Public International Law impacts every aspect of the international community, taxation law also has been seen under the preview of PIL. The sovereign has the right to tax, the public international law provides an effective mechanism for taxing the cross-border economic transaction, for the growth of smooth international trade. The current regime provides two principles for taxing income derived from cross-border economic activities. Most of developing countries have followed the source-based system which levied a tax on the income on their resident outside their own territory, India follows this system. Other than this, many countries levy tax on the income of non-residents, if such income arises from the situated business entity within the country. The legal nature of model tax treaties like OECD, and UN Model conventions are not enforceable. They lay down the guiding principles for the interpretation of tax treaties. OECD has formally suggested to its members to conform to the OECD MTC when negotiating bilateral conventions, the UN Model Convention also talks about the MTC. 


A treaty is ‘an international agreement concluded between the sovereign states in writing and governed by various international principles, it can be an in a single instrument, or more than one instrument and whatever its particular designation.’[1] Thus, tax treaty-making practices may be labelled as ‘agreements’, conventions,’ or otherwise, they are, in effect, treaties under international law. In India, the Income Tax Act, tax the income of individuals, and business enterprises, and different tax rates are applicable on different kinds of income. Section 9 provided three broad categories of income business income, royalty and fees for technical services, Business income comes under the higher tax slab. The treaty played a very important role in the while determining the tax rate, etc. Section 90(2) of the ITA talks about how the tax treaties will override the said act.[2]

Tax treaties depend upon the nature of taxes they cover, most of the tax treaties cover taxes on income and taxes on capital. These treaties are generally based on various ideas or model provisions in the UN Model Tax and OECD Model Convention. The present research is based on two important conventions and analyzes the DTAAs among leading India’s business partners. The DTAAs are signed only after a long and details discussion among the party of the treaty there might be a slight difference from the model convention. 

The interpretation of tax treaties played an important role in the determination of taxing rights of the contracting state, over the years interpretation has received considerable attention due to the changing nature of the economic activities of the international organization. The Commerzbank principles[3] are used in the interpretation of tax treaties by the domestic courts of the UK.


Mainly, tax treaties are concluded for two purposes among the nations: (i) Double Taxation Avoidance in cross-border economic transactions and (ii) the prevention of tax evasion in multinational jurisdictions. The introductory text or preamble of the OECD Model Tax Convention also confirmed both purposes in its objective para 2.  Section 4.3.1 to 4.3.3 provides mechanisms for the avoidance of double taxation and the prevention of tax evasion. The essential function of the tax treaties is mainly for the avoidance of double taxation and allocating the taxing rights to the contracting state, with the aim of prohibiting discriminatory taxation. The second aim of the international tax treaties has been the prevention of fiscal evasion.


After the First World War in the 1920s, global trade increased, and the League of Nations started the study the issue of double taxation, which affects global trade and commerce. The foremost objective of that study is to global general principles that on the basis of the international tax system will work and which would be capable of preventing double tax. The outcome of the study known as “Economic allegiance” helped to create the international tax framework. The research also provided essential elements, namely

  • Source of wealth or income,
  • situs of wealth or income,
  • enforcement of the rights to wealth or income, and
  • place of residence or domicile of the person entitled to dispose of the wealth or income 

The income generated in cross-border economic activities and taxed this income in two ways “Source-based” and the residence or domicile of the person system known as Residence-Based”. Both systems were one of the earliest international tax principles which are still very relevant in the 2020s. Some bilateral income-tax treaties also allow taxation if an enterprise maintains a PE in a contracting state but otherwise does not permit taxable any profit derived.

The Source principle is also commonly referred to as the territoriality principle.[4] This principle provides a taxing right to a state where income arises or has an economic nexus, irrespective of whether such income accrues to residents or non-residents.

The Residence principle is also known as the principle of worldwide taxation. In this principle, the residence jurisdiction of a person is determined by whether the income is taxable or not, the taxed worldwide income, irrespective of the source of income, and any concurrent residence in another country.  However, determining an enterprise is not as simple, under the international tax domain.[5]  

Residence taxation dominates with respect to international tax treaties.[6] These treaties are sometimes among a nation of equal level in terms of economic development and terms of bilateral trade decided only after a long discussion. In non-reciprocal between the developed and developing states does not benefit developing nations because usually developed nations follow the source and not the residence state, these treaties do not favour they have to give up the source taxing rights without getting anything in return.[7]

Here the main objective of understanding the concept of PE, is whether the existing system is capable of dealing with the challenges and issues that arise in the cross-border digital economy.  The scope of the study is limited, PE under source-based taxation to some extent it can cover cross-border e-commerce.

Also Read: Career In Customs Law Practice In India


            The 21st-century economy become global, and development in information and communication technology has pushed the interlinking of the global economy more challenges to the retaining existing international tax principles is an effective manner of taxing foreign transactions into clearer focus. Both principles have many drawbacks and overlapping jurisdictions which also continue in the digital economy era too. Bid and Wilkie define the framework of neutrality and equity choices.’

            The present international tax system taxes business profit only if the PE exit in both principles and in virtual commerce does not have PE.  If we apply the source-based tax principles (including the PE concept) to cross-border digital economic issues will raise whether these challenges may be overcome by adopting an exclusive residence-based tax system. Electronic commerce transactions would be taxed entirely in the countries where the businesses performing them are regarded to be resident under such a system, and source nations would have no jurisdiction to tax them.

            The OECD Commentaries are talking about modifying the Section 7 provision but such a suggestion is yet accepted by the developed world. The Brick and Mortar requires a physical presence where Residence Based taxation can work but in the Digital world this system is not suitable, the conflict between the Source and Residence has been seen in the unilateral approach to taxing the cross-border digital economy.   


In the International Tax Domain, the concept of Permanent Establishment plays a very important role in the existing global tax assessment. The contracting state is allowed to be taxable in another contracting state of business enterprise only if such enterprise maintains the PE, which is essential in the brick-and-mortar economic model. Thus, the legal concept of the PE is a contracting state, one state belongs to the source, another state belongs to the resident state, and one state (Source) is either exempted from the Resident State or only allowed to credit on the profit of PE.[8] All such compromises are done for the economic interest of the contracting states, the Convention just provided a model of the DTAAs or FTAs, which also help in the dispute settlement among foreign nations.

The development of ICT challenges the brick-and-mortar economic model and the global tax assessment system. The growth of the digital economy makes independent space for various studies or assessments of the impact, and the existing various domestic and international norms are ill-equipped in respect of international tax law.

In CIT Vs. Vishakhapatnam Port Trust[9] Andhra Pradesh High Court observed “Permanent Establishment”, as under:

“Permanent Establishment” postulate the existence of a substantial element of an enduring or permanent nature of a foreign enterprise in another, which can be attributed to a fixed place of business in that country. It should be of such a nature that it would amount to a virtual projection of the foreign enterprise of one country onto the soil of another country.”[10]

In Telenor ASA v. Dy. CIT 

The case has dealt with the issue of the constitution of PE under the India-Norway tax treaty for interconnected services provided under a unified agreement.[11]


The OECD model is a group of economically strong countries, that come out the existing with its tax system for cooperation between its members but gradually more nations join the system for the growth of the economy and strategy for tax treaties.[12] The OCED Mode Convention provides a definition of “enterprise” and “business” which is not provided by the UN Convention.

The provision Article 5(1) of the OECD Model Convention dealing with the PF “permanent establishment” means a “fixed place of business through which the business of an enterprise is wholly or partly carried on.”[13] There are essential elements that must be present to establish the permanent establishment given as an example in Article 5(2) place of business, that business must be fixed and the business must be carried out from that fixed place. The OECD model does not differentiate PE for the Goods and Services independently.   

Article 7 of the convention dealt with Business profits, and all the tax laws are enacted to tax thus profits.


The United Nations Model Tax Convention mainly follows the so-called “source country” Under this the taxing rights are vested in the host country rather than the “residence county”. The source-based system follows the business profits derived from the source country can be taxed. In a tax treaty that is based on the UN Model the source state is in principle the developing country, due to this, there is a certain opportunity for developing nations to earn a relatively large portion of the country’s financial resources.[14] This model is more beneficial for LDCs and developing countries.

The PE is essential for establishing the taxing right, UN Model provides separate provisions for goods and services, and the OECD does not make this distinguished.  

There are a few tests that determined the existence of PE under both models such as:-

  1. Objective Test

Objective tests two main components. The first test is “Place of the Business” and the second identifies the “fixed” place of the business. Generally, a business carried not from a single place, they have a physical presence in multi spot for the various related business activities, even in such cases the spot of business can exist without the presence of representatives.

  • Subjective Test

The Subjective Test normally applies to establishing the place of business of a non-residents enterprise and not of anyone else. The business location must be available to the company. As a result, what matters is the right to use the location, not how that right was obtained; that is, whether the location is owned, rented, or otherwise available to the business.

  • Functional Test

The mere having a fixed place of business does not constitute PE, without actually carrying out business activities from that place. The activity must be performed through that place of business by the enterprise. The functional test required the following satisfaction:-

  1. Business Activity conducted performed by the enterprise in the particular state must be under the domestic law of that state.
  2. That business activity is covered under the domestic legislation but such business profit will be treated under Article 7 of the UN Model Convention.   
  3. The business activity must be not in the nature of a preparatory or auxiliary, which is mentioned in Article 5(4).

Thus, all tests are required for the physical presence of the business enterprises to constitute a PE, but in the digital world the business exits in one place without any economic activities in that place, but the economic activities are done virtually.  All the tax treaties, DTAAs, etc. are followed almost the same principle of PE for taxable business profit either through source-based or resident. 

In Motorola Inc Vs. Deputy Commissioner of Income Tax [(2005) 95-ITD-269(SB)][15] ITAT ruled that

“A PE, i.e. fixed place of business of a non-resident, in India if a physical place at disposal of the non-resident use for the business in India. Employees of the non-resident must have unrestricted access to the place of Indian Subsidiary would be called a PR of the Non-resident supplier in India.”[16]

Thus, existing PE creates not only challenges to the digital economy but there is a conflict between the Resident and Sources tax system.   


The PF under Article 5(1) becomes very important to determine the business profits under Article 7 or attribution of profit to PE. Thus, the right to tax profits is, in the first instance, granted exclusively to the state of the resident of an enterprise, provided by Article 7(1) of OECD. The exception to the general rule is where the enterprise carries on business through a PR in the other contracting state.[17]

In case of American Leaf Blending Co. SDN BHD v.  Director of Inland Revenue,[18] Lord Diplock observed that:-  

“in the case of a company incorporated for the purpose of making profits for its shareholders, any gainful use to which it puts any of its assets prima facie amounts to the carrying on of a business.”

But the issue areas in the digital economy when the taxing profit, Article 7(1) provided only can tax when there is a PE but in the determination of PE in cyberspace is not possible if we read Permanent Establishment as it’s provided in Article 5. The effect of this article is that profit from the digital transaction is not covered by the state of residence of the enterprise’s definition.

There is a substantial difference between the concepts of OECD and UN-related to sub-paras (b) and (c) of Para 1 UN MTC which stipulate that profits derived:

  • From sales in the other State, of goods “of the same or similar kind” as those sold through the PE, and
  • Form other business activities carried on the other state “of the same or similar kind” as those effected through the PE,

The UN Model Convention has limited the business profit through the “force of attraction rule” One significant feature of the UN Model Convention, as compared with the OECD Model Convention. The rules differ from those in Art. 7 of the OECD Model Convention in that they allow taxation of certain profits not actually attributable under normal rules to the PE, but which relate to sales of similar goods or merchandise in the source country, as well as other business activities of the same or similar kind carried on by the enterprise in the source country.[19]

Galileo International Inc Vs. Deputy Commissioner of Income [20] In this case, the assessee is a resident of the USA and is doing business activities through the Computerized Reservation System (“CRS”) for providing the services of booking reservations in hotels, airlines, etc.

            The Indian Tax taxing authority and first appellate in tax proceedings has been decided that assesse has a “business connection” in India and profit taxable as per Income Tax Act, as well as a PE under Art. 5 of the India and USA DTAA.

There are considerable differences in taxing income under the international norm. The three primary types of income that are considered non-resident’s income such as ‘Royalty’, ‘Fees for Technical Services’ (‘FTS’), and Business Income. The tax rate of each category differs depending courtiers and their tax treaties.  Where the non-resident/taxpayer has made an incorrect classification of an income or the characterization of income is not in tandem with the international principles, then such non-resident taxpayers face a potential risk of double taxation in different jurisdictions and also end up witnessing protracted litigation.


Indian situation under Section 9(1)(i) of the ITA, business connection is required for taxing business profit and transactions. The term “business connection” is a wide one that does not only refer to physical/geographic links. Business Profits are taxed in the source state solely to the extent that they are traceable to a PE established by the enterprise, according to Article 7 of the model tax convention. Because the notion of PE was not established to deal with instances where transactions occur in the absence of a physical process, issues arise in this context due to confusion as to when a PE is formed in such transactions in India. Due to the fact that most PEs need territorial linkage, several e-commerce transactions are tax-free in the originating State.[21]


Before going to define the DTAAs, we have to understand the meaning of Double Taxation, in general, the taxing of the same income or subject matter twice in a different jurisdiction or at some time in the same jurisdiction. Till 1920 there is no common understanding among the states on the international tax regimes, The League of Nations formed a committee of four economists, Prof. Gijsbert, Prof. Luigi Einaudi, Prof. Edwin Seligman and Prof. Josiah Stamp the suggest International Taxation norms with respect to settled the Taxing right of the state, and the avoid the multiple taxes/Double Tax Avoidance on the same income in the different jurisdiction. They recommend dividing the taxing rights between residence and source of the state, at present, the recommendation has been modified accordingly to the needs of the society.[22]

            The Double Tax Avoidance Agreement (DTAA), mainly thus are based on four models of tax law convention namely i). OECD Model, ii) UN Model, iii) US Model, iv) Andean Community Income and Capital Tax Convention. All these models followed different patterns of taxing business profit and avoiding double taxation so, interpretation becomes very essential for settling the dispute without disturbing the commercial activities. The object of DTAAs is mainly for the avoidance of double taxation, to avoid the discriminatory tax regime in the contracting state taxpayer, to improve the coordination among the taxing authority, and the last but least object of the DTAA is clarity on the cross-border transaction with respect to international taxation.   

            The research will analyze India’s position on DTAAs and the approach to international taxation, India follows the UN Model of double taxation avoidance agreements. The researcher will study the India DTAAs with USA and UAE, and the problem in the digital economy. 

Section 90 of the Income Tact Act, Empowers the central government to enter into a DTAA for the avoidance of double taxation, and also Under Section 90A, an empowers the central government to enter into an agreement between any particular associations in India and specified associations in India. The DTAA will override the Income Tax Act, 1961. Currently, India has 96 Comprehensive Agreements & 14 Limited Agreements in India. DTAAs played an important role in attracting foreign investments, in addition to the exchange of goods and services among the contracting states.[23]

In U.O.I v. Azadi Bachao Andolan, exhaustively considered section 90 of the IT Act, and has made, inter alia, the following observations:

  • For the fiscal statute, delegate power is with the central government
  • The validity can be challenged only on the parameter of legislative Provision
  • Interpretation of Statute or Interpretation of Treaties are two different thin

The India’s response to taxing the digital economy, the many developed countries like the USA, UK, French, etc. the EL cited the violation of DTAAs. The research will explain the USA-French DTAAs, violation through the DTAAs.

[1] Article 2 Para 1(a) Vienna Convention on the Law of Treaties 1969

[2] Section 90(2) of Income Tax Act, 1962

[3] (2008) Sp C 669 at para 98

[4] OECD (1991) 36: Daly (1994) 13.

[5] Musgrave P.B. (200) Pg 52-53

[6] Dagan, 32 N.Y.U.J. Int’l L. & Pol 2000, 939

[7] Giovannini (1989) 350; Musgrave P.B (2000) 46, 50.


[10] [(1983), 144-ITR-146 (AP)]

[11] [2021] 129 taxmann.com 198

[12] Donald R Whittaker, An Examination of the O.E.C.D. and U.N. Model Tax Treaties: History, Provisions and Application to U.S. Foreign Policy, 23.

[13] OECD Model Tax Convention Art 5(1)

[14] Source state taxation in model tax treaties, https://leidenlawblog.nl/articles/source-state-taxation-in-model-tax-treaties (last visited May 10, 2022).

[15] Motorola Inc Vs. Deputy Commissioner of Income Tax 2005

[16] Analysis of the word ‘Permanent Establishment,’ TaxGuru (2018), https://taxguru.in/income-tax/permanent-establishment-parti.html (last visited May 30, 2022).

[17] 4th ed Jonathan Schwarz, Schwarz on Tax Treaties p 223 [2015]

[18] [1998] STC 561 (PC)

[19] Michael Lennard, The UN Model Tax Convention as Compared with the OECD Model Tax Convention – Current Points of Difference and Recent Developments (Article) Available at https://www.taxjustice.net/cms/upload/pdf/Lennard_0902_UN_Vs_OECD.pdf  (last visited April 18, 2022)

[20] Galileo International Inc Vs. Deputy Commissioner of Income Tax [(2008) 19-SOT-257(Del.)]

[21] SHREYA RAO & SRIRAM GOVIND, Taxation of e-Commerce in India, [2016] 66 taxmann.com 306 (Article)

[22] Taxmann, All About Double Taxation Avoidance Agreement (DTAA), Taxmann Blog (2019), https://www.taxmann.com/post/blog/831/double-taxation-avoidance-agreement-all-about-dtaa/ (last visited May 9, 2022).

[23] Aaliya Waziri, View: Unpacking India’s approach to digital taxation, The Economic Times, February 17, 2022, https://economictimes.indiatimes.com/news/economy/policy/view-unpacking-indias-approach-to-digital-taxation/articleshow/89638692.cms?from=mdr (last visited May 26, 2022).

Leave a Comment