Permanent Establishment in India – Article 5.

Concept of Permanent establishment (Permanent Establishment) under Article 5 of the OECD Model Convention

Introduction and Permanent Establishment Meaning

Article 5 of the OECD model convention deals with the concept of a Permanent Establishment (Permanent Establishment) . The term Permanent Establishment  is used to evaluate a Contracting State’s right to tax the  earnings of Enterprise of another Contracting State. Article 7 of the OECD model convention says other Contracting states cannot tax the profits of a business carried on by an Enterprise of other Contracting State , unless such enterprise conducts its operations through a permanent establishment in other Contracting State.

Tax treaties usually provide that a foreign company’s business profits in other country,  are only taxable   to the extent they are attributable to   a  Permanent Establishment , that such foreign company has in other Contracting   state.  Due to this, the definition of Permanent Establishment in tax treaties is crucial to determine if a non-resident business has to pay income tax in another state.

Structure of Article 5 – Permanent Establishment

• 5(1) – Fixed place PE
• 5(2) Permanent Establishment inclusions
• 5(3) Building site / Construction / Installation
• 5(4) Specific activities exemption
• 5(5) Agency Permanent Establishment
• 5(6) Independent Agent
• 5(7) subsidiary Permanent Establishment
• 5(8) Related Enterprise

Types of Permanent Establishment

Article 5(1) – Fixed place PE

Paragraph 1 of Article 5 of the OECD Model convention deals with a Fixed place Permanent establishment. The paragraph defines the term “permanent establishment” as a fixed place of business through which the company of an enterprise is wholly or partly carried on.

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Permanent Establishment inclusions in Article 5(2)

Under Article 5(2), a Permanent establishment specifically includes the following : –

• a place of management;
• a branch;
• an office;
• a factory
• a workshop
• a mine, an oil or gas well, a quarry or any other area to extract natural resources.

Construction PE or installation project PE – Article 5(3)

Paragraph 3 of Article 5 of the model convention clarifies that a building site or construction or installation project constitutes Permanent Establishment . However, it shall  constitute a PE only if permanent establishment lasts for more than a year in a particular contracting state. Therefore, any building site or construction or installation project  which exists for a lower threshold period   would not make a permanent establishment by itself.

A building site or construction or installation project includes building roads, bridges, or canals, the renovation of buildings, roads, bridges, or channels that involve more than just maintenance or renovating, the laying of pipes, and digging dredging.

Also, the term “installation project” doesn’t just mean installing something for a building project. It can also mean putting in new equipment, like a complex machine, in an existing building or outside. Paragraph 3 also includes planning and overseeing the construction of a building on the site.

Specific activities Exclusion to Permanent Establishment- Article 5(4)

In Article 5(4) of the OECD Model Convention, a list of business activities is excluded and therefore, they do not constitute a PE .” The following activities, even if they are done at fixed place of business, do not  constitute PE.

1. the use of facilities solely for the storage, display, or delivery of the enterprise’s goods or merchandise;
2. the maintenance of a stock of the enterprise’s goods or merchandise solely for storage, display, or delivery;
3. the maintenance of a stock of the enterprise’s goods or merchandise solely for processing by another enterprise
4. the maintenance of a fixed place of business solely for the enterprise.

Article 5(4) however provides that the abovementioned exceptions  apply only if such activities  are meant to be preparatory or auxiliary.

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Dependent Agent or Agency Permanent establishment Article 5(5)

In addition to the above, a business would be considered to have a permanent place of business in another country, if a person is working for it under certain conditions. In such a case, even if the business does not have a fixed place of business in that state, it would have a PE in the form of a  dependent agent of the enterprise.

A dependent agent is a person,   acting in a Contracting State on behalf of a foreign  enterprise and, in acting as such , routinely signs contracts or routinely plays the main role in signing contracts that the enterprise routinely signs without significant changes, and these contracts are

(a) in the name of the enterprise

(b) for the transfer of ownership of, or the right to use, property owned by that enterprise or that person,

(c) for the transfer of the right to use, or the right to use, property owned by that enterprise

Whenever a agent does such work for the business in the foreign state, , the business is considered to have a permanent establishment in such foreign state.

Independent Agent Article 5(6)

If an enterprise of a Contracting State carries on business dealings through an independent agent, then such enterprise cannot be taxed in the other Contracting as it is deemed that it does not have a PE in foreign country. This provision only applies if the agent is acting in the ordinary course of that business.

However, if a person works exclusively or almost exclusively on behalf of one or more enterprises to which  are closely related, that person shall not be considered to be an independent agent of any such enterprise

Subsidiary Permanent Establishment – Article 5(7)

This Article provides that merely  because a parent company has a subsidiary company in a foreign country, it would not imply    that the subsidiary company is a permanent establishment of the parent company. A subsidiary company will be considered a separate legal entity regarding taxes. Even if the parent company manages the business or trade that the subsidiary company does, that doesn’t make the subsidiary company a permanent location of the parent company.

In other words, if  a company based in one of the contracting states,  controls or is controlled by a company based in the other contracting state, or that a company based in one of the contracting states does business in the other contracting state (either through a permanent establishment or in some other way) it would not make either of those companies a permanent establishment of the other.

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