What is Permanent Establishment?
Permanent establishment is a key concept used in international tax law to determine the level of business activity that triggers tax in a foreign jurisdiction. The definition varies from jurisdiction to jurisdiction, but the OECD Model Tax Convention (OECD) provides a standard definition which is widely adopted in double taxation treaties.
Additionally, it is worth noting that not all jurisdictions use permanent establishment e.g. Hong Kong uses the Operations Test, and in other jurisdictions, simply earning royalties from that jurisdiction, could trigger tax.
Key Triggers for Permanent Establishment
Permanent establishment typically arises if:
- there’s a fixed (stable and ongoing presence) place of business, e.g. a factory, office, workshop, mine or well.
- there are dependent agents i.e. where individuals or entities habitually conclude contracts on behalf of the business, within the host jurisdiction, or have authority to do so.
- the duration of business activities (e.g. construction), exceeds a threshold duration, often 6-12 months.
Exclusions from Permanent Establishment
Exclusions ensure that minor activities don’t trigger permanent establishment and unnecessary tax.
An example of an exclusion, is activities of a preparatory or auxiliary nature, that aren’t the core revenue-generating operations of the business’s e.g.:
- using facilities solely for storing or displaying goods;
- maintaining stock for processing by another business; and
- purchasing goods or collecting information.
Tax Consequences of Permanent Establishment
If a foreign business has a permanent establishment in a jurisdiction:
- the income attributable to that permanent establishment becomes taxable in the host jurisdiction.
- the business may need to comply with domestic tax reporting (tax returns) and payment obligations.
Note that tax treaties may provide rules on profit attribution and methods to avoid double taxation.
The UK
In the UK, the domestic definition of permanent establishment is found in Section 1141 of the Corporation Tax Act 2010 and follows OECD principles.
Additionally, permanent establishment is used in tax treaties to determine whether foreign businesses are liable for UK corporation tax on the profits derived from UK activities.
Tax Treaties
Permanent establishment is often used in tax treaties. For example, the tax treaty between Canada and the U.S.A. overrides domestic rules and states that, if a business is resident in one of those jurisdictions but not the other, then it’s only taxable in the other jurisdiction to the extent it has a permanent establishment there.
There are, however, a few problems with tax treaties, including:
- while some jurisdictions have many tax treaties (e.g. U.S.A. has 50), most jurisdictions don’t have any, so the tax landscape remains complicated.
- a jurisdiction may not have domestic permanent establishment rules (or the treaty may not overrule domestic rules), e.g. under a tax treaty, the situation may constitute permanent establishment, but domestic rules may not be triggered – meaning the business won’t be taxed.
Conclusion
Permanent establishment is a cornerstone of international tax law, balancing the rights of host and foreign jurisdictions. Navigating the complexities of permanent establishment is crucial for global businesses to maintain compliance and optimise tax planning.
Next steps
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