[By Devanshi Gupta]
The author is a student of Symbiosis Law School, Pune
INTRODUCTION
In 2024, annual global revenue losses attributable to the challenges of taxing the digitalized digitalised economy were estimated at over USD 100 billion. This figure is projected to worsen as digital trade replaces traditional economic models. This challenge emanates from the existing tax rules that largely depend on physical presence, even as value creation increasingly occurs virtually and across borders. Nowhere is this tension more pronounced than in the Indian legal framework around the Service Permanent Establishment (PE) concept, a cornerstone of international income taxation and Double Tax Avoidance Agreements (DTAAs).
On 4th December, 2025, the Delhi High Court’s decision in the case of Commissioner of Income Tax v. Clifford Chance Pte. Ltd. crystallised this dilemma. The Court’s interpretation of Article 5(6) of the India-Singapore DTAA rejected the idea of a “virtual” Service PE, thereby reintroducing the older parameter of mandating the physical presence of service providers for taxation, despite rapid digitization. Yet, the same judgment solidified the requirement of the actual delivery of services over physical presence when calculating the 90-day service PE standard, revealing a doctrinal inconsistency.
This article examines the dissonance between the Clifford Chance judgement and earlier Indian precedents, such as ABB FZ-LLC v. DCIT and Verizon Communications Singapore Pte Ltd. v. ITO, which placed a greater emphasis on the economic substance of services provided. It examines how differing interpretations of the Service PE concept, along with parallel, contradicting domestic measures, like India’s Significant Economic Presence and Equalization Levy, reveal limitations in the current direct tax framework in responding to digitalisation. Finally, the article offers recommendations based on global best practices aimed at harmonizing India’s treaty-based rules with the economic realities of the digital age.
SERVICE PERMANENT ESTABLISHEMENT IN INDIA
The concept of Permanent Establishment (PE) is utilized to ascertain whether a country has the right to tax a non-resident, natural or artificial. If the said non-resident meets a mutually agreed criteria, its profits and dividends are liable to be taxed. The standard is widely inculcated in DTAAs between nations to resolve taxation conflicts and promote ease and efficiency in business.
True to its name, it was originally introduced with the intention of taxing non-residents undertaking business activities with a physical, permanent establishment and presence in India. However, with globalization and digitization, conduction of business and the administration of services is no longer restricted to physical spaces. The rapid expansion of the digital economy has disrupted the physical-presence paradigm. This has resulted in direct interpretation and adaption difficulties pertaining to the determination of ‘permanent establishment’ and the consequent taxation of such persons, raising questions regarding the relevancy and adequacy of existing definitions. It is against this backdrop that the Clifford Chance judgment, which directly addressed the limits of service PE in the digital context, assumes particular significance. The judgement is examined below.
THE CLIFFORD CHANCE JUDGMENT: REASONING AND RATIO
The court, in the Clifford Chance case, held that in the absence of explicit treaty language extending the application of PEs to virtual presence, no deduction can be made to that effect. It rejected the concept of virtual Service PE in cross-border services. Physical presence of employees administering the services in India was made mandatory under Article 5(6) of the India–Singapore DTAA and other parallel, similarly framed agreements.
This was based on the rationale that the textual interpretation of Article 5(6) does not support the inclusion of digital spaces, which states that “An enterprise shall be deemed to have a permanent establishment in a Contracting State if it furnishes services… within a Contracting State through employees or other personnel…”. The Court interpreted the phrase “within a contracting state” as having a clear “territorial connotation”, obligating the need for a physical footprint in India. The term “within” was therefore understood as referring to physical presence, not merely the place where services are implemented or have effect.
Notably, however, the judgment adopts a different emphasis when addressing the calculation of the service-day period. In the same judgment, the Delhi HC also held that for the purpose of computing the service-day period, primacy must be given to the actual provision of services rather than mere physical presence. On this basis, it excluded vacation days from the calculation of the 90-day requirement. This creates a dissonance: physical presence is treated as essential for the existence of a Service PE, yet insufficient for the calculation of the actual service days. Additionally, this also marks a shift in ideology from a more adaptive, purposive interpretation in previous precedents to a formalist, text-centric treaty interpretation, an approach that may undermine India’s long-term taxation objectives.. The position taken in Clifford Chance, therefore, sits uneasily with the pre-existing Indian jurisprudence. This divergence is examined below.
CONFLICTING INDIAN JURISPRUDENCE: IMPACT
Prior to this judgement, Indian tax jurisprudence had not been uniformly dismissive of virtual or non-physical presence as a sufficient nexus for taxation.
In the case of ABB FZ-LLC v. DCIT, the court rejected the necessity of physical presence, holding that in light of the technological advances, “it is rendition of services that is required and not the physical presence of employees” for establishing permanent establishment. Similarly, in Verizon Communications Singapore Pte Ltd. v. ITO, the court stated that “the traditional concepts of physical control, possession, location on economic activities and geographic rules of source of income recede to the background” and have become insignificant. The Court noted that where customers have access to data and services through equipment enabling speed and delivery, such virtual engagement may constitute a sufficient taxable presence. Traditionally, emphasis has been laid on the location of the customers receiving the service, in lieu of the service provider.
Notably, the judgment also contradicts the explanation to Section 2A of the Income Tax Act, 1961, which recognizes ‘Significant Economic Presence (SEP)’ as a part of ‘Business Connection’ leading to taxable income in India. It further clarifies that a physical presence is not necessary for SEP. Consistently, the CBDT Explanatory Memorandum to Finance Bill, 2018, revealed that the concept of SEP gives “primacy to the economic allegiance rather than physical location”, extending to DTAAs. Based on the same principle, equalization levies have been introduced under the Finance Act of 2016 and Section 84, Finance Act, 2020 to impose taxation of non-residents profiting from online advertisement and online sale-of-goods services.
The approach taken with respect to the taxation of cross-border Fees for Technical Services (FTS), also reflects a substance over form philosophy where taxability is determined by the “made available” test mandating transfer of services, dependence by the recipient and compensation, irrespective of physical proximity or presence. This principle has been reinforced in judgements such as De Beers India Minerals (P.) Ltd. and Raymond Ltd. v. Dy. CIT., where the focus remained on the economic substance and impact of service delivery rather than the location of the service provider.
Thus, assessors have consistently applied this line of purposive reasoning, which the Clifford Chance judgement significantly restricts by establishing physical presence as an essential criterion. This results in two identical economic outcomes being subject to different tax treatments, giving rise to an incentive for corporates to deliberately restructure their business activities to circumvent physical presence in India.
RECOMMENDATIONS BASED ON GLOBAL BEST PRACTICES
- Reconceptualize ‘Permanent Establishment’ by expanding source-based taxation – Drawing from the 2005 OECD Report recommendations, the definition of PE must be expanded to include ‘virtual presence’ applicable to all businesses providing services to users located in the country. However, such taxability must be aligned with existing SEP standards to ensure consistency.
This recommendation has also been endorsed by the Centre for European Economic Research and the 2013 KMPG Report titled Tax in the Digital Domain. It is imperative to note that the feasibility of such measures depends entirely on bilateral or multilateral treaty negotiations. Unilateral implementation risks creating instances of double taxation.
- Codification of digital nexus standards to limit discretion – Several jurisdictions have already adopted legislative measures reflecting this evolving approach to taxing cross-border services. Kuwait’s DMTT legislation, introduced in 2024, permits the taxation of business services performed for Kuwait “through a place of business other than the traditional PE definitions”. In the same year, Canada introduced the Digital Services Tax (DST) for service providers. Similarly, technical and professional services that create a SEP trigger a taxable presence in Nigeria.
The adoption of clearly articulated and uniform rules in this regard would constrain administrative discretion, reducing base erosion and profit shifting by multinational enterprises. A comparable policy rationale was articulated by the French Government in the 2013 Collin Report.
CONCLUSION
The transition from ABB to Clifford Chance exposes a widening digital tax divide in Indian Service PE jurisprudence. The Clifford Chance judgement separates itself from earlier approaches focused on the substance of PE, and is therefore in conflict with India’s existing legislative measures centred around the concept of ‘economic presence’, as evidenced by the SEP and Equalization Levy legislations. The divergence from the original precedent undermines the certainty related to taxation of digital profits and encourages tax avoidance or tax-evasive business structuring. Without a revision to the current approach through coordinated reform of tax treaties and establishment of clearer benchmarks or standards, the Indian tax framework will remain constrained by old notions, rendering it unsuitable to address the economic realities of an ever-expanding digital marketplace without having redefined Service PE parameters.