What Is Permanent Establishment?
Multinational corporations doing business in foreign countries are subject to the domestic tax laws of the countries where they are operating. The permanent establishment (PE) concept creates a minimum threshold of business presence below which the source country doesn’t attempt to tax a foreign enterprise’s business income. That threshold is set in terms of a minimum physical presence in the jurisdiction. An important part of international tax planning for U.S. corporations is determining whether its business presence in a foreign country is substantial enough for its income to be taxed.
What triggers a permanent establishment?
There are two means by which an enterprise may cross the minimum business presence threshold and thereby create a permanent establishment in a foreign country:
- By maintaining a fixed place of business in that country.
- By means of a dependent agent.
Permanent establishment in tax treaties
Tax treaty PE provisions typically reflect the OECD’s model treaty language, but specific treaties should always be consulted for differences or exceptions.
Bilateral income tax treaties normally define a PE as when a resident corporation of one contracting state has a “fixed place of business” within another contracting state, as defined by the specific treaty language, or when the corporation operates through a dependent agent that habitually exercises the authority to conclude contracts on its behalf in that country.
Under most income tax treaties, a resident of a contracting state with a PE in the other contracting state is subject to tax under the source country’s normal income tax rules, which usually means taxation on a net basis measured by the gross income attributable to the PE, reduced by any deductible business expenses.
Taxation potentially also extends to any other income earned in the other contracting state that is not attributable to the PE, such as investment income, in accordance with the applicable provisions of the treaty and the source country’s domestic tax law.
Examples of a permanent establishment
A “fixed place of business” includes, but is not limited to a:
- Place of management
- Branch or office
- Factory
- Workshop
- Mine, oil, or gas well; quarry; or any other place where natural resources are extracted
- Building site, construction, or installation project lasting at least 12 months
Dependent agent permanent establishment activities
Even without a fixed place of business in a treaty partner country, an enterprise may still have a permanent establishment to the extent that an agent in that country conducts activities on behalf of the enterprise. An agent in one country may be considered a permanent establishment of an enterprise of another country if:
- The agent is a dependent agent.
- The agent has and continues to habitually exercise an authority to conclude contracts in the agent’s country that are binding to the enterprise.
Under model treaty language, to avoid being a dependent agent there are two conditions that must be satisfied:
- The agent must be both legally and economically independent of the enterprise.
- The agent must be acting in the ordinary course of its business in carrying out activities on behalf of the enterprise.
What will not trigger a permanent establishment status?
There are exceptions to the general definition of permanent establishment for treaty purposes. De minimis exceptions include:
- Use of a facility solely for the storage, display, or delivery of goods or merchandise owned by the corporation
- Maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purposes of storage, display, delivery, or for processing by another enterprise
- Maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, collecting information, or carrying on any other preparatory or auxiliary activity for the enterprise
- Maintenance of a fixed place of business solely for any combination of the activities listed above
Authoritative analysis on international tax planning
Tax practitioners need to be aware of what triggers permanent establishment in the countries where their clients operate and to develop the right corporate tax planning strategies tailored to today’s business environment. Download our report on Navigating Permanent Establishment and U.S. Tax Thresholds for a high-level guide to navigating U.S. tax thresholds, including a decision tree and treaty chart.
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