What is a Permanent Establishment?

As you must know, if a multinational corporation is doing business in a foreign country, then they have to follow the domestic tax laws of that country. Here comes the concept of Permanent Establishment. It helps in creating a threshold for these businesses below which the foreign country is not allowed to impose taxes on their income.

One of the important parts of the international tax planning for US corporations is that they need to determine whether the presence of the business in a foreign country is good enough or not. It is an essential factor to find out whether their income is taxable or not. The physical presence of business in the jurisdiction is also a criterion to set the minimum threshold.

What Triggers a PE?

There are two ways by which an enterprise can cross the minimum threshold of business presence and create a permanent establishment abroad:

By maintaining a fixed place to operate a business in that foreign country
By taking help from a dependent agent

Permanent Establishment in Taxation

The PE tax treaty usually reflects the OECD's model treaty language. You should always consult the special treaties for the exceptions or differences.

Under many of the income tax treaties, the taxation rules are implied if a resident of a contracting state has a permanent establishment in the other contracting state. This comes under the income tax rules of the source country. It generally means that the taxation on a net basis is calculated by the gross income allocated to the PE. You can reduce the taxation by deducting the deductible expenses of a business.

The taxes are also imposed on any other income earned in a different contracting state, which should not be attributable to the permanent establishment income tax, such as income from investments. These rules of taxation are applied as per the provisions of the treaty and the domestic tax law of the source country.

Examples of Permanent Establishment

Some of the examples of " fixed place of business" are as follows:

Factory
Workshop
Branch or Office
Place of management
Construction, Building site, or installation project that lasts a minimum of 12 months
Mine, oil, or gas well, quarry, or other places where you can extract the natural resources.

Dependent Agent PE activities

An enterprise can still have a permanent establishment in a treaty foreign country even without a fixed place of business. It can be done to the extent that an agent of that foreign country can conduct all the business activities on behalf of the enterprise.

There are some conditions for an agent in one country to be considered a PE of an enterprise in another country:

If the agent is dependent in the country.
If the agent regularly exercises his authority to conclude contracts in the country of the agent, it should also be binding to the enterprise.

If you want to avoid being a dependent agent, then you have to fulfill the two conditions that should be satisfied under the model treaty language:

If the agent must be economically and legally independent of the enterprise in the foreign country.
If the agent is acting in the normal course of the business, he must be carrying out the activities on behalf of the enterprise.

Non-triggers of a Permanent Establishment Status

There are many exceptions to the general definition of PE for the treaty. Some of the exceptions include:

Maintenance of the stock of merchandise or goods that belongs to the enterprise. The only purpose should be display, storage, delivery, or establishing another enterprise.
Use of a facility mainly for storage, display, goods delivery, or the merchandise owned by the corporation.
Maintenance of the fixed place of business only for the purpose of buying the goods or merchandise, collecting all the information about the business, or carrying on any other auxiliary or reparatory activity for the enterprise.
It also includes the establishment of a fixed place of business only for the purpose of combining all the activities mentioned above.