For over two decades information technology has become an integral part of modern society. Moreover, technology has rapidly invaded everyday life and has brought with it a whole new industry, technological and telecommunication developments, and, most importantly, new ways in which business operates, encouraging globalization and integration of the markets (OECD, Action plan on BEPS, 2013, 7). In fact, due to the global integration of economies and markets it is possible for corporations that operate all around the world to shift manufacturing bases from high-cost to low-cost locations. Moreover, such enterprises manage risks and of developing by means of global models based on matrix management organizations and integrated supply chains that centralize several functions at a regional or global level. Additionally, globalization has allowed multinational corporations exploit intellectual property at different levels within such organizations (OECD, Action plan on BEPS, 2013, 8).
These developments have provided such enterprises with opportunities to significantly minimize their tax burden, taking advantage of the “loopholes” that may arise from the incoherence of the tax rules of jurisdictions whose infrastructure is used in the performance of the business activities. For example, in a given state where the residence status for entities is solely determined by the place of incorporation, a foreign company would not be subject to the tax burden provided for a resident entity, even though it has substantial presence; on the other hand, the country of residence might provide with an exemption for the foreign income earned by its residents, which may derive in no taxation of the income derived neither in the source country nor in the residence country.
Thus, countries have long worked to eliminate such non-taxation in order to minimize trade distortions and obstacles to sustainable economic growth by means of the elaboration of concepts that allow them to tax the revenue produced using their infrastructure and resources, and that cannot be levied under the standards provided in the traditional tax system.
Currently, the PE is understood as the fixed place of business through which the business of an enterprise is wholly or partly carried on (OECD Model tax Convention on Income and Capital, 2010). However, this concept has experienced a noteworthy dilution during the recent years to meet emerging commercial practices, where physical presence is not required. So far, although several theories has been formulated to adapt the current definition of permanent establishment to the challenges provided by the electronic commerce, the international organs, such as OECD, UN and other Governmental Authorities have not reached to a conclusion in the most effective framework to warrant the taxation of such transactions in the Country where economic activities occur and where value is actually generated.
II. An Approach to the Taxation of Electronic Commerce: Virtual Permanent Establishment (VPE)
As it is well known, MNC’s have exploited their digital presence to obtain significant income from different countries with low taxes, and in most of the cases without paying taxes. Thus, it has led to proposals to redefine the PE concept.
According to this “Virtual PE” (VPE) theory, it is proposed that the taxing nexus for electronic commerce should be “the continuous commercially significant conduit of business activity”, rather than the fixed place of business. The virtual PE approach applies to the jurisdictional criterion for source-based taxation of profits.
Furthermore, the modern PE definition should be “reinvented” in order to apply to electronic commerce the original idea of taxation on basis of economic commitment and equivalence and establish common thresholds for differentiating commercial mainstream from auxiliary business activity.
Additionally, in order to determine if the taxing nexus is met, it can be done by measuring the development of a qualitative and quantitative facts and circumstances test, taking into account issues like the turnover or number of transactions.
The “Virtual PE” approach
(i) is relatively and competitively neutral to the buyer or user in the market, since source taxation of its profit is probably more neutral than taxation exclusively based on residence,
(ii) it recognizes extensive source taxability according to economic allegiance and subject to thresholds,
(iii) it is effective because it establishes a link between the electronic business and its customer established in the source country
However, although VPE theory requires some kind of physical presence by the vendor, before he is taxed, because “you can neither have operations, nor systematic activities, within a state, without you or your employees or agents being present in that state.
III. VPE under the Loop of the OECD
The OECD has worked for more than 20 years analyzing the impact of the electronic commerce to the current international tax legislation. As mentioned before, in 1998 the principles that should guide the development of rules in international tax matters for the electronic commerce were established.
In 2005, the OECD released the report titled “Are the Current Treaty Rules for Taxing Business Profits Appropriate for E-Commerce?”, based on the work of the business profit Technical Advisory Group. In such report, the OECD, studied the “VPE” theory as an alternative nexus that would apply to electronic commerce operations.
According to such report, the PE definition requires to be extended in three ways in order to extend the PE definition, as follows (OECD, 2005, 67):
(i) A so-called “Virtual fixed place of business” through which the enterprise carries on business (i.e. an electronic equivalent of the Traditional PE). In other words, when the enterprise maintains a web site on a server of another enterprise located in a jurisdiction and carries on business through that website, a PE is configured and the place of business is the web site, which is virtual.
(ii) A so-called “Virtual agency” (i.e. an electronic equivalent of the Dependent Agent PE i.e. DAPE). This concept would be an electronic equivalent of a dependent agent and, therefore, will cover situations where contracts are habitually concluded on behalf of the enterprise with persons located in the jurisdiction through technological means rather than through a person.
(iii) A so-called “On-site business presence”, which would be defined to include “virtual” presence. An enterprise providing on-site services or other business interface (which could be a computer or phone interaction or internet connection) to users located in certain Country may be deemed as “on-site business presence”. Under this alternative, it would be necessary to specify a minimum threshold to ensure that source country taxation would only be applied where there is a significant level of economic activity. Possible thresholds might include a minimum time during which the enterprise regularly operates within the jurisdiction, or monetary thresholds or limitations on the types of activities covered (e.g. exclusions for preparatory or auxiliary activities, or intermittent and occasional activities).
IV. The Domestic Law Basic Framework & View of Indian courts
The domestic law of India contains basic framework for attribution of profits to a ‘business connection’ or ‘Permanent Establishment’. Section 9(1)(i) of the Act read with the relevant Explanation provides that income from a ‘business connection’ in India shall be taxable in India but only to the extent as is reasonably attributable to operations carried out in India.
Further, Rule 10 of the Income Tax Rules, 1962 provides that if the Tax Officer is of the opinion that income arising to a non-resident cannot be properly ascertained, the amount of such income may be calculated at (i) percentage of turnover, as may be considered appropriate; or (ii) an amount which bears the same proportion to the total profits of business of such person as the receipts accruing or arising bear to the total receipts of business.
Moreover, The Finance Act, 2016 introduced the concept of Equalisation Levy (Levy) which targeted specific transactions between residents and non-residents. At the time of its introduction, the Levy was charged at 6% of the consideration earned by non-resident entities from India for provision of online advertisements and digital advertising space. This was done with a view of reducing revenue loss to the Government by advertising income earned by non-resident falling outside the ambit of the tax net, in the absence of any business presence in India. It is apparent that digitalisation has affected various aspects of business beyond mere marketing and advertising services and changed the way of doing of business.
Moreover, by expanding the scope of the Levy in Finance Act 2020 w.e.f. 1st April 2020, the Levy shall be charged at 2% of the consideration earned by an e-commerce operator from:
> Online sale of goods/provision of services; or
> Facilitation of the sale of goods/provision of services; or
> Combination of the above activities.
The recipient being:
> A person resident in India or using an IP address located in India; (Indian resident) or
> A non-resident under specified circumstances
An e-commerce operator means a non-resident who owns, operates or manages digital or electronic facility or platform. Contrary to the prior application of the Levy, the compliance requirements are to be fulfilled directly by the operator on a quarterly basis. The receipts of the operator covered by the Levy as above, would not be subject to further taxation in India.
However, the Levy would not be applicable to:
Further, the inclusion of “services” increases the scope of the tax net by recognising the growing utilisation of digital platforms for provision of various services like media streaming services, etc.
In other words, looking to scope of section 9, Significant Economic Presence (SEP) and Eq. Levy, the domestic law framework provides for sufficient determination of a profit rate to the India-specific turnover of the foreign company for ascertaining the profits attributable to the operations or digital transactions carried out in India. Applying a global profit rate on India specific turnover would result in estimation of total profits from Indian turnover, though the entire activities giving rise to such profits, e.g. research and development, manufacturing, marketing and selling may not have been carried out in India.
For example, in some cases, certain marketing activities as well as negotiation and conclusion of sale contracts may have been carried out in India, but all other activities, e.g. research and development, manufacturing, technical services etc. may have been carried out outside India. In such cases, the Indian courts have, in the past, used an ad hoc basis for estimating the profits attributable to India specific activities, based on facts of each case.
a) In the case of Anglo-French textile Co. Ltd. v. CIT  25 ITR 27 (SC), for instance, the Supreme Court of India returned a finding that in the facts of the case, 10% of profits were to be attributed to operations carried out in India.
b) In Hukum Chand Mills Ltd. v. CIT 103 ITR 548(SC), the Supreme Court found that attribution of 15% of profits was reasonable in the facts of that case.
c) In case of Motorola Inc. v. Dy. CIT  95 ITD 269 (Delhi)(SB), a Special Bench of the Income Tax Appellate Tribunal held that attribution of 20% of profits was sufficient for role played by the PE in negotiation and conclusion of contracts and supply of equipment in India by the PE of the taxpayer.
d) In case of Morgan Stanley ruling  162 Taxman 165 (SC), the Supreme Court made a reference to a “software pe”, but did not define such notion. Moreover it held that In Morgan Stanley, the case related to an associated enterprise, which was also held to constitute a service PE and since remuneration paid to the associated enterprise was already at arm’s length and justified by a transfer pricing analysis, the Court did not consider any further need for attribution of profits to it.
e) Similarly, in Galileo International Inc. Dy. CIT  116 ITD 1/[2018 19 SOT 257 (Delhi), 15% of total revenues were considered to be attributable to the Indian PE on the basis that the PE played a role in negotiating contracts. More importantly ITAT held that a PE was configured in India because (i) existed a business connection of Galileo in India due to the fact that the Company provided equipment, connectivity and configuration through a continuous, process available to travel agents in India; (ii) there was a fixed place of business, since part of the reservation services performed with Galileo’s system took place in the premises of the clients where the computers were placed; and (iii) Inter globe constituted a dependent agent PE for Galileo in India, as it was functionally and financially dependent on the company.
f) In DIT v. Nipro Asia Pte Ltd.  79 taxmann.com 154 (Delhi – Trib.), the Delhi Bench of the ITAT held that Rule 10 of the Income tax Rules, 1962 can be invoked if the Assessing Officer is of the opinion that amount of income accruing to non-resident companies on account of business connection in India is not ascertainable.
g) Recently in case of LG Electronics Inc. Korea vs. Deputy Commissioner of Income-tax (International Taxation), Circle-2(2)1, Noida  109 taxmann.com 36 (Delhi – Trib.) it was held that Assessee-company was engaged in business of manufacture and sale of refrigerators, washing machines, air conditioners and other household appliances – It had a wholly-owned subsidiary in India (LG India) which had entered into several transactions relating to sale of raw materials and finished goods but no tax was deducted by LG India, on off shore supplies on ground that no portion of income from such supplies arose in India. AO held that assessee had a fixed place PE in India in terms of article 5(1) and 5(2) as LG India was legally and economically dependent on assessee and that assessee exercised total control over Indian subsidiary. AO attributed an income in addition to returned income as income allocable to assessee’s PE in India – DRP without considering profit attribution by Assessing Officer directed him to take profit attribution at 20 per cent of profit margin of 50 per cent of salary cost of expatriates in India.
h) The Madras High Court in the case of Verizon Communications Singapore Pte Ltd.  39 taxmann.com 70 (Madras) while deciding whether payments made to Verizon Singapore from India resulted in royalty income, stated that In any event, in a virtual world, the physical presence of an entity has today become an insignificant one; the presence of the equipment of the assessee, its rights and the responsibilities of the assessee, vis-a-vis the customer and the customers’ responsibilities clearly show the extent of the virtual presence of the assessee which operates through its equipment placed in the customer’s premises through which the customer has access to data on the speed and delivery of the data and voice sent from one end to the other.
i) New Delhi AAR in case of MasterCard Asia Pacific Pte. Ltd., In re  94 taxmann.com 195 (AAR – New Delhi) held that Applicant MasterCard Asia Pacific is a Singapore based company engaged in processing of electronic payment transactions – Customers are provided with a MasterCard Interface Processor (MIP) that connects to MasterCard’s Network and processing centers. Indian subsidiary owns and maintains MIPs placed at customers locations in India. Whether applicant has a PE in India under provisions of article 5 of India-Singapore DTAA in respect of services rendered/to be rendered with regard to use of a global network and infrastructure to process card payments for customers in India; there is fixed place PE, service PE and dependent agent PE. Arm’s length remuneration to PE on account of Indian subsidiary for activities performed/to be performed in India, would not absolve applicant from any further attribution of its global profits in India since FAR of Indian subsidiary does not reflect functions/risks of applicant performed/undertaken by it. Whether a part of fees received/to be received by applicant from Indian customers (being processing fees, assessment fees and transaction related miscellaneous fees) would be classified as royalty within meaning of this term in article 12 of India-Singapore DTAA, and not as FTS; however, since it is effectively connected to PE, it would be taxed under article 7 and not under article 12.
j) On other hand, regarding the configuration of a PE because of the virtual presence through a web page in India the Indian Income Tax Appellate Tribunal held in the Right Florists Pvt Ltd.  32 taxmann.com 99 (Kolkata – Trib.) case held that the presence of search engines of Google and Yahoo through websites, when servers are located outside India did not constitute a business connection or PE in India.
k) Similarly, recently in Union of India v. U.A.E. Exchange Centre  116 taxmann.com 379 (SC), the Supreme Court held that an Indian liaison office of a United Arab Emirates (‘UAE’) company engaged in fund remittance services did not constitute a permanent establishment (‘PE’) in India. The Supreme Court rules that the activities performed by the Indian liaison offices of the UAE entity were ‘preparatory and auxiliary’ in nature and hence outside the purview of PE and further relies on the scope of RBI permission for setting up the liaison offices for its conclusion.
V. The effect of adoption of MLI:
India ratified MLI and deposited ratified copy of MLI with OECD Depositary on 25 June 2019 –MLI effective for 29 Indian Tax Treaties w.e.f. 1 April 2020. Therefore, one needs to check the MLI provisions also for Tax compliance.
Recommendations under BEPS AP 7 adopted under MLI by way of:
Therefore, looking to expanded scope in MLI, PE concept will also change accordingly.
Consequences of PE:
√ Even a part of business carried on through a PE is sufficient for taxation
√ Books of accounts and audit requirements
√ TDS compliance and tax @ 40% on net profits
√ Transfer pricing implications for transactions with Associated Enterprises
At the end, it is not a secret that information technology has brought with new ways in which business operates, encouraging globalization and integration of the markets, which has made it possible for multinational entities to shift manufacturing bases from high-cost to low-cost locations and managing risks and of developing, provided with opportunities to impressively minimize their tax burden.
This is due to two important factors: (i) the existing ambiguities of the tax rules of the countries that may be involved in electronic commerce transaction (source and residence states) and, (ii) the dilution of important notions that were constructed in the inter- national field to harmonize the different domestic rules under the digital environment, where physical presence is not required.
With the ever-expanding digital advancements, existing taxation rules developed in a “brick-and-mortar” economic environment may need to adapt and evolve. Further, once a global taxation model for digital activities is in place, the legislative may introduce more detailed provisions for taxation of other such activities through the Indian tax laws itself as it is doing now.
Owing to the substantial and accelerated dependence on technology and growing complexity of the business models over the world, we may witness the steady increase in the scope of digital taxation possibly by amending the current DTAA & Income tax statute also.