Permanent establishment

The concept of PE emerged in the German Empire after 1845, culminating with the German Double Taxation Act of 1909.{{Cite book|chapter = History of tax treaties and the permanent establishment concept|last = Kobetsky|first = Michael|pages = 106–151|doi = 10.1017/cbo9780511977855.005|title = International Taxation of Permanent Establishments|year = 2011|isbn = 9780511977855}} Initially, the objective was to prevent double taxation between Prussian municipalities, and this was extended to the entire German federation. In 1889, the first bilateral tax treaty, including the concept of PE, was concluded between the Austro-Hungarian Empire and Prussia, marking the first time the concept was used in international tax law.[https://sites.google.com/view/austriaprussiataxtreaty1899 First tax treaty of 1899] After years of preparatory works, in 1928, the League of Nations developed a model to tackle cross-border double taxation and to counter tax evasion. Since then, an extensive network of bilateral tax treaties was gradually established, particularly through the influence of the OECD Model Tax Convention,{{Cite book|url=http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title=Model Tax Convention on Income and on Capital: Condensed Version 2014|last=OECD|doi=10.1787/mtc_cond-2014-en|series=Model Tax Convention on Income and on Capital: Condensed Version|year=2014|isbn=9789264211155}} where this concept persisted.

In the OECD Model Tax Convention, essentially three types of PEs can be construed:

• A fixed place of business PE (article 5(1));
• A construction or project PE, which is a special subset of the fixed place of business PE, with different requirements (article 5(3)); and
• An agency PE, through the actions of a dependent agent (article 5(5-6)).

The UN Model Tax Convention, which gives greater consideration to developing countries, adds what is known as a service PE in article 5(3)b.{{Cite web|url = https://www.un.org/esa/ffd/documents/UN_Model_2011_Update.pdf|title = UN Model Tax Convention (2011)}} Some countries, such as Saudi Arabia, have been trying to extend the concept of service PE into a virtual service PE.{{Cite web|url = http://www.ey.com/GL/en/Services/Tax/International-Tax/Alert--Saudi-Arabian-tax-authorities-introduce-Virtual-Service-PE-concept|title = Saudi Arabian tax authorities introduce Virtual Service PE concept|website = www.ey.com|access-date = 2016-03-15}}

Under the Base Erosion and Profit Shifting project being developed by the OECD and endorsed by the G20,{{Cite web|url = http://www.oecd.org/ctp/beps-about.htm|title = About Base Erosion and Profit Shifting (BEPS) - OECD|website = www.oecd.org|access-date = 2016-03-15}} a new nexus based on significant digital presence is being considered under Action 1, aimed at Addressing the Tax Challenges of the Digital Economy.{{Cite book|title = OECD/G20 Base Erosion and Profit Shifting Project, Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report|last = OECD|doi = 10.1787/9789264241046-en|series = OECD/G20 Base Erosion and Profit Shifting Project|year = 2015|isbn = 9789264241022}}

The starting point for determination if a PE exists is generally a fixed place of business. The definition of PE in article 5 of the OECD Model Income Tax Treaty{{Cite book|url=http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title=Model Tax Convention on Income and on Capital: Condensed Version 2014|last=OECD|at=Article 5 and Commentary|doi=10.1787/mtc_cond-2014-en|series=Model Tax Convention on Income and on Capital: Condensed Version|year=2014|isbn=9789264211155}} is followed in most income tax treaties.See, e.g., the [http://www.ustreas.gov/offices/tax-policy/library/uktreaty.pdf U.S./UK treaty] {{webarchive|url=https://web.archive.org/web/20100527220749/http://www.ustreas.gov/offices/tax-policy/library/uktreaty.pdf |date=2010-05-27 }} Article 5, which is virtually identical to the OECD Model Article 5. The [http://www.info.gov.za/view/DownloadFileAction?id=87999 Nigeria/South Africa treaty] {{webarchive|url=https://web.archive.org/web/20110629124238/http://www.info.gov.za/view/DownloadFileAction?id=87999 |date=2011-06-29 }} Article 5, is nearly identical to the OECD Model Article 5, with the addition of a provision clarifying that a fixed place of business used as a sales outlet is a PE, notwithstanding exclusions elsewhere in the article.

The commentary indicates that a fixed place of business has three components:

• Fixed refers to a link between the place of business and a specific geographic point, as well as a degree of permanence with respect to the taxpayer. An "office hotel" may constitute a fixed place for a business for an enterprise that regularly uses different offices within the space. By contrast, if there is no commercial coherence, the fact that activities may be conducted within a limited geographic area should not result in that area being considered a fixed place of business.{{Cite book|url=http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title=Model Tax Convention on Income and on Capital: Condensed Version 2014|last=OECD|at=Commentary 5-6 to Article 5|doi=10.1787/mtc_cond-2014-en|series=Model Tax Convention on Income and on Capital: Condensed Version|year=2014|isbn=9789264211155}}
• A place of business. This refers to some facilities used by an enterprise for carrying out its business. The premises must be at the disposal of the enterprise. The mere presence of the enterprise at that place does not necessarily mean that it is a place of business of the enterprise. The facilities need not be the exclusive location, and they need not be used exclusively by that enterprise or for that business. However, the facilities must be those of the taxpayer, not another unrelated person. Thus, regular use of a customer's premises does not generally constitute a place of business.{{Cite book|url=http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title=Model Tax Convention on Income and on Capital: Condensed Version 2014|last=OECD|at=Commentary 4 to Article 5|doi=10.1787/mtc_cond-2014-en|series=Model Tax Convention on Income and on Capital: Condensed Version|year=2014|isbn=9789264211155}}
• Business of the enterprise must be carried on wholly or partly at the fixed place.{{Cite book|url=http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title=Model Tax Convention on Income and on Capital: Condensed Version 2014|last=OECD|at=Commentary 7 to Article 5|doi=10.1787/mtc_cond-2014-en|series=Model Tax Convention on Income and on Capital: Condensed Version|year=2014|isbn=9789264211155}}

The requirements of what constitutes a PE within the scope of a particular treaty depend on what interpretation a particular country places on that term, in context of the text of that treaty. As per Article 3 of the Vienna Convention on the Law of Treaties, no one is entitled to claim rights under a particular treaty unless otherwise authorised by the contracting state. Therefore, if a particular contracting state places a different meaning on the term 'permanent establishment' than what the taxpayer seeks to place, the taxpayer would be left with virtually no remedy within that state, other than to seek a mutual agreement to that dispute with the other contracting state to that treaty.

The OECD Model Tax Convention includes a short indicative list of prima facie PEs. These, however, are not automatically PEs as the requirements set out, namely, for a fixed place of business PE must be met.{{Cite book|url=http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title=Model Tax Convention on Income and on Capital: Condensed Version 2014|last=OECD|at=Commentary 12 to Article 5|doi=10.1787/mtc_cond-2014-en|quote=This paragraph contains a list, by no means exhaustive, of examples, each of which can be regarded, prima facie, as constituting a PE. As these examples are to be seen against the background of the general definition given in paragraph 1, it is assumed that the Contracting States interpret the terms listed, a “place of management,” a “branch,” an “office” etc in such a way that such places of business constitute a PE only if they meet the requirements of paragraph 1.|series=Model Tax Convention on Income and on Capital: Condensed Version|year=2014|isbn=9789264211155}} The list is as follows:

• A branch
• A warehouse (but see excluded places below)
• A factory
• A mine or place of extraction of natural resources
• A place of management

Many treaties explicitly exclude from the definition of PE places if certain activities are conducted.{{Cite book|url = http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title = Model Tax Convention on Income and on Capital: Condensed Version, Model Tax Convention on Income and on Capital: Condensed Version 2014|last = OECD|at = Article 4 and Commentary thereon|doi = 10.1787/mtc_cond-2014-en|series = Model Tax Convention on Income and on Capital: Condensed Version|year = 2014|isbn = 9789264211155}} Generally, these exclusions do not apply if non-excluded activities are conducted at the fixed place of business. Among the excluded activities are:

• Ancillary or preparatory activities
• The use of a storage facility solely for delivery of goods to customers
• The maintenance of a stock of goods owned by the enterprise solely for purposes of processing by another enterprise (sometimes referred to as toll processing)
• Purchasing or information gathering activities

Many treaties provide specific rules with respect to construction sites. Under those treaties, a building site or construction or installation project constitutes a PE only if it lasts more than a specified length of time. The amount of time varies by treaty.For example, the [http://www.fin.gc.ca/treaties-conventions/Belgium_-eng.asp Canada/Belgium treaty] sets this limit as 12 months, as does the OECD Model. By contrast, the [https://www.irs.gov/pub/irs-trty/india.pdf US/India treaty] treats such a site, project or activities continuing for more than 120 days in any twelve-month period as a PE.

In addition, the activities of a dependent agentSee Agency (law) for a discussion of the essential characteristics of agent and principal. may give rise to a PE for the principal.{{Cite book|url=http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title=Model Tax Convention on Income and on Capital: Condensed Version 2014|last=OECD|at=Paragraph 5 of Article 5 and Commentary 31 to Article 5|doi=10.1787/mtc_cond-2014-en|series=Model Tax Convention on Income and on Capital: Condensed Version|year=2014|isbn=9789264211155}} Dependent agents may include employees or others under the control of the principal. A company is generally not considered an agent solely by reason of ownership of the agent company by the principal.{{Cite book|url=http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title=Model Tax Convention on Income and on Capital: Condensed Version 2014|last=OECD|at=Paragraph 7 of Article 5 and Commentary 40-41 to Article 5|doi=10.1787/mtc_cond-2014-en|series=Model Tax Convention on Income and on Capital: Condensed Version|year=2014|isbn=9789264211155}} However, activities of an independent agent generally are not attributed to the principal.{{Cite book|url=http://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2014_mtc_cond-2014-en|title=Model Tax Convention on Income and on Capital: Condensed Version 2014|last=OECD|at=Paragraph 6 to Article 5 and Commentary 36-39|doi=10.1787/mtc_cond-2014-en|series=Model Tax Convention on Income and on Capital: Condensed Version|year=2014|isbn=9789264211155}}

Some treaties deem a PE to exist for an enterprise of one country performing services in the other country for more than a specified length of timeSee, e.g., 183 days in any 12-month period in the [https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf United Nations Model Tax Convention] Article 5 paragraph 3(b). or for a related enterprise.See, e.g., the US/India treaty, supra., Article 5 paragraph 2(l).

In October 2015, the OECD released the final reports on the Base Erosion and Profit Shifting (BEPS) project. Action 7 was targeted at Preventing the Artificial Avoidance of Permanent Establishment Status and proposes a large number of changes that are set to be included in the next version of the OECD Model Tax Convention. The OECD expects many of these changes to be applied to currently existing tax treaties through the work based on Action 15 on Developing a Multilateral Instrument to Modify Bilateral Tax Treaties.{{Cite book|title = OECD/G20 Base Erosion and Profit Shifting Project, Developing a Multilateral Instrument to Modify Bilateral Tax Treaties, Action 15 - 2015 Final Report|last = OECD|doi = 10.1787/9789264241688-en|series = OECD/G20 Base Erosion and Profit Shifting Project|year = 2015|isbn = 9789264241671}} A large number of countries are involved in the negotiations that are expected to be concluded by the end of 2016.{{Cite web|url = http://www.oecd.org/tax/treaties/multilateral-instrument-for-beps-tax-treaty-measures-the-ad-hoc-group.htm|title = Multilateral instrument for BEPS tax treaty measures: the Ad hoc Group - OECD|website = www.oecd.org|access-date = 2016-03-15}}

The final report on Action 7 proposes substantial changes to the definition of Agency PE and stricter requirements to the exclusions provision:{{Cite web|url = http://www.oecd.org/tax/preventing-the-artificial-avoidance-of-permanent-establishment-status-action-7-2015-final-report-9789264241220-en.htm|title = Preventing the Artificial Avoidance of Permanent Establishment Status, Action 7 - 2015 Final Report - en - OECD|website = www.oecd.org|access-date = 2016-03-15}}

"These changes will ensure that where the activities that an intermediary exercises in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that enterprise will be considered to have a taxable presence in that country unless the intermediary is performing these activities in the course of an independent business.

The changes will also restrict the application of a number of exceptions to the definition of permanent establishment to activities that are preparatory or auxiliary nature and will ensure that it is not possible to take advantage of these exceptions by the fragmentation of a cohesive operating business into several small operations; they will also address situations where the exception applicable to construction sites is circumvented through the splitting-up contracts between closely related enterprises."

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