Evaluate arguments for and against fixed thresholds (time, revenue,
number of employees, asset value, others) for a basic rule PE
Adv LLM thesis
submitted by
Dhruv Sharma
Student ID – 12929891
dhruv.sharma@student.uva.nl
in fulfilment of the requirements of the
'Advanced Master of Laws in International Tax Law'
degree at the University of Amsterdam
supervised by
Dr. Bruno Da Silva
PERSONAL STATEMENT
Regarding the Adv. LLM Thesis submitted to satisfy the requirements of the 'Advanced
Master of Laws in International Tax Law' degree:
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fulfilment of the requirements of the 'Advanced Master of Laws in
International Tax Law' degree at the University of Amsterdam.”
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Name: Dhruv Sharma
Table of Contents
Table of Contents ... III
List of Abbreviations used ... IV
Executive Summary ... V
Main Findings ... VI
1.
Introduction ... 1
1.1. Concept of a PE ... 1
1.2. Requirements for a basic rule PE: Article 5(1) of the OECD and UN Model ... 1
1.3. Requirements for a Construction PE: Article 5(3) of the OECD Model ... 1
1.4. Requirements for a Service PE: Article 5(3)(b) of the UN Model ... 2
1.5. Requirements for an Agency PE: Article 5(5) of the OECD Model ... 2
1.6. Material difference between Article 5(1) and Article 5(3) ... 2
1.7. Comparison between OECD Model and UN Model ... 2
1.8. The BEPS update ... 3
2.
Threshold requirements for a basic rule PE ... 4
2.1. Is there a 6-months test for a Basic rule PE..?? ... 4
2.2. Additional issues with current Framework ... 5
2.3. Litigations arising as a result of uncertainty ... 6
2.3.1. India………. ... 6
2.3.1.1. Formula One World Championship Ltd. v. CIT ... 6
2.3.1.2. Production Resource Group. v. CIT ... 6
2.3.1.3. Seabird Exploration FZ LLC. v. CIT ... 7
2.3.1.4. Golf in Dubai LLC. v. Director of Income Tax ... 7
2.3.1.5. Fugro Engineering B.V. v. ADIT ... 7
2.3.2. Norway………… ... 8
2.3.2.1. PGS Geophysical AS. v. ADIT ... 8
2.3.3. United States……….. ... 9
2.3.4. Netherlands……… ... 9
2.4. Need for a clear concept ... 9
2.5. Benefits of a fixed threshold ... 10
3. Object and purpose with legal rationale for fixed PE thresholds ... 11
3.1. Object and Purpose ... 11
3.1.1. Preserving tax sovereignty of states………11
3.1.2. Increased legal certainty to businesses………..11
3.1.3. Reduce opportunity for circumventing PE rules………...……….12
3.1.4. Tackling rapid emergence of digital business models………...…...……...12
3.1.5. Establish bonafide economic nexus………...……….13
3.1.6. Promote cross-border trade and investment……….…...….13
3.2. Legal Rationale ... 14
3.2.1 The Benefit Theory ... 14
3.2.2 Principle of Non-intervention ... 14
3.2.1 Principle of Non-discrimination and capital import neutrality ... 15
3.2.4 Ability-to-pay principle ... 15
4.1. Time threshold ... 17
4.1.1. Service PE……… .. 17
4.1.2. Construction PE……… . 19
4.2. Revenue threshold ... 21
4.3. Threshold based on the value of assets ... 24
4.4. Threshold based on the number of employees ... 26
5. Conclusion ... 28
List of abbreviations used
Art. Article
BEPS Base Erosion and Profit Shifting
CAD Canadian Dollar
CIT Commissioner of Income Tax
Comm. Commentary
IBFD International Bureau of Fiscal Documentation IRS Internal Revenue Service
ITA Italian Tax Authority MNC Multinational Corporation MNE Multinational Enterprise MTC Multistate Tax Commission
OECD Organisation for Economic Cooperation and Development
PE Permanent Establishment
UN United Nations
US United States
WHT Withholding Tax USD United States Dollar
Executive Summary
Objective:The main objective of the thesis is to evaluate different potential thresholds that can be incorporated within Article 5(1) to avoid uncertainty as to the qualification of a permanent establishment.
Research question:
The thesis aims to answer the question – What are the issues/difficulties that may arise and what are the issues/difficulties that may be resolved as a result of fixing a minimum threshold (time, revenue, value of assets, number of employees, others) for a basic rule PE under Article 5(1) of the OECD Model Convention..??
Research methodology:
To begin with, the research involved identification of various issues that have originated as a result of no fixed threshold for a basic rule PE. For this purpose, various case laws have been cited from around the world to highlight the differences in interpretation of the PE concept by different countries.
The next step was to identify the object and purpose of having fixed thresholds for a permanent establishment. For this purpose, various articles and books were referred to find out the actual issues that are resolved with a threshold and the benefits that accrue to both the taxpayer and the tax authorities.
The next step involved justifying the incorporation of a fixed threshold in a permanent establishment. For this purpose, various generally accepted principles of international tax law are referred and researched upon.
The next step involved the core evaluation of fixed thresholds, for which the potential indicators of economic activity are considered – time spent in the other state, revenue generated, total value of assets and employees placed in the other state. The issues associated with each of these thresholds are discussed. For this purpose, the following have been used as a benchmark:
- already existing thresholds in the treaty models
- thresholds as agreed by certain states in their tax treaties - thresholds existing in the domestic law of certain countries Conclusion:
In light of the object and purpose of fixed thresholds for a permanent establishment, the thesis led to the conclusion that there is no single threshold that is free from flaws. There are both limitations and strengths to every particular threshold discussed. The said limitations and strengths may not be equally balanced in case of every threshold, since one threshold may have more limitations and strengths than the other. These limitations and strengths will essentially depend upon a number of factors such as the nature of the business activity being conducted, business model followed by the enterprise, the economic standing of contracting states as developed or developing country, bilateral trade and investment history between the contracting states, effectiveness, ease of administration and the level of legal certainty intended to be achieved.
The current market scenario demands a threshold that can provide a sufficient level of ring-fencing to the rapidly growing digital businesses. If an overall evaluation of all thresholds is considered, a gross revenue threshold seems to be the most appropriate alternative to serve as an additional pillar to the qualitative requirements under Art. 5(1). This view is based on the relative ease of administration associated with it. Undeniably, even a carefully devised revenue threshold, as similar to a time threshold, cannot be presumed to be universally accepted by one and all. There are still limitations attached to it.
Main Findings:
During the course of research, it was identified that the states have tailored the PE provisions according to their own needs and that of their treaty partner. Usually, there is no single model, neither OECD nor UN that is applied in entirety in its current form.
The general principles of international tax only justify the fixed thresholds in general, but do not give clear guidance on the allocation of taxing rights between states. When applied in isolation, no principle can provide a conclusive answer as to which state has greater justification for levying tax in a scenario where a transaction can span more than one jurisdiction. Their primary function is to set limitations on the design of the rules.
But in the end, selection of any particular threshold is a political decision between states and cannot be entirely explained by just theoretical concepts. An adequate balance needs to be struck between the different policy aims. As rightly put forward by Schön, “one should not look for the holy grail of a ‘natural’ allocation of taxing rights and for absolute truth, but for relative consistency and equity”. The overall aim of allocation rules is to achieve a ‘fair’ distribution of tax revenues between states, sometimes also referred to as “inter-nation equity”. It is, however, hard to grasp what ‘fair’ really means and is actually subject to political and social developments. Hence, although there may be legitimate justifications for source taxation by countries and to distribute the tax burden between taxpayers, it seems more difficult to determine convincing principles that can lead to a fair distribution of the tax pie among different states.
1. Introduction
1.1 Concept of a PEThe concept of PE has a long and well-documented history. The definition of a PE as enshrined in article 5 of the OECD Model is universally understood to be the decisive threshold in determining whether or not the source state has the right to tax business income generated by a non-resident taxpayer. In an international context, the PE works effectively as a ‘tool’ to:
1. establish a taxing right for the country where the business activities are conducted; and 2. allocate the business profits generated between the residence country of the investor and the
country where the investment takes place.
Only if the income generating business activities satisfy the criterion provided for in the said article, can the source state tax such income. However, the criterion provided are of such a nature that almost every time it leads to the question of whether a permanent establishment exists or not. One can only imagine the myriad of opportunities for interpretation that Article 5 leaves open as a result of the uncertain criterion and failure to prescribe an explicit threshold in determining the existence of a PE.
Article 3(2) of the OECD Model provides that any term not defined in the treaty will have the meaning as provided for under the domestic law of the contracting state as prevailing at that time. However, since the definition of a PE is already available under the treaty, it cannot be subjected to a domestic law definition. Many countries, both developed and developing, do not even have a definition of a permanent establishment under their domestic law, or at least not a clear one; and the countries that do have, their definition corresponds mainly with the one provided under Article 5. For this reason, the term is interpreted by the tax authorities on a case-by-case basis, after analyzing all the facts and circumstances.
1.2 Requirements for a basic rule PE: Article 5(1) of the OECD and UN Model
Art. 5(1) of both the OECD and UN Model define a permanent establishment as a ’fixed place of business through which the business of an enterprise is wholly or partly carried on.’
From the plain reading of the text of Article 5(1) and corroborating it with the Commentary, It is clear that a basic rule PE constitutes the following three essential elements –
i. a place of business (e.g. premises or even machinery or equipment) exists;
ii. this place of business is “fixed”, i.e. it is established at a distinct place with a certain degree of permanence;
iii. the business of the enterprise is carried on through this fixed place. This usually entails that persons dependent on the enterprise (personnel) conduct the business of the enterprise in the state wherein the fixed place is situated.
1.3 Requirements for a Construction PE: Article 5(3) of the OECD Model
From the plain reading of the text in Article 5(3), it can be easily concluded that for establishing the existence of a construction or installation PE, the activity must be carried on for a minimum period of 12 months. Commentary 55 further states that in calculation of this period, the periodical breaks in the activity shall be included.
Of course the construction clause should not be interpreted as independent of the general clause but as a subordination of it. This means that although a separate provision is created for a construction PE, the requirement under the general clause Article 5(1) also needs to be fulfilled. This could mean that the construction clause is created by merely inserting a time threshold to the general clause which acts as an additional element for identification of a PE in cases of construction and installation. A possible reason for creating a separate provision for a construction PE could be the generally long duration of activity and the time spent on the site. Having said that, the creation of a separate construction clause can be clearly held to be a discerning act by the OECD since it has provided a clarity in what could have resulted in immense confusion and ambiguity over the existence of a PE in cases involving construction or installation.
1.4 Requirements for a Service PE: Article 5(3)(b) of the UN Model
A service PE is triggered when an enterprise provides services in the other state through its employees for a period aggregating more than 183 days in any 12-month period commencing or ending in the fiscal year concerned. This means that a Service PE is essentially dependent upon the physical presence of an enterprise’s employees in the other state for a fixed duration.
1.5 Requirements for an Agency PE: Article 5(5) of the OECD Model
In case of an agency PE, the threshold requirements fixed are of a qualitative nature rather than quantitative. This threshold requires a certain level of physical presence of the foreign enterprise in the other jurisdiction through an ‘dependent agent’, who performs business activities such as local marketing, distribution, inventory management etc. on behalf of the foreign enterprise in that other jurisdiction.
However, the requirements are of such a nature that they leave some tax planning opportunities open for the businesses. In the words of Gupta, “As long as the principal is doing something a little bit more than merely rubber-stamping the contracts finalized by the agent, it should be able to avoid a PE”.1 On
the contrary, there is no Agency PE if the acting person is an independent agent. 1.6 Material difference between Article 5(1) and Article 5(3)
If a general comparison is made between a basic rule PE and a Construction or installation PE, the most relevant point of difference that can be observed is the time threshold that is clearly specified for the construction PE, but none for a basic rule PE. This difference has led to an enormous uncertainty in establishing the existence of a basic rule PE, instigating unnecessary conflict between the taxpayers and tax authorities all around the world.
Even the commentaries to Article 5(3), although not entirely perspicuous, can be perceived as more comprehensible then those to Article 5(1), probably because of the fact that the time threshold has been fixed for a construction PE, which eliminates most of the ambiguity in establishing its existence. On the contrary, the commentaries to Article 5(1) mostly provides for cases and circumstances in which a PE ‘may be’ deemed to exist but minus the conclusive guidance on time threshold.
1.7 Comparison between OECD Model and UN Model
For reference purposes, it is pertinent to mention that the definition of basic rule PE as enshrined in
1 A. Gupta, BEPS Action 7 (Artificial Avoidance of PE Status): A Mixed Bag of PE Recommendations, 80 Tax Notes International 2, p. 120 (2015).
Article 5(1) of both the OECD and UN Model Convention is substantially similar. This consequently means that the UN Model also does not provide any guidance as to a fixed time threshold that can provide certainty over existence of a basic rule PE. Even the commentaries related to Article 5 of the UN model remain silent in this respect.
In respect of a construction PE, both OECD and the UN Model provide fixed time thresholds, except for the difference in the time limits. According to the OECD Model, a building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months, whereas in case of the UN model, the said time limit is 6 months.
An additional feature of the UN Model is the concept of Service PE under Art. 5(3)(b), which is absent in the OECD Model.
1.8 The BEPS update
The initiative to update the definition of PE was taken only after February 2013, when the OECD published its report addressing the issue of Base Erosion and Profit Shifting (BEPS). The report, which was produced at the request of the G20, identified the root causes of BEPS and raised questions in that context about whether the existing PE rules remained fit for purpose. In July 2013, as a follow-up to the BEPS report, the OECD published the BEPS Action Plan. Action 7 of this 15-point plan to address BEPS in a comprehensive manner included the following commitment to update the PE definition to prevent identified abuses:
Action 7 – Prevent the Artificial Avoidance of PE Status:
Develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS including through the use of commissionaire arrangements and the specific activity exemptions. Work on these issues will also address related profit attribution issues
The end result of this work was that in October 2015, the final report on Article 7 was published which contained certain recommendations for changes in Article 5 of the OECD Model and the commentaries related to it. The recommendations majorly addressed the following issues:2
- Tightening of Agency PE rules
- Artificial avoidance of PE status through the specific activity exemptions - Fragmentation of activities between related parties
- Splitting up of construction contracts
However, the focus of the working party seemed strictly to be on the avoidance of PE by the taxpayers through artificial means. This could probably mean that all other aspects of the PE definition were considered to be complete in the view of the working party, so much that the possibility of strengthening the PE concept and making it more certain by fixing thresholds for basic rule PE’s was overlooked.
2 S. Chatel & L. Harley, Chapter 2: Article 5 of the OECD Model: Recent Amendments and Upcoming Challenges in New Trends in the Definition of Permanent Establishment (G. Maisto ed., IBFD 2019), Books IBFD (accessed 28 Apr. 2020).
2. Threshold requirements for a basic rule PE
2.1 Is there a 6-months test for a Basic rule PE..??According to the OECD commentary, in particular commentary 28 to Art. 5, in general a minimum period of 6 months should be enough to pass the tempus test. The said commentary reads as follows:
‘’..A place of business may, however, constitute a permanent establishment even though it exists, in practice, only for a very short period of time because the nature of the business is such that it will only be carried on for that short period of time. It is sometimes difficult to determine whether this is the case. Whilst the practices followed by member countries have not been consistent in so far as time requirements are concerned, experience has shown that permanent establishments normally have not been considered to exist in situations where a business had been carried on in a country through a place of business that was maintained for less than six months (conversely, practice shows that there were many cases where a permanent establishment has been considered to exist where the place of business was maintained for a period longer than six months)..’’
Whether this is the exact minimum also remains unclear in further discussions by the OECD. Reasons of the OECD not to set a hard minimum time frame, is that such a time frame would not take into account the different business models. In fact, there has been no threshold in any respect fixed by the OECD that may give certainty to the presence of a basic rule PE.
The guidance provided by the commentary to shed clarity on the PE concept seems to hold certain contradictions. For instance, Commentary 30 to Art. 5, provides a direct contradiction to the aforesaid general practice by the countries. It states the example of an individual who learns that a television documentary is about to be shot for a period of 4 months in the remote village of a state, where her parents own a large house. She enters into a contractual arrangement with the producer of the documentary for providing catering services to the crew members. For this purpose, she turns the house into a cafeteria for the next 4 months. The said case is deemed to create a PE in the view of OECD on the ground that ‘the time requirement for a permanent establishment is met since the restaurant is operated during the whole existence of that particular business.’3 An inverse situation is also presented
in the same commentary where a company which operates various catering facilities in another state, also carries out the business activity in another state during the 4 months when the documentary is shot. In such a case, a PE would not be triggered. The reasoning provided is that for such a company, the business carried on in the state of documentary would only be of a temporary nature since it already carries out the same activity on a permanent basis in another state.
Therefore, commentary 28 should not be conceived as providing any conclusive threshold in respect of time because it merely depicts the general practice followed by the countries and hence cannot be relied on by either the taxpayer or the tax authorities in case of a conflict. There is a clear difference in the attitude of tax authorities across countries and regions when it comes to determining the existence of a PE. The said view stems from the several varied and contradictory case laws and the tax treaty policy of different countries involving permanent establishments, which shall be discussed in section 2.3.
2.2 Additional issues with current Framework
According to the current framework, 2 major tests need to be satisfied in order to trigger a PE: 1. Permanence test – The place of business needs to be geographically fixed to term it as
‘permanent’
2. Disposal test – The place of business needs to be ‘at the disposal’ of the foreign enterprise. However, the above framework leaves unanswered a fundamental question:
How long does a business need to be carried on at a place of business to term it as ‘permanent’ or ‘at the disposal’?
There is no fixed threshold for a basic rule PE under Art. 5(1), whether in terms of a time element or any other that can answer the aforesaid question with certainty. The commentary to Art. 5 uses vague terms like:
- sufficiently long’ period of time (Comm. 15) - intermittent or incidental’ presence (Comm. 18) - ‘extended period of time’ (Comm. 19)
- recurrent nature (Comm. 29) - short duration (Comm. 30)
- a very short period of time (Comm. 34)
- operations must be carried out on a regular basis (Comm. 35)
As already stated, Commentary 28 to Art. 5 does not provide any time threshold for a basic rule PE but only the general practice followed by states, thus allowing no clarity. Another puzzling guidance can be found in Comm. 29 related to recurrent activities. The commentary provides a general exception to the guidance provided under commentary 28, providing another general practice of states stating that:
‘..where the activities were of a recurrent nature; in such cases, each period of time during which the place is used needs to be considered in combination with the number of times during which that place is used (which may extend over a number of years).’
The said guidance seems hysterical owing to the fact that the exception provided is actually in reference to a guidance which is already not conclusive in itself, i.e. in comm. 28. So the reference seems nothing but just another of the loose threads in a string of pre-existing ones. The aforesaid is just one of the many other similar ambiguous references that exist in the current text of Article 5 and the commentaries to it.
Even the examples cited in the commentaries are not of much help since they cover very particular examples and do not cover many general business activities. For instance, comm. 17 narrates the example of a painter who, for two years, spends three days a week in the large office building of its main client. In this case, the office building is deemed a PE for the painter on the basis that he is performing the most important functions of his business (i.e. painting) there and his presence there is ‘sufficiently long’. However, if the same example is considered, the commentaries do not provide any guidance for situations where the painter, instead of working three days a week for two years, works 2 days a week
for one year. Therefore, the example has been criticized as ‘confusing’ and ‘controversial’.4
2.3 Litigations arising as a result of uncertainty
As a result of no conclusive guidance, most cases are left to the whims of the tax authorities, to be interpreted as per their own understanding of the concept. This uncertainty has led to several conflicts of PE qualification, leading to litigations around the world.
2.3.1 India
Before reciting cases from India, it is pertinent to mention that India has more cases on permanent establishment than rest of the world combined. Almost every litigation between the taxpayers and the tax authorities results in favor of the tax authority and thus leads to the emergence of a PE and imposition of tax by the Indian tax authorities. So to begin with, we take the most famous case in India which has formed the basis for several subsequent rulings on PE in India:
2.3.1.1 Formula One World Championship Ltd. v. CIT
The case dealt with a motor racing championship, which was held in India over a brief period of three days – the question being whether the income earned from the event should be taxed in India. In its decision, the Supreme Court has ruled against the taxpayer and held that such brief activity could also result in the creation of a PE in India.5
The Supreme Court also opined that the fact that the taxpayer company had exclusive access to the place of business (racing circuit, etc.) satisfied the ‘disposal test’ and the fact that this access lasted for a period of six-weeks during the season satisfied the ‘duration test’ to constitute a PE under Article 5(1) of the India-UK Double Tax Avoidance Agreement.
A noteworthy aspect here is that a brief activity lasting merely six weeks was considered enough to satisfy the ‘duration test’ in the eyes of the Indian legal system to constitute a PE. The view seems a bit eccentric considering that the India-UK tax treaty does not provide for any fixed threshold. Furthermore, there is no treaty model in the world at present that provides for a fixed time threshold in respect of a basic rule PE under Article 5(1). This case is a classic example depicting the intention of the states to interpret the concept of PE in a broad sense.
2.3.1.2 Production Resource Group v. CIT
Production Resource Group (PRG), a company based in Belgium, entered into a contract with the Organizing Committee of the Commonwealth Games, Delhi (OCCG), for providing on a turnkey basis, lighting and searchlight services during the opening and closing ceremonies of the Commonwealth Games Delhi, 2010. The employees and equipment of PRG were present in India for a period of 66 days, for carrying out preparatory, installation and dismantling activities. The actual services were rendered only on 2 days – the opening and closing days of the ceremony. In PRG’s view, its income from these activities was not taxable in India.
However, the Indian tax authorities held a different view and opined that PRG had a PE in India. The
4 J. Nitikman, The Painter and the PE, 57 Can. Tax J. 2, at 249 (2009)
5 Patnaik, S.R. “Formula One: SC Lays Down the Formula for Permanent Establishment.” Direct Tax (blog), June 6, 2017. https://tax.cyrilamarchandblogs.com/2017/06/formula-one-sc-lays-formula-permanent-establishment/#
rationale for the view was that PRG had an overarching physical presence on the ground for the purposes of carrying out the activities. In passing the judgment, reliance was also placed on the Formula One judgment and a similar reasoning was followed, stating that the ‘duration test’ was satisfied owing to the distinctive nature of the taxpayer’s business. The ‘disposal test’ was also considered to have been passed in this case as the employees of PRG were provided with certain lockable space for storing their tools and equipment inside the stadium for a full period of 66 days.
2.3.1.3 SeaBird Exploration FZ LLC v. CIT
SeaBird Exploration FZ LLC is a UAE based company engaged in the business of rendering geophysical services to the oil and gas exploration industry. Its core business activity involves collection and processing of the seismic data in order to help its clients maximize their production of oil and gas. In India, the said services were rendered to the Oil and Natural Gas Corporation of India (ONGC) and some other oil companies for a total period of 113 days. As per the taxpayer company, the income from these Indian customers was not taxable in India and for this purpose, it sought an advance ruling from the Authority for Advance Ruling (AAR).
The India-UAE tax treaty contains a specific Service PE provision under Article 5(2)(i) which stipulates a 9-month ‘time threshold’ to trigger a Service PE. However, the AAR ruled that the presence of a vessel for conducting the exploration activities gave rise to a fixed place PE under Article 5(1) of the treaty and the fact that the business activity in essence consisted mainly of services was ignored. The AAR also referred to the Supreme Court’s decision in Formula One case and held that the taxpayer company’s vessel passed the prerequisites for existence of a fixed place PE under Art. 5(1) of the treaty. The AAR also opined that it was irrelevant that the taxpayer company’s activities in India lasted for merely 113 days.
2.3.1.4 Golf In Dubai, L.L.C. V. Director of Income Tax (Int. Tax.)-I, New Delhi
Golf in Dubai LLC is a tax resident of United Arab Emirates (UAE) and is engaged in the promotion of golf globally by organizing gold tournaments in which top golf players from all around the world participated. It organized two golf tournaments in two different cities in India and was held for a total period of 13 days – 6 days in Bangalore and 7 days in New Delhi. The organizer received income in the form of management fee, sponsorship fee and income from the sale of merchandise at the venue and also over the internet. The question before the AAR was whether the organizer had a PE in India. This case is one of the exceptions and the taxpayer is probably one of the few lucky ones who has been spared by the Indian tax authorities when it comes to determining the existence of a PE in India. Or a possible reason for it could be that since this case predates the Formula One decision, the AAR did not have a prominent case to rely on.
2.3.1.5 Fugro Engineering B.V. v. ACIT [2008] 122 TTJ 655 (Del)
Fugro Engineers BV, a company tax resident of the Netherlands, contracted with three different parties in India for carrying out geo-physical and geo-technical site investigation. The contracts lasted for 13, 41 and 37 days respectively, amounting to a total period of 91 days. The work was carried out at different sites in India by the company, using its own specialized equipment such as a rig and a vessel. The question before the Income Tax Appellate Tribunal was whether Fugro Engineers BV had a PE in India. The Tribunal, after considering various case laws and commentary, held as follows:
‘’It is clear that no length of time is prescribed in Paragraph 1 to Article 5. To our mind, in such a situation if a place of business is available to the assesse during which its independent work can be completed, it shall constitute a PE and it is accordingly held.’’
2.3.2 Norway
2.3.2.1 PGS Geophysical AS v. Government of Norway
PGS Geophysical is a Norwegian joint stock company and a resident of Norway for tax purposes. It entered into two separate contracts with 2 different oil companies of Ivory Coast for the geophysical exploration of the offshore seabed of Ivory Coast. Two special purpose vehicles fitted with advanced acoustic equipment were used for this purpose. One exploration contract lasted for 25 days and the other for 41 days, making it a total 66 days presence of the Norwegian company in Ivory Coast. The company assumed it had triggered a PE in Ivory Coast and thus deposited the due tax on the income earned from the two contracts. Further, it claimed the credit of tax paid in Ivory Coast from the Norwegian tax authorities.
The Norwegian tax authorities refused the credit of the tax paid in Ivory Coast stating that the taxpayer had no PE in Ivory Coast. The matter reached the Court of Appeal of Borgarting which upheld the decision of the tax authorities on the ground that a period of 66 days was not sufficient enough to constitute a PE.
An old but prominent example can be stated in relation to the Lillehammer Winter Olympics that took place in the year 1994, where it was decided by the Norwegian Minister of Finance that the broadcasting company which had exclusive broadcasting rights of the event, had a PE in Norway, even though the event lasted for merely 15 days.6
The website of the Norwegian tax administration provides for the following definition of a Permanent Establishment:
A ‘permanent establishment’ means that the company or self-employed person has a fixed place of business through which they run the business all or some of the time. The business must also have been operating for a sufficient period of time.7
From a critical observation, there appear to be two outcomes of the said elaboration: First, it seems that in an attempt to elaborate the meaning of a permanent establishment, the Norwegian tax authorities have imbibed the idea of well-known ambiguous and uncertain time threshold. Second, it might be possible that by explicitly inserting an uncertain time limit, Norway may have extended the definition of a PE to all possible businesses, without any regard to the period of time that the business is carried on. So, keeping in mind the different types of businesses, states that wish to include a time threshold in respect of basic rule PE’s in Article 5(1), may devise a provision on the following lines:
‘An enterprise of a contracting state shall be deemed to have a permanent establishment in the other contracting state if a business activity in respect of (business type) is carried on in the other contracting state for a period of more than (time threshold). In calculating such
6 28 T.C. 127, 152 (1957), aff’d, 265 F.2d 320 (6th Cir. 1959).
7 The Norwegian Tax Administration. “Permanent Establishment - Foreign Limited Companies.” Accessed May 5, 2020. https://www.skatteetaten.no/en/business-and-organisation/foreign/foreign-companies/tax-returns-and-tax-assessment-notices/permanent-establishment/
time limit, the time undertaken in relation to setting up of the business shall be excluded.’ Explicitly excluding the time spent on setting up of the business is done for the purposes of greater clarity and as less ambiguity as possible. Developing countries concerned with revenue loss may set the aforesaid time limit at the minimum possible considering the average duration of activities conducted by foreign businesses in the country.
2.3.3 United States
A definition of the term “permanent” has been provided by the US Tax Court in the case Consolidated Premium Iron Ores Ltd. v. Commissioner,8 which was decided under the 1942 United States–Canada
treaty. The Tax Court stated as follows:
The descriptive word “permanent” in the characterization “permanent establishment” is vital in analyzing the treaty provisions. It is the antithesis of temporary or tentative. It indicates permanence and stability.
With respect to the length of presence that will be considered to be “permanent”, the IRS held in Rev. Rul. 67-322, 1967-2 C.B. 469, that a period of 6 months in each of 2 taxable years (i.e. a total of 12 months over 2 years) during which a Danish enterprise operated a restaurant at the New York’s World Fair was sufficient to cause the enterprise to have a permanent establishment in the United States under the 1948 United States–Denmark treaty. On the other hand, the IRS held in Rev. Rul. 67-321, 1967-2 C.B. 470, that a French corporation that had presented a floor show in a hotel in the United States for 10 weeks was not considered to maintain a permanent establishment in the United States under the 1946 United States–France treaty due to the relatively short duration of the performance period.9
2.3.4 Netherlands
In the case of ‘artificial eyes’, the Dutch Supreme Court opined that paying rent of different hotel rooms for only a limited amount of time would not be enough to pass the tempus test.10 The period of
three months was also not considered enough in the Drilling Rig case.11 Further, in the Supreme
Court’s view, periods of merely ‘a few months’12 or even ‘half a year’13 were not considered to have
enough substance to establish taxable presence.14 In the case of Sonar Ship-II15, a period of 4.5
months and in case of Room/Shed16, a period of 9 months was considered enough to constitute a PE.
The Dutch Supreme Court seems to give more relevance to the nature of activity than the intended duration of the activities.
2.4 Need for a clear concept
Due to the substantial increase of case laws in many countries, the need has become apparent for clear concepts in the text of article 5 and for clear guidance in the commentaries within the limits put by the text of the provisions. It should also be observed that a lot of relevant case laws are produced by courts
8 28 T.C. 127, 150
9 F. Jacob et al., Article 5: Permanent establishment in Commentary on US-German Income Tax Convention (IBFD), Para 116, Books IBFD (accessed 5 June 2020).
10 HR 15 June 1955, nr. 12 369 (BNB/277)
11 Hof ‘s Gravenhage 10 September 1990, nr 4. 4287/87, (BNB 1992/51). 12 HR 22 January 197, nr. 17 537 (BNB 1975/66).
13 HR 24 march 1976, nr 17 812 (BNB 1976/121).
14 Van den Berg, Is there a permanent establishment? IFA Cahiers 2009, p. 469 15 Supreme Court, 9 June 1976, No. 17,910, BNB 1976/169
from countries not being a member of the OECD and thus not bound by or fully familiar with the long history of the PE concept as developed e.g. in the OECD Model and its commentaries. However, even in the case of countries which are not a member of the OECD, reference is regularly made by the relevant courts to both the OECD texts (which are many times identical to the UN Model) and commentaries. This increasing involvement of non-OECD countries further shows the need for more legal certainty which can only be reached by clear texts and guidance in the commentaries.17 In the
author’s view, the current text does not really provide such certainty required for taxpayers but only adds to the already large number of rather factual examples which many times have a limited scope. In the words of Arnold, the following has been used to defend the need for fixing of threshold requirements in establishing the existence of a PE:
‘’Firstly, the threshold requirements are necessary to enforce taxation effectively. Identification of the non-residents and data collection, verification and tax collection would be too time consuming. Secondly, a threshold would provide certainty for the taxpayer, as the taxpayer would know that he would only be taxable in the country where he performs activities if he would meet the threshold criteria. Thirdly, the compliance costs of the business might exceed the tax due, as filing and administration requirements might lead to additional costs which are higher than the proceedings from the activities in the other country. Lastly non-residents might not comply, as they might not be aware of the regulations, or consider the third argument to be a reason not to pay, which would undermine the integrity of a tax system.’’18
2.5 Benefits of a fixed threshold
From the above cases it can be easily deduced that providing for a fixed threshold in a basic rule PE may lead to the following benefits:
- Increased certainty to the taxpayers whether a PE will emerge from their business activities or not
- Reduced litigation which at present, is essentially the result of uncertainty over the existence of a PE
- Reduced litigation will eventually lead to cost savings for both the taxpayer and the tax authorities
- The increased certainty would also bring down the time spent on the groundwork and planning activities in ascertaining the emergence of a PE.
- The reduction in planning time would eventually promote swift and efficient deployment of resources to the country where the business activity is to take place.
The importance of a fixed threshold, in another context, can also be realized in the beneficial owner requirement under Article 10(2)(a) of the OECD Model 2017 and the UN Model 2017. The minimum holding requirements, both in terms of capital and holding period are incorporated to prevent the abuse of the provision which allows the benefit of a lower rate to be claimed only when the requirement is fulfilled.
17 “Comments by IBFD on Public Discussion Draft ‘Interpretation and Application of Article 5 (Permanent
Establishment) of the OECD Model Tax Convention.’” Accessed June 8, 2020.
https://www.oecd.org/ctp/treaties/49782184.pdf
3. Object and purpose with legal rationale for fixed PE thresholds
This chapter focuses on the object and purpose for having fixed thresholds under Art. 5(1) with legal rationale or justification.
3.1 Object and Purpose
3.1.1 Preserving tax sovereignty of states
The PE threshold “has a long history and reflects the international consensus that, as a general rule, until an enterprise of one State has a permanent establishment in another State, it should not properly be regarded as participating in the economic life of that other State to such an extent that the other State should have taxing rights on its profits”.19 The concept of PE is a direct connecting factor to justify the
taxation of business profits by the source state. Therefore, the rules governing PE need to be very clear in order to ensure that the business has sufficient economic presence in the other country. This will ensure that the source country has the right to enforce substantive jurisdiction over the non-resident taxpayer. It has also been advocated that the permanent establishment rule is "designed to ensure that business activities will not be taxed by a State unless and until they have created significant economic bonds between the enterprise and that State".20
The best explanation to the tax sovereignty principle was given in the case of Govt. of India V. Taylor21
by Lord Keith of Avonholm. He held the view that if the taxation laws of one country are enforced by another country, then it shall be termed as an extension of the sovereign power of that state to impose tax and would be in direct conflict with all concepts of independent sovereignties.
3.1.2 Increased legal certainty to businesses
Absence of legal certainty by way of a fixed threshold, makes businesses more often than not, skeptical of their actions while engaging in any kind of business activity in another country. Furthermore, businesses are at so many occasions have no intention of triggering a PE, but are unaware that their actions could result in the emergence of a PE in the other country.
Legal certainty allows a business to overcome a huge number of obstacles that can have a potential impact on the financial position and its market standing. For instance, legal certainty can prevent unnecessary conflict with the tax authorities, saving them a substantial amount of time and money. This benefit is also shared by the tax authorities since they have to indulge in the allocation of resources and time to assess the constitution of a PE of the foreign enterprise. It also allows the businesses to assess in advance the tax consequences of their business activities in the other state, allowing for efficient allocation of resources.
The interested parties, in their comments to the Discussion Draft on the definition of permanent establishment, have cited legal certainty, as the primary reason for demanding a fixed threshold, under Art. 5 of the OECD Model Tax Convention.22 It is only logical to devise that legal certainty holds a great
19 OECD Model Commentary Art. 7, para. 11
20 Vogel, Klaus, Klaus Vogel on Double Taxation Conventions (3rd ed., 1997), at 280 21 (1955) AC 491, 511
22 “Public Comments Received on the Discussion Draft on the Definition of ‘Permanent Establishment’ in the OECD Model Tax Convention - OECD.”
https://www.oecd.org/ctp/treaties/publiccommentsreceivedonthediscussiondraftonthedefinitionofpermanentest ablishmentintheoecdmodeltaxconvention.htm.
value for both businesses and tax authorities when it comes to cross-border trade and investment. 3.1.3 Reduce opportunity for circumventing PE rules
The data released by OECD suggests that countries around the world lose 100 to 240 Billion in tax revenues due to tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules. The said gaps and mismatches also extend to different interpretation by the countries of the common tax rules (typically the tax treaties) where no clear guidelines are available for the application. One part of MNCs’ global tax strategy – aimed at reducing the overall effective tax burden – directly relates to the nexus issue. Put simply, MNCs can avoid taxable presence in certain, usually high-tax countries that provide the market for their products/services by planning around the nexus requirements enshrined in international tax law de lege lata, particularly around the PE nexus.23
As Judge Billings Learned Hand rightly held in the case Helvering v. Gregory24:
“Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes”.
One cannot help but agree with the words of Judge Billings that there is no obligation on the taxpayer to serve the interest of the treasury by increasing their own taxes. Therefore, as long as there remains an uncertainty and ambiguity in the definition of basic rule PE under Article 5(1), there will always remain a possibility for the taxpayers to use the same to their best advantage in order to put in place tax structures that circumvent the PE provisions.
Considering the phenomenal increase in cross-border trade, it has become more important than ever to set clear threshold rules that can be relied on to establish a taxable nexus to the state of source. No fixed threshold is judged by many as a big loophole in the present PE framework. Inclusion of a fixed threshold can most likely prevent the exploitation of PE rules to a significant extent.
3.1.4 Tackling rapid emergence of digital business models
The digitalization of world economy has allowed businesses to carry out their business operations without any physical or representative presence in the other country being necessary. At a fundamental level, this problem can be outlined as follows: while most states exercise their taxing jurisdiction in the area of income tax on the basis of different benchmark that reflects a certain territorial link (or nexus) established between the taxpayer and the state, digital businesses make it very difficult to determine, in geographical terms, the states and different territories where the relevant business activities take place. It is a commonly used proverb that the Internet knows no borders.
This ability of the digital businesses to carry out business without any physical or human presence has been identified as a peculiar characteristic of digital businesses. This characteristic has triggered the need for reconceptualization of the source rules that can lead to effective taxation of business profits arising from digital transactions in the source country.
23 S. Gadžo, Chapter 6: Nexus Norms in the Context of the Global Economic Environment in Nexus
Requirements for Taxation of Non-Residents’ Business Income – A Normative Evaluation in the Context of the Global Economy (IBFD 2018), Books IBFD (accessed 29 June 2020).
3.1.5 Establish bona fide economic nexus
There are two steps that need to be undertaken in order to geographically allocate the income of a multinational business. Firstly, the business activities undertaken by a firm in a particular state must exceed a certain minimum threshold, i.e. nexus. Nexus essentially refers to the location for origin of income. Once the threshold has been met and the taxable nexus has been established, the second step entails the attribution of appropriate share of income to that state. This process is called income allocation and it essentially evaluates how much of the income derived by the business can actually be allocated to a particular jurisdiction. However, it must be noted, that the second step is entirely dependent upon the completion of the first step. Therefore, in order to reach the second step, it is crucial that the first step is passed without any complications. But current PE rules do not allow the hassle free completion of the first step in many cases. This is because the present criteria for establishing the taxable presence (or a PE) suffers from the lack of any fixed criteria that can confirm such a presence in an indisputable manner.
All nexus concepts utilized in international taxation at present, set a qualitative threshold standard referring to legal and physical-geographical connecting factors. The problem, however, first, is that legal realities do not always correspond with economic realities. Typically, only the legalities agreed upon by third parties are driven by market forces; Intra-firm legal realities are not. Second, the same has also become true regarding the physical-geographical brick and mortar realities currently required to establish taxable presence, as under the permanent establishment threshold. Also these no longer necessarily correspond with economic reality. The digitization of the economy, for instance, has made the requirement to establish a physical presence within a country to service its market rather insignificant.25
3.1.6 Promote cross-border trade and investment
Most of the examples provided under Art. 5(2) – office, factory, workshop, mine, and oil or gas well – typically point to the fact that mere physical facilities can be termed as PE. Although in most cases, such facilities are seldom present, but in several other cases where physical facilities do not fall under any of the aforementioned categories, the issue of PE qualification arises.
It has been rightly recognized in Comm. 45 to Art. 5 that the list is by no means exhaustive. Even in cases where the physical facility comprises of one as provided under Art. 5(2), it still does not automatically lead to the creation of a PE. This is because the facilities under Art. 5(2) still have to conform to the requirements under Art. 5(1) and are also covered by exceptions under Art. 5(4). For instance, a vessel used for exploration and exploitation activities in the territorial waters of another state, a room in a hotel, a stall in a market, all have been identified as constituting a PE if business activities are carried out for a sufficiently long period. The only uncertainty to be noted here is the one arising due to the time period requirement. This uncertainty puts the non-resident taxpayer in a problematic situation since he is not expecting the triggering of a PE. But the tax authority, on the account of terming it as a PE, imposes the assessment on the non-resident taxpayer. And in most cases, there are assets available in the country against which the tax authority can satisfy the tax liability of the non-resident taxpayer. Such situations are likely to hinder cross border trade and investment between the country of the taxpayer and that of the tax authority.
Analyzing several deficiencies and inconsistencies in the existing threshold requirements of the OECD and UN Models, Arnold has argued that some minimum threshold requirement for source-country
taxation of business profits is desirable because it promotes cross-border activity, which is the fundamental goal of tax treaties.26
3.2 Legal rationale 3.2.1 The benefit theory
The benefit theory states that a jurisdiction’s right to impose tax essentially depends upon the sum of benefits and various state services enjoyed by the taxpayers in their interaction with a country. It demands the taxpayers to contribute to the public expenditure of that country, in the capacity of an agent, who is affiliated with the economic life of any particular country. In other words, it provides that both resident and non-resident taxpayers can be taxed in a state if they derive some sort of benefits from the services provided by that state. The benefits derived may be general or specific in nature. Some common examples can be that of police, education, fire services, defense protection, infrastructure such as roads, railways, bridges etc. To ensure proper functioning of business, the state may also provide conducive and operational legal structures in the form of stable regulatory and legal environment, protection under certain consumer laws, protection of intellectual property, telecommunication services and various other utilities.27
With a fixed threshold, it becomes clear that a foreign enterprise has attained a minimum level of benefits by making use of the economic and legal infrastructure of the other state. This works as a justification for the resulting tax liability imposed on the permanent establishment of the foreign enterprise. 3.2.2 Principle of Non-intervention
The principle of international law has evolved over time to go beyond the mere restrictions of threat or armed action against other states. Fifty years ago, i.e. in 1970, The United Nations issued its ‘Declaration on Principles of International Law regarding Friendly Relations and Cooperation among states in accordance with the Charter of the United Nations’.
The declaration provides as follows:
No State or group of States has the right to intervene, directly or indirectly, for any reason whatever, in the internal or external affairs of any other State. Consequently, armed intervention and all other forms of interference or attempted threats against the personality of the State or against its political, economic and cultural elements, are in violation of international law.28
It further provides that:
Every State has an inalienable right to choose its political, economic, social and cultural systems, without interference in any form by another State.29
By requiring sufficient nexus with the state, a fixed threshold is intended to ensure that a source country can enforce its jurisdiction unequivocally and impose tax without any intervention from the other state
26 J. Arnold, Brian. “Threshold Requirements for Taxing Business Profits under Tax Treaties,” October, 2003.
https://research.ibfd.org/#/doc?url=/collections/bit/pdf/bifd100302.pdf.
27 OECD (2014), “Fundamental principles of taxation”, in Addressing the Tax Challenges of the Digital Economy, OECD Publishing, Paris.
28 UN. “Declaration on Principles of International Law Regarding Friendly Relations and Cooperation among States in Accordance with the Charter of the United Nations,” n.d., 11
and has administrative capabilities to enforce its tax jurisdiction over the non-resident taxpayer. A fixed threshold may also work to prevent the other state from taxing the income on the basis of its own different interpretation of the PE concept.
3.2.3 Principle of Non-Discrimination and capital import neutrality
Article 24(3) of both the OECD and UN Model provide that the tax imposed by a state on a permanent establishment of the foreign enterprise shall not be more burdensome than the tax imposed on the resident enterprises of the PE state, carrying on the same activities. It is also provided that the general rules governing the principle of non-discrimination do not constitute an exhaustive list of the possible consequences of this principle with respect to the determination of the tax base.30
However, owing to this provision, it is only logical to conclude that a permanent establishment should not be taxed on a tax base which does not satisfy the minimum threshold criteria to impose tax in the PE state, as this would be a direct violation of the non-discrimination principle. The separate entity approach as enshrined under Article 7(2) must be respected in calculation of the tax base and the tax rate.
When a fixed threshold is agreed in the tax treaty, the contracting states explicitly agree to grant the other state the taxing right on the PE of their residents. And this provides a minimum sense of security to both contracting states that the PE’s would not be taxed unless a minimum criteria is achieved. A fixed threshold in the tax treaty provisions works as a lex specialis rule over the domestic law and can ensure that the taxing rights have actually been awarded to the other state. Without a fixed threshold, there is always a possibility of the PE state to unintentionally impose a taxation on the PE which is more burdensome than that imposed on its own resident enterprises. Therefore, it is right to say that a fixed threshold strengthens the principle of non-discrimination by drawing a clear tax line and also ensures capital import neutrality as the overall tax liability on the enterprise remains the same upto that fixed threshold.
3.2.4 Ability-to-pay principle
The ability-to-pay principle is essentially designed on the idea that the tax burden on a taxpayer must be imposed in accordance with his ability to pay. The ability-to-pay principle and the benefit principle are considered as the guiding principles in the interpretation and design of direct tax laws. It can also be said that both principles go hand-in-hand due to the reason that it is actually the benefit (or profit) derived from a state that in turn develops the ability to pay of the taxpayer.
With respect to direct tax law, states usually apply the principles of territorial and worldwide taxation in establishing taxable nexus to the source of income or the taxing right to the residence of the taxpayer. In an international context, these principles may lead to some overlap in granting taxing rights on the same income between the source state and the residence state. Such overlap is mitigated by the application of tax treaties concluded between these states, which contains distributive rules for the allocation of taxing rights to either one or both states, along with the provision for elimination of double taxation between them. One of the most common links for the allocation of taxing rights to the source state, is the concept of ‘permanent establishment’.31
However, the exact benefit derived by the taxpayer may still not be ascertained until a clear demarcation
30 OECD Model Commentary Art. 24, para. 43
31 K. Spies, Permanent Establishment versus Fixed Establishment: The Same or Different?, 71 Bull. Intl. Taxn. 12 (2017), Journals IBFD (accessed 30 June 2020).
line is fixed for the same. For instance, according to the commentary to Art. 5, an outside market or fair may constitute a PE for a trader if he regularly conducts trading activities in that market.32 The Hoge
Raad33 case may be cited as an example here. In this case, two Dutch residents bought flowers in the
Netherlands and travelled to Germany to sell those flowers. They were lent a room by a friend in Germany. They also had certain space available to them for storage purposes and for carrying out preparatory work. In addition, they operated a licensed stall in the market. After considering all the circumstances, it was held that the two Dutch residents had a PE in Germany.34 In such a case, the
trader may be making use of the other state’s resources, but for how long or how much benefit is actually attained to assume the paying ability of the taxpayer, cannot be identified with certainty, as the current PE framework does not allow it as such.
The fixed thresholds in a PE can be used to identify the minimum level of benefit (or profit) that can reasonably be assumed to have been derived from the activities of the foreign taxpayer in the PE state. Once the minimum level of benefit is ascertained, then the tax can be imposed by the PE state taking account of the paying ability of the taxpayer developed as a result of this benefit.
In addition, the ability-to-pay principle is also directly linked with the principle of non-discrimination, which means that the non-resident taxpayer must be treated in the same manner as the resident taxpayer. Therefore, if only the ability-to-pay of the resident taxpayers is taken into account and that of non-resident taxpayers is ignored, then it is a direct contradiction of the non-discrimination principle. Further, it also based on the reciprocal principle of sacrifice, which means that the taxpayer sacrifices a certain portion of his income for the welfare of the state for availing the resources offered by that state which lead to the generation of that income.
32 OECD Model Commentary Art. 5, para. 23 33 Decision of 24 March, 1976, BNB 1976/121
4. Evaluation of fixed thresholds
4.1 Time threshold:The current tax treaties around the world only include an explicit time threshold, majorly for other forms of PE like the Service PE and Construction PE. There are many proven examples around the world of cases where even the PE’s with fixed time thresholds, like the construction PE and the Service PE have led to issues over their qualification as such. For instance, the OECD and UN commentaries to Article 5(3) provide that a series of activities constitute a single project if they have a commercial and geographical coherence.35 Such a concept raises a plethora of interpretation issues. Therefore, it is
only logical to conclude that a time threshold for a basic rule PE will most likely also lead to similar interpretational and qualification issues. A basic rule PE, on the other hand, still remains devoid of a fixed quantitative threshold and continues to be defined in qualitative terms.
Several efforts have been made in the past by various scholars to interpret the time presence required for the constitution of a PE under Art. 5(1). But none of the efforts have yielded any conclusive outcome. In light of this fact, we evaluate the time thresholds that already prevail in certain types of PE’s: 4.1.1 Service PE:
Service companies are usually confronted with the analysis about whether or not the services provided by their personnel in foreign jurisdictions constitute a PE. Facts and circumstances relating to said business activity may vary greatly from one case to another but, in general:
The employees of the service provider are bound to travel and stay for a variable period of time in another jurisdiction (although they could be constantly travelling within said jurisdiction or other jurisdictions).
The employees may work in the premises of the client (service recipient), including (for example) construction sites, the premises of a local affiliate of their multinational group, or at their own home in said jurisdiction (including hotels).
Sometimes, the personnel may not even be under the payroll of the company responsible for the project (the “principal”) but, rather under the payroll of the affiliate company (related) or a third party subcontractor
It should be noted that many countries have a service sector equivalent or even bigger than the goods sector. However, not just the ones with a bigger service sector, but other countries too prefer to include the Service PE provision in their tax treaties based on article 5(3)(b) of the UN Model, which states that the term “permanent establishment” also encompasses:
... the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue within a Contracting State for a period or periods aggregating more than 183 days in any 12-month period commencing or ending in the fiscal year concerned.
Considering that the service sector may be equivalent or even bigger in size than the goods sector, but with a clear threshold of 183 days for establishing a PE, sounds a bit odd. From the reading of the commentaries to said provision, it appears that some of the Commentary and some of the examples
35 OECD Model (2017): Commentary on Article 5(3), Para. 51; UN Model (2017): Commentary on Article 5(3), Para. 11
provided are aimed at assessing the relative importance of the time spent in the foreign state in which activities are undertaken to the overall activity of the service provider in that foreign state. The said importance is probably derived from the policy perspective behind the provision which says that-
‘’……if a non-resident provides services in a country for more than 183 days, the non-resident’s involvement in the commercial life of that country clearly justifies the country taxing the income from those services whether the services are provided for one project or multiple projects.’’36
States have tailored the said provision in their tax treaties, as per the mutual agreement with the other contracting state. For instance, Article 5(3)(b) of the Luxembourg-Singapore tax treaty reads as follows:
3. The term "permanent establishment" also encompasses:
(b) the furnishing of services, including consultancy services, by an enterprise of a Contracting State through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 365 days in any 15-month period.
From its wording, the Service PE clause seems to be quite clear, considering the explicit provision of the time threshold. The current 183-days threshold has actually evolved from the ‘6-months’ threshold that was prevalent in the UN Model 2001. This was done to make the provision consistent with the approach followed in Art. 14 of the Convention.37 Otherwise, the 6-months threshold could have been
misunderstood as the first 6 months or a continuous period of 6 months during any 12-month period. Further, a provision of service during any day of the month could have been counted as an entire month of service. Therefore, the change looks like a clear example of the genuine efforts by the UN to make the provision more precise and to prevent such misinterpretations.
However, there are still some questions that arise with this threshold. For instance, it is not clear if the provision of services leads to an overlap between two fiscal years, whether it would lead to the constitution of a PE in both fiscal years or just one.38 And if one, would it be the year in which the foreign
enterprise started providing services or the year in which such services end. In the author’s view, in such a case where the provision of services overlaps two fiscal years and the time threshold exceeds 183 days in total, the wording of the provision should be interpreted so as to constitute a PE in both fiscal years.39
This interpretation is likely to strengthen the source taxation of services. However, such an interpretation may create an imbalance in the allocation of taxing rights between states and may eventually discourage cross-border investment and trade. But some states, in order to avoid any potential misinterpretation, have implemented the said rule with certain modification. For instance, the India-US tax treaty provides that in case of overlap of services between two fiscal years, a PE shall not be deemed to exist in the fiscal year in which the services are provided for an aggregate period of less than 30 days.
Another issue that arises is determining the relevant days that the services is provided by the foreign enterprise. First question in this issue is whether the 183-days threshold is applicable for a single
36 UN Model Commentary 2017, Art. 5, para. 12 37 UN Model Commentary 2017, Art. 5, para. 9
38 Bijal Desai, International Taxation – A Compendium, p. I-693
