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The Permanent Establishment notion in international tax law

Lior Pick & Co. Legal Offices
May 02, 2012
January 10, 2019

The question “is there a Permanent Establishment?” is a very important question that we have to deal with very often in tax law matters. In that short article, we will try to define precisely the OECD model convention’s definition of a Permanent Establishment (hereinafter: PE) and to explain the applications of this definition in tax law cases.

The basic definition of a PE

The basic rule in the OECD model convention defines the term PE as a fixed place of business through which the business of an enterprise is wholly or partly carried on.

The “Place of Business” Test

1.The need of a physical presence of the non-resident

The place of business is defined as a tangible asset of a substantial nature.

It should be noted that securities and bank accounts do not meet the place of business place. A website or a mailing address don’t either.

2.A meaning of place: a broadly interpretation

An open-air place, for instance a forest where logging equipment is demonstrated, can be a place, also the wharf of a shipping enterprise, and the vessel itself.

A home office can be a place too

As a rule, please note that any place which is a place in a general meaning can be a place of business.

Furthermore, the place of business has to be situated in the country so places situated underground such as mines can be considered as places of business.

3.Places without staff or personnel

To have a place of business, it doesn’t need any presence of people.

Gaming machine, vending machine antennas …should be considered place of business.

4.The place of business as an object of the business

We can see in some countries a controversy about the place of business which is also the object of the business activity. Those countries distinguish between the object of the business and the place of business.

Real estate can be a place of business but the building is also an asset which is the object of the activity. In that case, the taxpayer must also have another place.

5.Animals considered as a place of business

For a dog or a horse in race the animal itself is a place of business as well as the track used during the stay.

But other conditions for a PE are not met is these cases.

The Location Test

1.Underground places

Underground pipelines, mines… meet the requirements under the location test for a PE.

A tent can pass the location test also.

2.Movable place of business

There is no PE if the locations are changing all the time (because there is no geographical coherence in that case)

But equipments don’t need to be fixed to the soil. A tent or a van equipped for selling products may constitute a fixed place of business.

Nevertheless, if they are moving to different places, those places can’t be considered to be one place.

A truck, an aircraft or a vessel who are used for their normal purpose don’t meet the location test because they change position all the time.

If there is a movement, there won’t be a place of business.

3.A geographical area as a place of business

If the taxpayer is moving around but inside of a geographical coherent area performing a coherent business activity for clients, we can consider that this area is a place of business.

The most important in the location test is commercial coherence, and PE is constituted even if the geographical coherence is debated.

The Duration Test

1. The duration test the right of use test

In Germany for example, for the place of business to be considered as a place, the enterprise must have a right to use a particular place not only temporarily. It seems logical to link the duration test to the PE test.

2.Factual duration indefinite duration

Historically no PE is constituted if the right of use the place of business is only for a definitive period of time, for example, construction projects.

But the requirement of an indefinite period of time was abandoned by all countries several decades ago.

A certain period of time is sufficient: permanent doesn’t mean perpetuity.

3.Intention factual duration

What is important is more the factual duration than the intention: if a business which was intended to last for a short period of time but lasts in practice, it can be considered to meet the duration test.

But there is a situation in which the intention of the tax payer is more important : if his intention was to use the place of business for a long period, but terminated after a short period, we consider that there is a PE.

4.Temporary suspensions of business activity

Temporary suspensions of business activity in a country are not a cessation of a PE. For instance, a suspension of 14 months has been considered as temporary by the Court of South Africa.

But, the absence is not temporary if the business activity ceased and the right to use the place of business too or the intention of the tax payer is not to come back.

5.The duration test: 6 months ?

The duration test is met when the right of use to the place of business was maintained for a period of at least 6 months

Sometimes, there was a 12-month requirement to drilling activities offshore (but maybe this is because it was construction activity)

6.What about recurrent activities?

If each season doesn’t last enough to constitute a PE (less than 6 months), each season should be considered in combination with the number of times during which that place of business is used.

For example, a non-resident enterprise that is selling goods from a stand in the street once a week meets the duration test if the aggregate exceeds the 6 months threshold.

7.What about “one-off projects”?

Some countries support the view that a short time limit is sufficient for activities of a special nature, some no.

For example, a sporting event of one week or teaching classes for a few days are not a one-off project

Lists of examples of fixed places of business: the positive list

1.Is this list a “Deeming Provision”?

The question is: The positive list is a list of examples of different places of business which can or not meet the other conditions, or the positive list is a list of examples that constitute a PE even if the other conditions in the basic rule are not met?

As a rule, those examples require the basic rule condition to be met (the conditions of the article 5.1)

Consequently for example a branch is not a PE unless the tax payer has the right to use a fixed place of business.

2.A non-exhaustive list

This list is an illustration: other facilities that meet the general definition in the basic rule may also constitute a PE.

3. The place of management

Management means a place where directive and controlling power is exercised. It will be normally an office where business decisions of some level are made.

A place of management is constituted if a part of the management of an enterprise is conducted through an office.

It is important to note that there is a difference between place of management and place of effective management

4. The branch

The article doesn’t tell something about the nature of the activity at all. But the registration of a branch is not enough to meet the place of business or location test.

5. The office

As a rule, an office doesn’t exist unless it is located in a building

But is has to meet the business activity test too.

6. Mines, oil or gas wells

The article 5 of the OECD model convention provides that “the term permanent establishment includes especially a mine, an oil or gas well, a quarry or any other place of extraction of natural

resources”. If there is extraction conducted through these places, it constitutes a PE

The right of use test: what is “the Place of Business at the disposal of”?

The taxpayer needs to have some legal rights to dispose of the place of business, but no formal right to use the place is required: factual use is enough.

The taxpayer has to control over the place of business.

It has to be noted that a home office of a resident employee of a non-resident enterprise may be a fixed place of business.

But as a rule, the home of an employee is not at the disposal of the employer, so it doesn’t meet the right of use test and doesn’t create a PE.

However, we can prove the control of the employer if he has a key of the home or pay for the employee’s expenses for part of a home.

What is the business activity test?

It is important to raise the question: is the business activity operated through the place of business? Then if not, it won’t be considered as a PE. For example, if a foreign enterprise A agrees with an enterprise B that a part of A’s business shall be conducted by B, a PE won’t be constituted, except if the business activity becomes a join business activity.

There is a negative list, which includes business activities who are excluding from creating a PE.

Only a core activity constitutes a PE, which is not the case for an auxiliary activity (advertising, market research, etc) and a preparatory activity (setting up of a place of business including planning, training of personnel etc)

An activity is a core business activity if it constitutes a material and essential part of the enterprise’s entire activity. Sale activities, management or manufacturing are considered core activities but the signing of a contract may be considered as a auxiliary activity.

The meaning of “sale” is quite broad: activities that imply solicitation of products or service will be considered core activities, and receiving orders is often evidence of a core business activity.

Moreover, activities of technical support for clients, answering of telephone calls, etc are not considered as core activities.

The business connection test

The question is: is the business conducted through the place of business?

As a rule, only a different (that is to say unrelated) business should be excluded from PE taxation.

The special rule for construction sites

This article provides that: “A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months”

The term construction has a wide meaning: it covers construction of roads, renovation, laying of pipelines, construction of a building and demolition or renovation of it.

As a rule, activities related to oil exploration and extraction seem to be not covered.

It is important to quote paragraph 18 and 20 of the OCDE commentary which define the meaning of “site” and “project”. About that definition, the USA branch report indicates that the construction of 12 gasoline stations spread out over a long distance on a highway could be a one project.

What is the “Agency PE” Rule?

The agency PE rule is a deeming rule: which means that this rule is an alternative to the basic PE rule.

The most important condition for the application of the agency PE rule is that the person who acts locally for a foreign enterprise has and exercises an authority to conclude contracts in the name of the enterprise.

It is not required for this person to sign the contract which binds the enterprise: about that, the paragraph 33 of the OECD commentary provides that a person who is authorized to negotiate all elements and details of a contract in a way binding on the enterprise can be said to exercise this authority in this State, even if the contract is signed by another person in the State in which the enterprise is situated.

It has to be noted that paragraph 33 OECD commentary provides that “the authority to conclude contracts must cover contracts relating to operations which constitute the business proper of the enterprise.”

Nevertheless, participation in the negotiations can be a relevant fact in trying to establish that a person has exercised an authority to conclude contracts, but it is not sufficient itself.

There is an independent agent exception that has to be noted. The paragraph 6 of the PE definition of the OECD models provides that “an enterprise shall not be deemed to have a permanent establishment in a contracting state merely because it carries on business in that State through a broker general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business”

First of all, the term of independent agent has to be defined: exclusivity can be a factor of dependence. Some court decisions suggest that the fact that an agent acts exclusively for one principal is a sign of dependence.

Then, what is “acting in the ordinary course of their business”?

Paragraph 38 (8) of OECD commentary suggests that it must be determined by comparison with the activities of an agent of the same branch or business.

The rule concerning related companies

Paragraph 7 of the OECD model provides that a company which controls or is controlled by a company shall not of itself constitute either company a PE of the other.

The branch reports takes the position that a subsidiary is automatically a PE of its parent and should be taxed separately. However, the courts didn’t rule that a subsidiary is a PE just because of its status as a subsidiary but because of activities carried on.

Article 33 of the commentary of the OECD convention: 33.1: “a person who is authorized to negotiate all elements and details of a contract in a way binding on the enterprise can be said to exercise this authority in this State, even if the contract is signed by another person in the State in which the enterprise is situated.”

The aforementioned should not be perceived as a recommendation and/or expression of opinion. In all instances we recommend receiving professional individual advice in accordance with the concrete circumstances of each and every event.

We would be happy to be at your disposal for any queries and or explanations regarding this matter or in general.

Yours sincerely,

Lior Pick & Co. Legal Offices

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