Why foreign digital firms are facing tax scrutiny in India
What's the story
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). A permanent establishment refers to a fixed place of business through which a foreign company conducts its business in another country. These companies are preparing to contest the assessments, challenging them at the assessing officer level or before the Dispute Resolution Panel (DRP).
Tax implications
Permanent establishment: A tax law and treaty concept
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. This means 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. At the core of the dispute is how broadly the concept of permanent establishment is interpreted in the digital economy.
Business operations
Tax authorities' scrutiny on digital companies
Tax authorities are examining whether certain digital, operational or technical arrangements—even without a conventional office—are sufficient to create a taxable presence. The final liability depends on how much income is attributed to the PE; 35% is the standard corporate tax rate applied to foreign companies. 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.
Legal battle
Companies challenge tax department's classification
The companies argue that their digital Indian operations do not amount to a PE. Accepting that would fundamentally change their tax position. 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.
Tax reform
Government explores presumptive tax system for digital companies
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. 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," a person familiar with the developments told Moneycontrol.
Legal proceedings
Prolonged litigation expected over PE classification
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.