[By Aviral Singhai and Shubham Sharma]
The authors are students of National Law Institute and University Bhopal
Introduction
A foreign company can earn significant revenue from Indian users without adhering to the traditional notion of a fixed place. AppleTV, a service distinct from Apple Inc., can collect subscription fees from Indian viewers, Supercell can earn revenue from Indian gamers, and platforms such as Twitch or OnlyFans can generate advertising and subscription income from Indian users. Yet, under most of India’s tax treaties, much of this income may remain outside India’s taxing jurisdiction.
The significance of this issue has increased with the growth of the digital economy. The OECD Digital Economy Outlook 2024 reports that the information and communication technology sector grew at nearly three times the rate of the overall economy across OECD countries between 2013 and 2023, while the UNCTAD Digital Economy Report 2024 records global business e-commerce sales of US$27 trillion in 2022. India has emerged as one of the world’s largest digital markets, with a January 2025 ICRIER study identifying it as the world’s third-largest digitally engaged economy. This shows the number of people engaging with companies online without any necessary physical presence.
Despite this transformation, most Double Taxation Avoidance Agreements (DTAAs) still allocate taxing rights through the concept of a Permanent Establishment (PE), which generally requires physical presence. India and many of its treaty partners have explored alternatives based on digital or economic presence, but the DTAA framework continues to limit such approaches. The Protocol signed on 23 February 2026 amending the India-France DTAA expanded source taxation through a Service PE provision but still required the physical presence of personnel. Furthermore, the OECD’s update to the Model Tax Convention on 18 November 2025 introduced a commercial reason test for home office Permanent Establishments but this did not recognise a Virtual PE or taxing rights based solely on digital presence.
This article examines these developments in depth and evaluates what is necessary to recognise meaningful digital presence as a basis for taxation.
India’s approach to Virtual PE Regime
India’s tax law does not require a Permanent Establishment, as Section 9(1)(i) of the Income Tax Act, 1961 (Income Tax Act) taxes income arising from a “business connection” in India. However, in cross-border situations, Section 90(2) allows the taxpayer to choose between the Income Tax Act and the DTAA, depending on which is more beneficial. This weakens the scope of domestic taxation and creates problems in taxing digital businesses, where significant income is earned from India but goes untaxed due to the absence of a Permanent Establishment under Article 5 of the OECD Model DTAA.
As business shifted towards digital platforms and remote service delivery, disputes arose over whether treaty concepts developed for offices, factories and employees could adequately deal with these new business models.
The concept of fixed place PE was explained in Formula One World Championship Ltd. v. CIT, where the Supreme Court held that a PE exists only when the place is at the disposal of the foreign enterprise and business is carried on through it. While the Court adopted a more practical approach by focusing on control over operations rather than ownership, it still treated physical presence as an essential requirement under DTAA.
In order to address the problem of digital taxation, India introduced the Equalisation Levy in 2016 and expanded it in 2020. It applied only to online advertising and e-commerce services involving Indian users, including targeted ads and use of user data. Since it operated outside the Income-tax Act and treaty network, it enabled taxation even without a PE. However, it was withdrawn to align with the OECD/G20 BEPS framework and Pillar One, which allocated taxing rights based on business activity and user markets rather than physical presence.
India then introduced the concept of Significant Economic Presence (SEP) through the Finance Act, 2018, effective from AY 2022–23. SEP creates a taxable nexus based on revenue from India and continuous user interaction. As per Explanation 2A of Section 9, it covers transactions where payments exceed the prescribed threshold or there is systematic and continuous interaction with users. The thresholds under Rule 11UD of Income Tax Rules, 1962 are INR 2 crore in revenue or 3 lakh users.
However, the application of SEP is substantially limited by Section 90(2) of the Income-tax Act, which permits a taxpayer to rely on the more beneficial provisions of an applicable DTAA. Since India’s DTAAs continue to require a Permanent Establishment based on physical presence before business profits can be taxed, SEP has had limited practical effect in most treaty situations.
The difficulty became clearer as technology transformed cross-border service delivery. In ABB FZ-LLC v. Dy. CIT, the ITAT recognised that consultancy and technical services could be provided virtually through e-mails, internet platforms, video conferencing, remote monitoring and remote-access systems and observed that continuous physical presence was no longer necessary for a Service PE. A similar shift is seen in Hyatt International Southwest Asia Ltd. v. ADIT, where the Supreme Court held that substantive control over operations of an Indian entity could establish a fixed place PE even without ownership of premises. These decisions reflected a growing judicial focus on how business was actually conducted.
The limits of this judicial expansion became apparent in CIT v. Clifford Chance Pte Ltd. The Revenue argued that a “Virtual Service PE” could arise through services provided remotely into India. The High Court rejected the argument and held that the DTAA required services to be performed within India through personnel. Merely rendering services from abroad for Indian clients was insufficient. With regards to “Virtual Service PE” the Court expressly acknowledged that modern business models have exposed weaknesses in the traditional PE framework and referred to developments such as Significant Economic Presence as evidence of a broader policy shift. It made clear that recognising digital or virtual economic participation as a basis for taxation would require amendment of the DTAA itself.
Domestic response of countries having DTAAs with India
While India may seek changes to the existing taxation framework, such changes cannot override the provisions of the DTAAs it has entered into with other countries. Further, a DTAA cannot be amended solely at India’s instance; any modification requires the agreement of the other contracting state as well.
What is important to note, however, is that although there has been no move to amend these DTAAs, India is not alone in finding the traditional PE framework inadequate for taxing digital business models. Several jurisdictions that maintain DTAAs with India have expanded their domestic tax rules to account for the value generated by companies even in the absence of a physical presence.
France addressed this issue through the introduction of a Digital Services Tax (DST) in 2019. The tax applies to large multinational enterprises with global revenues exceeding €750 million and French digital revenues exceeding €25 million and is levied at three percent of specified digital revenues. The French rationale was that users contribute significantly to value creation, justifying taxation even where the enterprise lacks a traditional PE.
Indonesia adopted a nexus-based approach through the concept of Significant Economic Presence. Its rules focus on indicators such as local revenues, user base, and digital interaction with the Indonesian market. The underlying premise is that sustained economic engagement with a jurisdiction may justify taxation even in the absence of physical operations. Saudi Arabia has similarly endorsed the concept of a “Virtual Service PE”, recognising that businesses can establish a meaningful economic presence through digital networks without deploying personnel or maintaining premises in the country. However, the 2023 guidelines of Zakat, Tax and Customs Authority (ZATCA) clarifies that the concept of Virtual PE, earlier used for taxing non-resident service providers in the Kingdom, cannot be recognized until DTAA recognizes it.
Israel has also explored alternatives to the traditional PE standard. In 2016, the Israeli Tax Authority issued guidance suggesting that a foreign enterprise with a Significant Digital or Economic Presence in Israel could, in certain circumstances, be regarded as having a PE despite the absence of a substantial physical footprint. A large local user base, substantial transactions with Israeli customers, and localisation of services were treated as indicators of nexus. Similarly, the European Union proposed a “Significant Digital Presence” standard under which revenues, users, or digital contracts within a Member State could create a taxable nexus without physical presence. Although not ultimately adopted, the proposal reflected an effort to align taxing rights with digital economic activity rather than physical establishment.
This shows that even though both the parties wish to adopt a modern model for taxation taking into account the needs of present times, they are prevented from doing so by a DTAA so aimed at helping both the countries/parties. This is because the unilateral changes, even if made by both the parties in their domestic tax legislation, cannot override the provisions of the DTAA.
Treaty framework
The OECD has long recognised the difficulty of applying traditional PE rules to digital business models. Its 2018 Interim Report on Tax Challenges Arising from Digitalisation discussed the concept of a “Virtual Service PE” but retained the prevailing view that a service PE generally requires employees or other personnel to be physically present in the source country. The report nevertheless noted that Saudi Arabia had endorsed a virtual service PE concept. Earlier, the OECD’s 2005 report E-commerce: Transfer Pricing and Business Profits Taxation examined alternatives such as a virtual fixed place of business, a virtual agency PE, and an economic-presence-based nexus standard. However, none of these proposals was incorporated into the OECD Model Convention. Consequently, although the OECD framework has considered alternatives capable of taxing businesses operating remotely in a market jurisdiction, India has not adopted these concepts in its treaty network.
Although India amended the India-France DTAA in 2026, it did not incorporate any of these OECD proposals. Instead, one of the key changes was the introduction of a Service PE clause under which a French enterprise may create a PE in India if its employees furnish services in India for more than 183 days within a twelve-month period. This expands the PE concept beyond fixed establishments such as offices or factories and recognises that sustained service activity can create a sufficient economic connection with the source state. However, the provision still depends on physical human presence. A digital enterprise providing streaming services, digital advertising, cloud computing, or platform services entirely through remote infrastructure would generally remain outside its scope because its employees may never enter India. The amended DTAA also incorporates the OECD-led Multilateral Instrument’s Principal Purpose Test (PPT), which permits treaty benefits to be denied where obtaining such benefits was one of the principal purposes of an arrangement.
The India-France DTAA is not an isolated example. Similar amendments have been incorporated into India’s treaties with the United Kingdom from 1 October 2019, Japan from 2019, and Australia through the Multilateral Instrument. These amendments introduced the PPT and other BEPS-related measures aimed at preventing treaty abuse, while the India-Japan DTAA also incorporates changes designed to prevent the artificial avoidance of PE status through commissionaire arrangements and similar structures. These changes strengthen source-based taxation and reduce opportunities for treaty shopping within the existing treaty framework.
However, like the India-France DTAA, none of these treaty amendments incorporates a virtual fixed place of business, virtual agency PE, virtual service PE, or an economic-presence-based nexus standard. The result is that while treaty abuse and artificial PE avoidance have been addressed, the core issue identified by the OECD remains unresolved and foreign enterprises can continue to derive substantial revenue from a market through digital means without necessarily creating a treaty PE in that jurisdiction.
Recommendations
Based on the above analysis, it becomes clear that amending India’s DTAAs with other countries is necessary. The question that then arises is how the same should be done?
- Article 5 of India’s DTAAs should be amended to recognise a Digital Service PE. The existing definition should be expanded to provide that a non-resident enterprise may constitute a PE where it maintains a sustained digital presence in India, notwithstanding the absence of any physical place of business or personnel. To ensure certainty and minimise disputes, the provision should be based on objective criteria such as revenue generated from Indian users, the size of the Indian user base, and the continuity of digital engagement. However, to avoid overlap with the existing framework, the provision should apply only where a fixed place Permanent Establishment or a dependent agent Permanent Establishment does not already exist. Such an amendment would better align the treaty framework with modern digital business models while preserving clear and predictable nexus standards.
- The OECD’s 2018 Interim Report on the Tax Challenges Arising from Digitalisation discussed the concepts of a Virtual Fixed Place of Business PE and a Virtual Service PE as possible alternatives to the traditional Permanent Establishment framework. While neither concept was incorporated into the OECD Model Convention due to the lack of international consensus, they recognised that physical presence is no longer an adequate basis for allocating taxing rights in the digital economy. India should consider pursuing the incorporation of a Virtual Service PE, or similar treaty-based nexus rules, through bilateral DTAA negotiations. Such an approach would enable DTAAs to recognise sustained digital service activities as creating a taxable nexus, even where the non-resident has no physical presence in the source state.
Conclusion
The existing Permanent Establishment framework does not adequately address the challenges posed by the digital economy. While India and several other countries have introduced domestic measures to address this issue, their effectiveness remains limited because the DTAAs between them continue to require a Permanent Establishment based on physical presence. As businesses increasingly earn substantial revenue and maintain continuous economic engagement through digital means without any physical presence, the traditional PE framework no longer aligns taxing rights with modern business models. Therefore, India’s DTAAs should be amended to go beyond the requirement of physical presence, enabling the treaty framework to effectively tax highly digitalised businesses.