‘Virtual Service PE’ Theory Rejected; Delhi HC Quashes 5.25% Withholding Tax Order Against Ernst & Young LLP

The Delhi High Court has set aside an order directing Ernst & Young LLP (EY India) to withhold tax at 5.25% on payments proposed to be made to its UK group entity, Ernst & Young (EMEIA) Services Limited. The Income Tax Department’s reliance on the concept of a “virtual service permanent establishment (PE)” under the India–UK Double Taxation Avoidance Agreement (DTAA) was legally untenable. The bench of Justice V. Kameswar Rao and Justice Vinod Kumar ruled that the DTAA does not recognise a “virtual” service PE and that the Revenue cannot read such a concept into the treaty when it is conspicuously absent from both the DTAA and the Income-tax Act, 1961. The controversy arose after the Assistant Commissioner of Income Tax (International Circle) rejected EY India’s application under Section 195(2) of the Income-tax Act for a nil withholding tax certificate. EY India had sought permission to remit around ₹1,750 crore to its UK affiliate, contending that the payments did not constitute taxable income in India. However, by an order and certificate dated September 17, 2025, the tax authority concluded that the UK entity had a “virtual service permanent establishment” in India under Article 5(2)(k) of the India–UK DTAA. On that basis, the payments were treated as business income chargeable to tax in India, resulting in a direction to withhold tax at 5.25%. The department argued that the UK entity furnished services “through employees or other personnel” within India and that physical presence was not mandatory under Article 5(2)(k). It relied on the assessment order of the UK entity for Assessment Year 2022–23, where a service PE was allegedly established, and submitted that the withholding proceedings under Section 195 are only prima facie and protective in nature. The Department also contended that EY India had an alternative statutory remedy under Section 264 of the Act and that the High Court should not interfere under Article 226 of the Constitution. EY India challenged the very foundation of the Revenue’s case. It argued that the sole basis for rejecting the nil withholding application was the assumption of a “virtual service PE,” which had already been rejected by judicial precedent. The firm relied heavily on the Delhi High Court’s earlier judgment in Commissioner of Income Tax v. Clifford Chance Pte. Ltd. (2025), where the Court had categorically held that service PE provisions in tax treaties require the physical presence of employees in India. EY submitted that Article 5(2)(k) of the India–UK DTAA is pari materia to Article 5(6) of the India–Singapore DTAA interpreted in Clifford Chance, and therefore the same reasoning must apply. The Bench agreed with EY India, observing that the wording “within a Contracting State through employees or other personnel” has a clear territorial connotation. The Court reiterated that, in the absence of personnel physically performing services in India, there can be no furnishing of services “within” India. Relying on Clifford Chance, the Court held that tax treaties must be interpreted strictly as negotiated instruments. Courts cannot read into a treaty concepts that are not expressly provided. The idea of a “virtual service permanent establishment” finds no place in the DTAA or in domestic tax law. The Court rejected the Revenue’s argument that physical presence was unnecessary and clarified that the service PE clause contemplates actual rendition of services by employees present in India. While setting aside the impugned withholding tax certificate and order, the High Court stopped short of directly granting a nil withholding certificate. Instead, it remanded the matter to the assessing officer for fresh consideration, directing that a new order be passed within two weeks, strictly in line with the legal position laid down by the Court. Case Details Case Title: Ernst And Young LLP Versus ACIT Case No.: W.P.(C) 16158/2025 & CM APPL. 66147/2025 Date: 14/01/2026 Counsel For Petitioner: Kamal Sawhney Counsel For Respondent: Indruj Singh Rai Click Here To Read Order Read More: ICMAI Releases Handbook on GST Dept. Audit

‘Virtual Service PE’ Theory Rejected; Delhi HC Quashes 5.25% Withholding Tax Order Against Ernst & Young LLP

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