MC EXCLUSIVE Tax department issues notices to 4–5 foreign digital firms over permanent establishment

The core dispute is over how broadly the concept of permanent establishment should be interpreted in the digital economy.

• Tax notices sent to major foreign digital firms over permanent establishment status
• Companies to challenge PE assessments, may face lengthy legal battles
• Govt mulls presumptive tax for digital firms to simplify profit attribution

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The tax department has issued notices to as many as five large foreign digital companies, saying their activities in India meet the threshold of a permanent establishment (PE), sources aware of the development said.

These companies are preparing to contest the assessments, challenging them at the assessing officer level or before the Dispute Resolution Panel (DRP).

“Four to five large foreign digital companies have already received tax notices that their Indian operations are a permanent establishment. In some cases, assessments have already treated them as PE,” one of the sources cited above told Moneycontrol.

A permanent establishment refers to a fixed place of business through which a foreign company conducts its business in another country.

Under tax law and treaties, once a company is classified as having a permanent establishment in India, it is treated as having a taxable presence in the country. Indian tax authorities can attribute a portion of the company’s India-linked income to that establishment, deduct related expenses and tax the resulting profit.

Testing the PE boundary

At the core of the dispute is how broadly the concept of permanent establishment is interpreted in the digital economy.

Tax authorities are examining whether certain digital, operational or technical arrangements — even without a conventional office — are sufficient to create a taxable presence.

“The demand depends entirely on how the PE is calculated. Once that is decided, income attribution follows,” the person said.

The final liability depends on how much income is attributed to the PE; 35 percent is the standard corporate tax rate applied to foreign companies.

“It is theoretically revenue minus expenses but in practice, it is exceedingly complex. Every assumption is contested,” the person said.

Digital companies push back

The companies argue that they have only a “communication set-up which is not even owned by them”, which does not automatically create a PE.

“They are saying their digital Indian operations do not amount to a PE. Accepting that would fundamentally change their tax position,” the person said.

The companies have approached the tax department and are expected to begin litigation at the assessment or DRP stage. Once a matter enters a judicial process, the Central Board of Direct Taxes (CBDT) typically does not intervene administratively.

Government explores presumptive tax route

The complexity of PE-based profit attribution has led the government to explore alternative models.

An internal report has proposed moving to a presumptive tax system for digital companies, where tax is calculated as a fixed percentage of revenue rather than through detailed profit calculations.

“MeitY is trying to push a presumptive tax approach. They did something similar for electronic companies earlier,” the person said. Such a system would reduce disputes over cost allocation and margins.

Foreign digital firms, however, are resisting this approach. “From their perspective, agreeing to presumptive tax is like accepting that they have a PE in India. That is what they are trying to avoid,” the person said.

Legal battle ahead

Officials and companies expect prolonged litigation. With high-value assessments and unresolved questions about how PE should apply in the digital economy, the cases are likely to move through multiple layers of appeal.

“This is the first real test of how India will apply the PE concept to digital businesses. Whatever happens here will set the tone for future cases,” the person said.