Do outdated PE tax rules risk slowing India’s smartphone manufacturing push?

India’s smartphone manufacturing story has gathered strong momentum over the past five years. Smartphone exports have risen sharply from about $3 billion in FY2020 to nearly $24 billion in FY2025, while the sector has created close to two lakh direct jobs. Assembly capacity has scaled up rapidly, and policy attention is now shifting towards component manufacturing through the Electronics Component Manufacturing Scheme.

However, Ishita Jain, Senior Programme Associate at the Foundation for Economic Development, argues that an outdated aspect of India’s tax framework is quietly constraining the next phase of growth. According to her, the current Permanent Establishment (PE) rules are misaligned with how modern global value chains operate and risk undermining India’s ambitions.

“Unless simplified, India risks losing its opportunity to become an assembly line for the world, missing out on higher value addition, becoming a large-scale component hub, and establishing a globally competitive electronics manufacturing ecosystem,” Jain said.

Why the PE framework matters

Jain explained that PE rules determine when a foreign company is considered to have a taxable presence in a country. Traditionally, this meant having decision-making authority, ownership of assets or core business operations within that jurisdiction.

“The smartphone global value chain complicates these assessments,” she said, noting that production is highly fragmented across countries. An iPhone, for instance, sources displays and camera modules from Japan, memory from Korea, chassis and batteries from China, and is finally assembled in India. Many of these countries, Jain pointed out, have updated their tax laws to assure global firms that profits linked to routine or auxiliary activities will not be taxed locally.

India’s PE framework, she argued, has not kept pace with this reality. Routine activities such as storing components or consigning machinery to Indian manufacturers can potentially trigger a PE and expose global firms to tax on their worldwide profits.

“For example, if Apple or Samsung provide machinery or components to Indian contract manufacturers, this activity may create a PE in India, resulting in their global profits being taxed here,” Jain said. This uncertainty, combined with India’s history of retrospective taxation, makes it difficult for firms to factor tax risks into long-term investment decisions.

Consignment of machinery

Jain highlighted consignment models as a key area of concern. Under such arrangements, brands provide machinery to contract manufacturers without selling or leasing it, allowing them to maintain quality control and protect intellectual property.

“Consignment models allow brands to scale up and down rapidly as they redeploy machinery across plants as demand and cost structures change,” she said. For contract manufacturers, this reduces capital requirements and financing costs, improving returns on capital employed.

Yet, under current interpretations, consignment of machinery may create a PE and trigger tax liability for the brand. Citing public financial statements, Jain noted that a leading contract manufacturer invested about $250 million in machinery between FY2020 and FY2024, and up to 40% of this cost could potentially have been avoided if consignment models were clearly permitted.

Component warehousing bottlenecks

A similar issue arises with component warehousing. Globally, just-in-time manufacturing is supported by local warehouses run by foreign suppliers. In India, however, storing components locally can also trigger a PE.

“When foreign suppliers store components in India, it may create a PE and tax liability,” Jain said. In contrast, China does not tax such warehousing, while Vietnam levies only a 1% withholding tax. As a result, suppliers prefer to store components there, reducing costs and lead times.

Indian contract manufacturers are forced to hold higher inventories, locking up capital and hurting margins. Jain estimated that in FY2024 alone, leading firms held nearly $600 million in raw material inventory, of which about $200 million in inventory and financing costs could have been avoided.

The case for reform

Beyond direct costs, Jain emphasised that PE rules create long-term policy uncertainty. Disputes can take six to twelve years to resolve, with unpredictable outcomes. Even the safe harbour provisions announced in the Union Budget 2025–26 have a limited impact until detailed rules are issued.

Clarifying tax treatment for component warehousing and machinery consignment, Jain argued, would unlock efficiency across the ecosystem. “Far from shrinking the tax base, such reforms are likely to expand it over time,” she said, through higher exports, more competitive firms and a broader domestic tax base.