Tax authorities in any country may determine that a company has created a permanent establishment (PE) under local rules if the company engages in certain activities. This typically includes maintaining a fixed place of business, hiring a local dependent agent to act on behalf of the company, or providing services locally.
Most financial, tax, and other leaders in multinational organizations are familiar with the concept of permanent establishment (PE) and understand the importance of complying with local PE rules. Triggering a permanent establishment essentially means that the organization has established a local tax presence. In many cases, this results in setting up a local legal entity, such as a subsidiary, through which corporate taxes can be filed and, in some cases, paid.
However, some stakeholders at multinational organizations may mistakenly assume that establishing a legal entity in a specific jurisdiction eliminates the risk of triggering a permanent establishment in that region. Unfortunately, even with a legal entity in place, a multinational company may still be at risk of inadvertently creating a permanent establishment and facing unexpected corporate tax liabilities. This article discusses a recent case between Indian tax authorities and a US-based company to highlight this often-overlooked PE risk.
Caterpillar Group, a US-based company, established an Indian subsidiary in 1996 called Progress Rail Locomotive Inc. This subsidiary operates a factory in India, originally based in Noida and later relocated to Hubli. Progress Rail also provides support services to Caterpillar on an intra-group cost-plus basis.
Indian tax authorities argued that Progress Rail India had triggered a permanent establishment in India because it was substantially involved in the core business activities of Caterpillar. In response, Progress Rail and Caterpillar contended that the activities conducted by Progress Rail India were preparatory and auxiliary in nature and not part of its core operations. They also argued that their transactions were conducted at arm's length, following objective transfer pricing studies.
On May 28, 2024, India’s High Court ruled in favor of Progress Rail India and Caterpillar, concluding that their activities did not constitute a permanent establishment under the US-India tax treaty. The Court’s decision considered several key factors:
The High Court ruled in favor of Progress Rail and Caterpillar, but it’s important to note that this decision was based on the specific facts of the case. The ruling doesn’t imply that a non-resident company cannot trigger a PE just because it has a local subsidiary. Had the facts been different — for instance, if the Indian subsidiary had regularly concluded contracts on behalf of Caterpillar or if its activities were more closely linked to Caterpillar’s core business — the Court might have determined that a permanent establishment was triggered.
This case highlights the fact that tax authorities in any country may scrutinize the activities of a local subsidiary in relation to its non-resident parent company to determine if a permanent establishment has been triggered. Simply having a local subsidiary doesn’t eliminate the risk of creating a permanent establishment. Therefore, subsidiaries of non-resident companies must be prepared to answer questions from tax authorities regarding their activities and whether these could trigger a fixed place, dependent agent, or service-related permanent establishment. Additionally, multinational groups should be aware of potential PE risks in any country where they have operations.
Finally, it’s important to remember that each country has its own rules regarding permanent establishments, tax treaties, and enforcement practices. PE risks will vary by country and by the specific activities an organization undertakes in each jurisdiction. Most multinational organizations mitigate these risks by engaging third-party global tax experts to conduct regular reviews of their activities in light of relevant permanent establishment rules.
