Preparatory and Auxiliary Activities Exception

What Is the Preparatory and Auxiliary Activities Exception?

The preparatory and auxiliary activities exception is the carve-out in Article 5 of India's tax treaties that keeps certain low-intensity activities — storage, display, purchasing, and information-gathering — from turning a foreign company's physical presence in India into a taxable Permanent Establishment (PE). Without this exception, almost any fixed place a foreign company uses in India — even a small warehouse or a one-person purchasing office — could trigger Indian tax on the company's business profits. The exception exists precisely to stop that: activities that are merely preliminary or supportive to the real, profit-generating business, rather than part of it, do not create a PE.

The exception is a treaty concept, not a domestic-law one. India's Income-tax Act defines "permanent establishment" only in outline — section 173(c) of the Income-tax Act, 2025 (section 92F(iiia) of the Income-tax Act, 1961) says a PE "includes a fixed place of business through which the business of the enterprise is wholly or partly carried on" — and leaves the detailed exclusions to whichever Double Taxation Avoidance Agreement (DTAA) applies. Where no DTAA is in force, the domestic "business connection" test under section 9(2)(c) (section 9(1)(i) of the 1961 Act) applies with no preparatory-or-auxiliary carve-out at all. Section 9(9)(c)(ii) excludes only a short closed list of activities from a business carried out in India — buying goods in India for export, collecting news for transmission out of India, displaying uncut and unassorted diamonds in a notified zone, and shooting a film — and none of those is a general exception of the treaty kind.

Legal Basis

DTAAs — Article 5(3)

Most Indian DTAAs place the exception in Article 5(3) (a few number it Article 5(4), following the OECD or UN Model). The India-US DTAA, Article 5(3), excludes:

• "the use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise"
• "the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display, or occasional delivery"
• "the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise"
• "the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise"
• "the maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research or for other activities which have a preparatory or auxiliary character, for the enterprise"

The India-UK DTAA, Article 5(3), uses near-identical language, excluding "the use of facilities solely for the purpose of storage or display of goods or merchandise," "the maintenance of a stock of goods or merchandise... solely for the purpose of storage or display," stock held "solely for the purpose of processing by another enterprise," a fixed place "solely for the purpose of purchasing goods or merchandise, or for collecting information," and a fixed place used "solely for the purpose of advertising, for the supply of information or for scientific research, being activities solely of a preparatory or auxiliary character in the trade of business of the enterprise."

Every Indian DTAA has its own wording — whether "delivery" is included, whether it must be "occasional," and how the closing limb is phrased differs treaty by treaty. The India-US and India-UK texts above are illustrative, not a template; the applicable DTAA must always be checked directly.

The MLI Overlay — Article 13 and the Anti-Fragmentation Rule

The 2015 OECD/G20 Base Erosion and Profit Shifting (BEPS) project found the pre-existing Article 5(3)/(4) list was being used to shelter activities that were, in substance, core to the business — the clearest example being large e-commerce fulfilment warehouses claiming the "storage" exclusion even though warehousing was central to their business model. Article 13 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the "MLI") lets each signatory choose how its treaties respond: apply Article 13(2) ("Option A," tightening the exclusion list to turn on the activity genuinely being preparatory or auxiliary in character), apply Article 13(3) ("Option B," closer to the pre-BEPS position), or apply neither.

India ratified the MLI, depositing its instrument of ratification with the OECD Depositary on 25 June 2019; the MLI entered into force for India on 1 October 2019. Where India's position matches a treaty partner's position for a given DTAA, the MLI modifies that DTAA automatically and the two governments jointly publish a "synthesised text" showing the treaty as modified. The India-Netherlands synthesised text confirms the match for that treaty: "the following paragraph 2 of Article 13 of the MLI applies with respect to the paragraph 4 of Article 5 of this Convention" — i.e., India applies Option A, and the Netherlands' position matched it, so Option A now governs the preparatory-and-auxiliary exclusion under the India-Netherlands DTAA.

Article 13 also carries a separate anti-fragmentation rule, which applies independently of the Option A/B choice. It denies the exception where a foreign enterprise (or a closely related enterprise) splits its India activities across multiple fixed places to keep each piece individually below the preparatory-or-auxiliary line, while the combined activity is not preparatory or auxiliary at all. The India-Netherlands synthesised text states that the exclusion "shall not apply to a fixed place of business that is used or maintained by an enterprise if the same enterprise or a closely related enterprise carries on business activities at the same place or at another place in the same Contracting State" where the combined activity is not, overall, preparatory or auxiliary. A foreign group cannot avoid PE status by putting its warehouse in one entity and its sales office next door in another.

The United States has not signed the MLI, so nothing overlays the India-US Article 5(3) text quoted above. Whether a given DTAA has been modified by the MLI, and by which option, must be checked treaty by treaty against the relevant synthesised text on the Income Tax Department's website — it cannot be assumed either way.

How the Exception Interacts With a Liaison Office in India

Foreign companies often reach for the preparatory-and-auxiliary exception when deciding whether to register a Liaison Office (LO) in India instead of a subsidiary or Branch Office. The two tests are related but not identical, and conflating them is a common mistake.

An LO is registered with the Reserve Bank of India (RBI) under the Foreign Exchange Management Act (FEMA). The RBI's Master Direction on the establishment of Liaison/Branch/Project Offices in India by foreign entities (FED Master Direction No. 10/2015-16) lists the activities an LO may undertake, at paragraph B.1, "Permissible Activities for a Liaison Office": representing the parent or group companies in India; promoting export/import from or to India; promoting technical or financial collaboration between the parent/group companies and Indian companies; and acting as a communication channel between the parent and Indian companies. That list is closed — an LO cannot generate revenue in India, and its running costs must be funded entirely by remittances received from its head office abroad.

The FEMA test and the tax-treaty test serve different purposes and are decided by different authorities. RBI approval to run a liaison office confirms only that the activities fall within that permitted list for exchange-control purposes; it says nothing about whether those same activities also satisfy the treaty's preparatory-or-auxiliary test for PE purposes, which the Indian tax authority determines independently during an assessment or audit. The two lists overlap heavily in practice — a communication channel or technical-collaboration liaison role reads as preparatory or auxiliary under most DTAAs too — but an LO found, on the facts, to be closing sales or negotiating contract terms (activities outside paragraph B.1 and outside most Article 5(3) lists) risks both an RBI compliance problem and a PE assessment, decided on separate tracks.

Why It Matters for Foreign Companies and Investors

Getting this exception right changes the tax outcome dramatically. If an activity genuinely falls within Article 5(3)/(4), the foreign company owes no Indian tax on the profits attributable to that presence, and no Indian tax return is required on that account. If the activity falls outside the exception — because it is not "solely" storage/display/purchasing/information-gathering, because it fails the preparatory-or-auxiliary test, or because the anti-fragmentation rule catches a split structure — the foreign company has a PE, and India can tax the business profits attributable to it at the (materially higher) foreign-company corporate rate, rather than the rate available to a properly incorporated Indian subsidiary.

The exception is read narrowly by Indian tax authorities. Three words carry the whole test: "solely," "preparatory," and "auxiliary." An activity that is only partly storage, or that supports the parent's actual India business rather than merely preceding it, falls outside the exception even if it looks small in scale.

Checklist: Is an India Activity Still Preparatory or Auxiliary?

• Is the fixed place used solely for a listed purpose (storage, display, delivery, purchasing, information-gathering, advertising, scientific research), with no other function mixed in?
• Does the activity precede or support the enterprise's actual revenue-generating India business, rather than forming part of it?
• Is a closely related enterprise carrying on business at the same or a nearby place whose activity, combined with this one, is no longer preparatory or auxiliary overall (the anti-fragmentation question)?
• Has the applicable DTAA been modified by the MLI, and does that modification (Option A) apply the "preparatory or auxiliary" test to every sub-clause, not just the closing one?
• If run through a Liaison Office, does the activity stay within RBI's paragraph B.1 list — and, separately, does it also satisfy the treaty test?

Practical Example

A US-based industrial parts manufacturer rents a small facility in India solely to store spare parts shipped from its US factory, for delivery to Indian customers who have already placed orders with the US head office. No sales are negotiated in India, no contracts are signed in India, and the facility has no staff beyond a caretaker. Under Article 5(3) of the India-US DTAA, this fits "the use of facilities solely for storage, display, or occasional delivery of goods" — the exception applies, and the facility does not create a PE.

Now change the facts: the same facility also employs two India-based staff who receive customer orders directly and negotiate delivery terms on behalf of the US company. The facility is no longer used solely for storage and delivery — it is transacting business. The exception no longer applies, and the Indian tax authority can treat the facility as a PE, taxing the profits attributable to it.

Common Mistakes

• Assuming small or low-cost presence automatically qualifies. Size is not the test. A tiny office that negotiates contracts is not preparatory or auxiliary; a large warehouse used solely for storage can be.
• Missing the word "solely." If a facility does anything beyond the listed purpose, the exception can fail entirely for that facility, not just for the extra activity.
• Treating RBI approval for a Liaison Office as tax clearance. The Master Direction's permitted-activities list and the treaty's Article 5(3)/(4) exclusions are related but legally separate tests.
• Ignoring the anti-fragmentation rule where the MLI applies. Splitting storage and sales functions across two group entities at the same location does not avoid PE status once it is in force for that treaty.
• Assuming every Indian DTAA has been modified by the MLI the same way. Whether Option A, Option B, or neither applies depends on both countries' positions matching for that treaty; check treaty by treaty against the synthesised text.

Frequently Asked Questions

Does storing goods in an Indian warehouse always avoid creating a Permanent Establishment?

No. It avoids PE status only if the warehouse is used solely for storage, display, or (under most treaties) occasional delivery, with no sales negotiation, contracting, or other business activity carried on there, and only if the applicable DTAA's Article 5(3)/(4) exclusion still applies unmodified or matches how the treaty has been modified by the MLI.

What is the anti-fragmentation rule, and does it apply to India's treaties?

It is a rule in Article 13(4) of the MLI that denies the preparatory-and-auxiliary exception where a closely related enterprise carries on business at the same place, and the combined activity is not, overall, preparatory or auxiliary. It applies to a given Indian DTAA only where the MLI has entered into force for both India and that treaty partner and their positions align, as confirmed treaty by treaty in the published synthesised text.

Does registering a Liaison Office in India guarantee there is no Permanent Establishment risk?

No. RBI's approval confirms only that the liaison office's activities fall within the permitted list at paragraph B.1 of the Master Direction on Liaison/Branch/Project Offices for exchange-control purposes. Whether those same activities also satisfy the separate, treaty-based preparatory-or-auxiliary test for PE purposes is decided independently by the Indian tax authority.

Which option did India choose under Article 13 of the MLI?

India applies Article 13(2), Option A, which is confirmed in the published synthesised texts for treaties where the partner country's position matches — for example, the India-Netherlands synthesised text states that "paragraph 2 of Article 13 of the MLI applies with respect to the paragraph 4 of Article 5" of that treaty. Whether Option A actually applies to any other specific DTAA depends on that partner country's own MLI position matching India's.

What happens if an activity that started as preparatory or auxiliary grows into a core business function?

Once the activity stops being "solely" for a listed purpose, or stops being merely preparatory or auxiliary to the enterprise's real business, the exception no longer applies to that fixed place from that point. The Indian tax authority can assess it as a Permanent Establishment and tax the profits attributable to it, so foreign companies should reassess the classification whenever an India presence's role expands.

See also: Permanent Establishment, Liaison Office, and DTAA.

Beacon Filing helps foreign companies assess PE exposure and choose the right India structure.