, Samsung Heavy Industries) have held that the “disposal test” requires the parent to control a place of business within the subsidiary’s office.

2. Agency PE – If the subsidiary habitually concludes contracts for the foreign parent, plays the principal role leading to contract conclusion, or maintains stock for on-behalf sales, an Agency PE arises. In Rolls Royce Plc (Delhi HC), the Indian subsidiary’s sales and marketing activities created a PE. Conversely, E-Funds IT Solutions (SC) held that no PE exists if the subsidiary only performs support functions without contract-concluding authority. Mere marketing support is insufficient (Set Satellite).

3. Service PE – When the foreign parent deploys employees in India through the subsidiary beyond the DTAA threshold (typically 90/183 days), a Service PE is triggered. Morgan Stanley (SC) confirmed this, while Centrica India Offshore (Delhi HC) held that seconded employees exercising control in India constitute a Service PE.

Key Judicial Principle

Courts have consistently held that subsidiary status alone is insufficient. Shared directors, routine support, or back-office operations do not create a PE. However, once real business operations, negotiations, contract conclusion, or control flow through the subsidiary, PE exposure becomes real.

Tax Implications of a PE

If a subsidiary becomes a PE of the foreign parent:

• Taxation of foreign parent – Profits attributable to the PE are taxed in India at 40% + surcharge + cess under Article 7.

• Transfer pricing scrutiny – Subsidiary must be compensated at arm’s length; otherwise, additional profits may be attributed to the parent.

• TDS obligations – Payments to the foreign parent attract TDS under Section 195; concessional DTAA rates may not apply, and reimbursed secondment salaries require TDS under Section 192.

• GST implications – The PE becomes a separate fixed establishment, requiring separate GST registration and reverse charge compliance.

• Subsidiary’s taxes – Subsidiary remains taxable domestically but may face transfer pricing adjustments.

Conclusion

A subsidiary is not automatically a PE, but improper structuring, excessive control, or contract-concluding authority can quickly trigger one. Companies must ensure that the subsidiary’s role aligns with transfer pricing and PE principles, with proper profit attribution documentation.