Permanent Establishment | Article 5 – OECD Model Tax Convention


Article 5 of the OECD Model Tax Convention treats with the concept of Permanent Establishment. One of the most critical and litigation driven topics is the existence of a permanent establishment. Although the name hints of a brick and mortar structure, it is not so. PE can be a person, a machine, a shop, or a webpage too!

Permanent Establishment summary

So why does a Contracting state would be eager to decipher whether there exists a PE of the Foreign entity in its country? The reason being, Article 7 of the OECD Model Tax treaty expressly states that the Contracting state cannot tax the profit of an enterprise of the other Contracting State if it does not have PE therein.

You can listen to the entire post through the podcast too.

Permanent Establishment Lesson Summary.
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Note: Many states allow foreign companies to obtain VAT/GST registration. It does not deem to be the PE in that State. The indirect tax laws procedure and compliances are independent of whether there exists a PE for income tax purposes.

For this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

Paragraph 1 of Article 5, OECD Model Tax Convention

Above paragraph provides the essential feature of the term permanent establishment, i.e., the distinct situs, a fixed place of business. The definition consists of the following conditions:
1. PE must have a place of business
2. The location of the business is fixed
3. The business of the enterprise must be carried in a fixed place.

What is the place of business?

The term ‘place of business’ covers any premises, facilities, machines, or persons used for carrying on the activity of the enterprises. Exclusive usage of the area or ownership or legal rights is irrelevant while determining the existence of PE. The following are the places which can be a PE: a customs warehouse, a corner in an associate’s office, rental premises, etc. The presence of business will not purport to the place being always at the disposal of the company. To constitute a ‘place of business where enterprise conducts business wholly or partially,’ we need to ensure enterprise has sufficient power to use that location, extent of the presence of the enterprise, and the activities it performs there.

ABC Inc is a USA based entity that specializes in ketchup made from Spain tomatoes. It has a 100 sq ft commercial space in Barcelona used for the procurement of tomatoes, which is critical raw material. Twenty experts are working for the quality test of farmers’ produce. Say Spain and USA have the OECD Model tax treaty as their DTAA, then as per Paragraph 1 of the OECD Model Tax Treaty, the office of ABC Inc in Barcelona, qualifies for PE, even if it is a Cost Centre.

Does the home of an employee will be the place of business if he works from home?

Many employees work from their homes, including another country. As a considerable amount of business is carried from that employee’s home office, we cannot automatically presume it to be as a place of business. Whether the home office will be a place of business depends upon the facts and circumstances of the case:
Whether the place was used continuously or intermittently?
Whether no place of work(office) provided to the employee?

Based on the analysis if it is determined that the place is at the disposal of the enterprise, it may be treated as PE. But if there is a place of work provided to employee and he chooses to work from home, then the home cannot be considered as a PE.

What is a fixed place of business?

The term ‘fixed’ creates a link between a place of business and a geographical location. The continuity of the usage and the area of the company being fixed in the soil is immaterial.
A single place of business: In the business, where the activities frequently move from one location to another or neighboring areas, it is difficult to identify a single place of business. In such a situation, a single place of business exits in a particular location in which the activities move, constituting a significant place where commercial coherence and geographical interest of the enterprise vests.

Whether a satellite in geostationary orbit is a PE?

For identifying the PE status of the satellite, it is critical to know the extent of territory of the State in space. No member country would agree that the location of these satellites can be part of the region of a Contracting State under the applicable rules of international law and hence no question of PE status for them. Also, the particular area over which a satellite’s signals are received (the satellite’s “footprint”) cannot be considered to be at the disposal of the operator of the satellite to make that area a place of business of the satellite’s operator.

What is the business of the enterprise?

For being PE, the enterprise has to undertake wholly or partly the business of the enterprise through it. The activity may not be productive nor continuing. But it has to be regular.
When a tangible property like cable, instruments, machinery, industrial or commercial facilities, or intangible property like patents, trademarks, etc. are provided by an enterprise of one contracting State to another contracting state, then it is generally regarded as a place of business.
Some business is conducted by the person who is the agents or the employees of the enterprise. If such a person is allowed to conclude contracts on behalf of the enterprise, then it creates a PE.

The definition is silent on the productivity or profitability of PE. The reason being, it is an understanding the set up would be made by pragmatic enterprises with the objective of the profit. Hence we assume that every component of an enterprise contributes towards productivity.

The existence of PE changes depending upon the facts and circumstances. Hence the test of the presence of PE should be conducted for that given period and not be based upon the past or future period.

The test of PE is an independent concept, not to link with the nature of the income dealt with by PE.

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