A Dummy’s Guide to Permanent Establishment

The Concept of Permanent Establishment

The concept of permanent establishment is found in the early model conventions including the 1928 model conventions of the League of Nations. The modern conventions of United Nations and OECD reaffirms the concept. The concept of “permanent establishment” is used in tax treaties to determine the right of a State to tax the profits of an enterprise of the other State. Specifically, the profits of an enterprise of one State are taxable in the other State only if the enterprise maintains a permanent establishment in the latter State and only to the extent that the profits are attributable to the permanent establishment. A permanent establishment (PE) is a fixed place of business that generally gives rise to income or value-added tax liability in a particular jurisdiction. The concept of PE emerged in the German Empire after 1845, culminating with the German Double Taxation Act of 1909. Initially, the objective was to prevent double taxation between Prussian municipalities, and this was extended to the entire German federation. In 1889, the first bilateral tax treaty, including the concept of PE, was concluded between the Austro-Hungarian Empire and Prussia, marking the first time the concept was used in international tax law.First tax treaty of 1899 After years of preparatory works, in 1928, the League of Nations developed a model to tackle cross-border double taxation and to counter tax evasion. Since then, an extensive network of bilateral tax treaties was gradually established, particularly through the influence of the OECD Model Tax Convention, where this concept persisted.

Now what constitutes a “permanent establishment” and what constitutes “profit attributable to a permanent establishment” is the topic that will melt the brains from our pretty head.

Why Permanent Establishment?

Let’s say a foreign enterprise wants to operate their business in another state. How would they do it? They may have these ways among many others:
1. Establish a legal entity in another state and carry out the business operations
2. Supply the services / goods to the customers in another state through deployment of employees or other dependent personnel in that state
3. Setting up a main equipment / machinery in another state for business activity

Looking at the options above, a foreign enterprise could operate in multiple ways in another state. The tax consideration could be different in the above arrangements in absence of the concept of Permanent Establishment concept. A legal entity established in another company would be taxable but an entity with same functions and objective working through a agent, employee or through its establishment other than actual set up of a legal entity. Why should there be tax consequences when the enterprise operates through a legally recognized taxable entity in another place but not when through other alternative arrangement which essentially constitutes the same business? This being the main reason for the concept of permanent establishment.

The Consequence of having a PE in another Tax Jurisdiction

Naturally the transaction between associated enterprises should be made at a price determined under arm’s length principle. This is generally the minimum rule prescribed by the domestic tax laws of any country.

Not all establishment of a foreign enterprise in another tax jurisdiction qualifies for being a permanent establishment. Even then, these establishments and foreign enterprises are associated enterprises and transfer pricing guidelines applies to them. Its application will however be limited to the extent of determining the reasonableness of the value and substance of transaction being made between an enterprise and its foreign establishment.

The real burden of having a PE in another tax jurisdiction is that the operation in the foreign establishment will be viewed as an distinct operational segment of the enterprise and the transfer pricing guideline will be applied to reasonably determine the revenues and expenses attributable to that unit. Such profits attributed to the establishment will be subject to taxation in the particular tax jurisdiction where the establishment is located. A permanent establishment (PE) also generally gives rise to income or value-added tax liability in a particular jurisdiction.

Why operate as a PE?

When entering a country, companies often structure their investment using a PE rather than incorporating a subsidiary. The main reason is generally based on non-fiscal motivations as a PE provides more flexible commercial features than subsidiaries. As a general rule, a PE can be easier to set up and close down, making this structure more convenient for companies that frequently enter into new countries lacking full knowledge of and experience in their markets. If the investment turns out to be unsuccessful (e.g. when there is no commercial viability or findings or marketability during the preparatory/exploratory phase), the companies needs to smoothly withdraw from the block or contract area, sometimes leading to de-registering the branch.

Benefits of Managing PE Risk

What are the benefits of getting this right? Pro-actively managing PE risk can provide the following:
• comfort on a potentially high-profile area of challenge;
• reduce the risk of unexpected tax payments by minimising the risk of errors, including penalties and interest charges;
• identification of opportunities for tax efficiencies and/or improvements to the internal control framework; and
• the ability to make appropriate disclosures to tax authorities showing that reasonable care has been taken to manage PE issues, reducing the risk of challenge and penalties.

Harms of not Managing PE Risk

What happens if a PE is not managed correctly? A PE risk that is not correctly managed can result in:
• damage to reputation;
• unfunded and corporate tax liabilities;
• potential indirect tax cost in a territory if appropriate VAT registrations have not been made;
• increased audits from tax authorities resulting in increased management time and cost being incurred;
• penalties and interest charges;
• long unprovided for issues can lead to the requirement to restate financial accounts;
• employer reporting obligations, including payroll and social security;
• immigration considerations for employees; and
• regulatory issues (for certain industries).

The Meaning of Business

Economic Definition

Shall we dare to interpret this? If yes, how? What is business? Where is the place of business? Let’s take the most generic definition of “business” and “place of business” from lawinsider.

“Business” refers to the organized efforts to pursue an economic activity. Here, two key concepts arise “organized efforts” and “economic activity”. “Place of business” means the place of a non-transitory establishment to pursue business. In this context the concept of organized efforts in a business activity refers to: (i) Economic Activity constituting earning of revenues, (ii) Production/purchase and Sales of goods and services, (iii) Continuity and regularity and (iv) Risks and uncertainty.

Economic activity are the activities that constitutes earning of revenues. The meaning of Activity for tax purpose should mean an economic activity. Any economic activity is indicated by Land/Resource Decisions, Labor Decisions, Entrepreneurship Decisions and Capital Decisions aimed in earning revenues. In perspective of taxation: employment, investing and business activity are all economic activity because each of these activity in some form constitutes some form of or combination of Land/Resource Decisions, Labor Decisions, Entrepreneurship Decisions and Capital Decisions.

But what really distinguishes business activity from investing and employment activity are:
1. Business activity constitutes all Land/Resource Decisions, Labor Decisions, Entrepreneurship Decisions and Capital Decisions
2. Business activity includes production/purchase and Sales of goods and services
3. Business activity is characterized by Continuity and regularity
4. Business activity involves risks and uncertainty

Definition from commentary from The Commonwealth of Symmetrica

The slice-by-slice approach adopted in the Symmetrica means that income is calculated separately for each activity of a person that constitutes an employment, business, or investment. It is, therefore, necessary to determine the character of a person’s activities in order to determine whether they are of these types.

“Employment” is the dominant definition and whether an employment exists is primarily determined according to general law. Employment is typically an earning activity consisting predominantly of the provision of labor by an individual.

“Business” is defined broadly to include trades, professions, vocations, and arrangements with a business character. In this way, the term is used throughout the Sample as a shorthand reference to these types of activities. If a business activity may also be characterized as employment, primacy is given to the characterization as employment. However, unlike employment, business is an earning activity typically consisting not only of the provision of labor but of the combined provision of assets, labor and capital.

“Investment” is used as the residual manner in which income may be derived and “income from an investment” is the residual category of income. In contrast to employment and business, investment is typically an earning activity consisting predominantly of the provision of capital.

Commentary from UN and OECD

The Convention does not contain an exhaustive definition of the term “business”, which, should generally have the meaning which it has under the domestic law of the State that applies the Convention.

The question whether an activity is performed within an enterprise or is deemed to constitute in itself an enterprise has always been interpreted according to the provisions of the domestic laws of the Contracting States. No exhaustive definition of the term “enterprise” has therefore been attempted in the commentaries or Model DTAAs. However, it is provided that the term “enterprise” applies to the carrying on of any business. Since the term “business” is expressly defined to include the performance of professional services and of other activities of an independent character, this clarifies that the performance of professional services or other activities of an independent character must be considered to constitute an enterprise, regardless of the meaning of that term under domestic law. States which consider that such clarification is unnecessary are free to omit the definition of the term “enterprise” from their bilateral conventions.

The FAR Test

The authoritative statement of the arm’s length principle found in OECD Model Tax Convention which states as follows- “Where conditions are made or imposed between the two associated enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.”

Such differential amount whatever that is accrued or deemed to accrue by the reason of that establishment is determined through the “arm’s length principle” following the FAR test.

By seeking to adjust profits, the arm’s length principle follows the approach of treating the members of an MNE group as operating as separate entities. Because the separate entity approach treats the members of an MNE group as if they were independent entities, attention is focused on the nature of the transactions between those members and on whether the conditions thereof differ from the conditions that would be obtained in comparable uncontrolled transactions. Such an analysis of the controlled and uncontrolled transactions, which is referred to as a “comparability analysis”, is at the heart of the application of the arm’s length principle.

Tax authorities and taxpayers often have difficulty in obtaining adequate information to apply the arm’s length principle. Because the arm’s length principle usually requires taxpayers and tax administrations to evaluate uncontrolled transactions and the business activities of independent enterprises, and to compare these with the transactions and activities of associated enterprises, it can demand a substantial amount of data. The information that is accessible may be incomplete and difficult to interpret. In addition, it may not be possible to obtain information from independent enterprises because of confidentiality concerns.

Analysis of transactions and functions

Functional analysis is an understanding of the related party transactions, business operations, functions performed, assets employed and risks assumed to determine the characterization of the taxpayer’s business.

Details of Functions performed, Assets Employed and Risks Assumed (FAR)

A functional analysis is a crucial process in determining an arm’s length price as it forms the basis for identifying comparable. It involves the determination of how functions, assets (including intangible property) and risks in a business are divided up between parties involved in the transactions under review. Thus, a functional analysis serves three important purposes:
i. to provide an overview of the organization and its business operations;
ii. to identify the functions performed, risks assumed and assets employed by both the associated and independent persons, and
iii. to assess important and economically significant functions, risks and assets undertaken by both the associated and independent persons.

Functions Performed (F)

Functions are activities performed by each person in business transactions such as procurement, marketing, distribution and sales. The principal functions performed by the associated person under examination should be identified first. Any increase in economically significant functions performed should be compensated by an increase in profitability of the person.

Usually, when various functions are performed by a group of independent persons, the party that provides the most effort and, more particularly, the rare or unique functions would earn the most profit. For example, a distributor performing additional marketing and advertising function is expected to have a higher return from the activity than if it did not undertake these functions.

It is thus relevant to consider the relative importance of each function in a functional analysis. The sheer number of functions performed by a particular member of a multinational group does not necessarily mean that it should derive the greater share of the profit. A party performing the most, or more, economically significant functions of the group’s operations, albeit fewer functions relative to the other associated person, should be entitled to the greater share of the profit.

Assets Employed (A)

In comparing functions performed, it is also important to identify and consider the assets (tangible and intangible) that are employed, or are to be employed, in a transaction. This includes the analysis of the type of assets used (e.g. plant and equipment and valuable intangibles) and the nature of the assets used (e.g. the age, market value, location, and property right protections available).
i. Tangible assets employed: Tangible assets such as property, plant and equipment are usually expected to earn long-term returns that commensurate with the business risks assumed. Profitability of a company should rightfully increase with the increase in the amount, as well as the degree, of specificity of assets employed. Quantifying these amounts whenever possible helps to determine the level of risks borne and the level of profit a company should expect.
ii. Intangible assets employed: Intangible assets are also expected to generate returns for the owners by way of sales or licensing. It is thus essential to identify the parties to whom the returns generated are attributable.

Risks Assumed (R)

Evaluation of risks assumed is crucial in determining arm’s length prices with the economic assumption that the higher the risks assumed, the higher the expected return. Controlled and uncontrolled transactions are not comparable if there are significant differences in the risks assumed, for which appropriate adjustments cannot be made.

Types of risks:
i. Operational risk (including risks for manufacturing liability, systems failure, reliability of suppliers, inventory and carrying costs, environmental and other regulatory risks);
ii. Market risk (including industrial risks, country political risks, reliability of customers and fluctuation in demand and prices);
iii. Product risk (including product liability risk, warranty risk / costs and contract enforceability);
iv. Business risks related to ownership of assets or facilities;
v. Financial risk (including currency, commodity, interest rate and funding risks);
vi. Credit and debt collection risks (including delay or default in payment of trade receivables, default on guaranties, loans and other receivables); and
vii. Risks of the success or failure of investments in research and development.

Allocation of risks
The allocation of risks between associated persons should be based on functions performed. A functional analysis helps identify important risks, as well as differentiate between the party which bears and controls the risks in the legal contractual terms and the party which bears the risks based on the economic substance of the transaction.
In an open market the assumption is that, an increased risk will be compensated by an increase in the expected return. However, this does not always mean that the actual return must necessarily also be higher, as it also depends on the degree to which the risk is actually realized.

Consistency of risk allocation with economic substance
Allocation of risks must also be consistent with the economic substance of a transaction. The best evidence, in determining whether a purported allocation of risks is consistent with the economic substance of a transaction, is in the parties’ conduct.
An additional factor to consider in examining the economic substance of a purported risk allocation is the consequence of such an allocation in an arm’s length transaction. In an arm’s length dealing, it generally makes more commercial sense for one party to be allocated a greater share of those risks over which they have relatively more control and from which they can insulate themselves less costly than the other party.

Characterization of business
Characterization is an important element in the steps towards determining the arm’s length price of a controlled transaction. The most common characterizations, based on the nature of activity as well as the complexity of the operations, are:
i. Manufacturing
ii. Distribution
iii. Service provider

Identification of comparable transactions

In order to determine the arm’s length price, it is important to determine the basis of the comparability. The basis of comparability may be as follow:
i. To compare a single transaction (e.g. the sale price and terms of sale of particular product);
ii. To compare a bundle of transactions;
iii. To compare results at gross margin level;
iv. To compare results at net margin level; or
v. To compare results by reference to some other measures, such as return on capital, ratio of costs to gross margin, etc.
The selection of comparable transaction depends on the method of transfer pricing as illustrated below in the respective section.

Selection of Tested Party

The tested party will be the participant in the controlled transaction whose profitability/pricing attributable to the controlled transactions can be verified based on the most appropriate data and requiring the fewest and most reasonable adjustments, and for which reliable data regarding uncontrolled comparable can be located.

Selection of Profit Level Indicator

Profit level Indicators (PLIs) are ratios that measure relationships between profits and costs incurred or resources employed. A variety of PLIs can be calculated in any given case. PLI ensures greater accuracy in determining the arm’s length transaction. PLI is presented in the form of ratio i.e. financial ratios. Selection of appropriate depends upon the several factors including, but not limited to, following:
i. Characterization of the business;
ii. Availability of reliable comparable data; and
iii. The extent to which the PLI is likely to produce a reliable measure of arm’s length profit.
The various PLIs that could be used include Return on Asset (ROA), Return on Capital Employed (ROCE), Operating margin, Return on Total Cost, Return on Cost of Goods Sold, etc.

Identifying and quantifying the differences between the controlled and uncontrolled transactions

Factoring in the difference between the controlled and uncontrolled transaction to determine the arm’s length price.

The threshold for being a “business” for the purpose of PE is pretty low

Continuity of business: Isolated events should not constitute a business connection and the foreign company should be able to demonstrate continuity of its business activities in a State.

Business activities: There should be a real and intimate connection between the business activities of the foreign company and its activities in Nepal, including business activities such as back office operations and support services, which do not generally constitute a PE in the country.

Also, Indian judiciary has also observed that where no business operations are undertaken in India, business connection is not established in the country. Asia Satellite … vs Director Of Income Tax on 31 January, 2011 which held that in order to constitute a business connection, the test to be applied was that there must be an activity of the non-resident in India having an intimate relationship of a business character with the business of the non-resident which contributes to the earning of the profit by the non-resident in his business. The Tribunal took the view that business is carried on at a place where some activity capable of producing income is carried on.

स्थायी संस्थापन निर्धारणका आधारहरु

आयकर कानून अनुसार कर व्यक्तिलाई लाग्दछ। व्यक्तिको परिभाषाभित्र कम्पनी, फर्म जस्ता निकाय पनि पर्दछन् । कुनै गैर बासिन्दा निकायको नेपालमा कुनै व्यावसायिक क्रियाकलाप भएमा कर लगाउँदा पूरै व्यक्ति (Whole Entity) को रूपमा आय गणना गर्दा आइपर्ने प्रशासनिक झण्झटलाई कम गरी कर निर्धारण प्रक्रियालाई सरलीकृत गर्न स्थायी संस्थापन (Permanent Establishment, PE) को अवधारणा महत्वपूर्ण हुन्छ । गैर बासिन्दा व्यक्तिले नेपालमा गर्ने कारोबारहरूको सम्बन्धमा कस्तो प्रकृतिका व्यवसायहरू स्थायी संस्थापन हुने र यिनीहरूको निर्धारण कसरी गर्ने भन्ने सम्बन्धमा देहायका विषयहरूलाई आधार लिनुपर्दछ।

क. आपूर्तिको कार्यले मात्र स्थायी संस्थापन सिर्जना नहुने

आपूर्ति (Supply) र व्यवसाय (Business) दुवै कुरा व्यावसायिक कार्य नै भए तापनि कर प्रयोजनमा फरक व्यवहार हुन्छ। आपूर्तिका कारण गैर बासिन्दा निकायको नेपालमा व्यावसायिक कार्य हदैमा स्थायी संस्थापन सिर्जना हुँदैन। आयकर कानूनमा कस्तो अवस्थामा त्यस्ता व्यावसायिक कार्यहरू व्यवसाय (Business) हुन्छन् भन्ने आधारमा स्थायी संस्थापन सिर्जना हुने अवस्था तोकिएको हुन्छ।

ख. प्राकृतिक व्यक्ति स्थायी संस्थापन नहुने

आयकर कानूनले प्राकृतिक व्यक्ति (Individuals) र निकाय (Entity) दुई थरिका व्यक्तिको व्यवस्था गरेको छ । स्थायी संस्थापन निकायको समूहमा पर्दछ, प्राकृतिक व्यक्तिमा पर्देन। प्राकृतिक व्यक्तिको नेपाल स्रोतको आय भएमा सोही प्राकृतिक व्यक्तिलाई कर लाग्ने हुनाले स्थायी संस्थापन हुँदैन ।

ग. स्थायी संस्थापन हुन गैर बासिन्दा निकायको नेपालमा संस्थापन नै हुनुपर्ने

स्थायी संस्थापन हुन गैर बासिन्दा निकायको नेपालमा रहेको संस्थापन (Establishment) नै हुनु पर्दछ । त्यसकारण विदेशमा दर्ता भएका कम्पनी, साझेदारी, सिमित साझेदारी, सरकारी निकाय, विश्वविद्यालय, सामुहिक कोष (युनिट ट्रस्ट), पारिवारिक समूह वा जुनसुकै खालका संस्थागत निकाय (Corporate Body) को नेपालमा स्थायी संस्थापन हुन्छ।

घ. बिदेशमा दर्ता नभएका संरचनाको नेपालमा व्यवस्थापन भए तापनि स्थायी संस्थापन नहुने

विदेशी व्यक्तिहरूबाट संस्थागत भए तापनि विदेशमा दर्ता नभएका संरचना (Unregistered body of individuals) को नेपालमा व्यवस्थापन भएमा भने त्यो संरचना स्थायी संस्थापन नभएर आयकर कानून अनुसारको कम्पनी सरहको निकाय हुन्छ।

ङ. गैर बासिन्दा निकायको व्यवसाय र त्यस्तो व्यवसायको सञ्चालन अनिवार्य हुने

स्थायी संस्थापन हुनका लागि गैर बासिन्दा निकायको व्यवसाय र त्यस्तो व्यवसायको सञ्चालन अनिवार्य हुन्छ। व्यवसायको परिभाषाका सम्बन्धमा आयकर ऐन, २०५८ को दफा २ को खण्ड (कज) मा देहायको व्यवस्था गरिएको छ:

व्यवसायको प्रकृति र स्थायी संस्थापन

व्यवसायमा उद्योग (Conversion of goods), व्यापार (Trading of goods ) र पेशा (Rendering services) गरी तीन थरी विषय समावेश हुन्छन् । उद्योग, व्यापार वा पेशासँग सम्बन्धित तयारीजन्य (Preparatory and Auxiliary) कार्यहरू मात्रै व्यवसाय हुँदैनन् । आपूर्ति (Supply) मात्र हुनु पनि व्यवसाय हुँदैन। व्यवसाय (Business) मा कम्तीमा केही हदसम्मको निरन्तरता रहेको (Ongoing) वा सामान्य अवस्थाको कारोबार (Habitual) दुवै हुन सक्दछ। तर कुनै सामान आयातकर्ताको कार्यालयमा आएर गरिदिने जडान वा सञ्चालन गर्न दिइने तालिम जस्ता एक पटक हुने कारोबार (One time service) वा कसैको सामानको कहिलेकाँही हुने मर्मत (Occasional repair service) यस प्रयोजनका लागि निरन्तरता रहेको व्यवसाय मानिदैन। अर्कोतिर मुख्य कार्यहरूमध्ये जडान नै एक प्रमुख काम भएमा वा परेका बखत मर्मत गरिदिने कार्य भने व्यवसायमा वर्गीकरण हुन्छ।

व्यवसायमा खरीद, रूपान्तरण र बिक्रि

व्यवसायको प्रकार अनुसार बेग्लाबेग्लै नामाकरण हुनसक्ने भए तापनि व्यवसाय (business) मा मुख्य रूपमा खरीद (Purchase), रूपान्तरण (Conversion) वा बिक्री (Sales) तीन अवस्था रहन्छन् ।
(१) खरीद (Purchase) मा स्थानीय खरीद वा आयात दुवै क्रियाकलाप पर्दछन्। खरीदमात्रै भएको रूपान्तर (Conversion) वा बिक्री (Sales) नभएको क्रियाकलाप व्यवसाय होइन ।
(२) रूपान्तरण (Conversion) भन्नाले सामानको स्वरूप परिवर्तन गर्ने कारखाना वा उद्योगलाई जनाउँछ। खरीद कार्य नेपालमा गरे वा नगरे पनि रूपान्तरणको कार्य (Manufacturing or Conversion) नेपालमा गरेमा त्यसको बिक्री नेपालभित्र गरे वा नगरेमा पनि वा आफैले उत्पादन गरी मूख्य कम्पनी वा कुनै सम्वद्ध निकायमा सो सामान हस्तान्तरण गरेमा वा उपयोग गरेमा त्यो व्यवसाय हुन्छ ।
(३) नेपालभित्र वा बाहिर जहाँसुकै गरिएको बिक्री (Sales) व्यवसाय देहायका कुनै पनि क्रियाकलाप पर्दछन्:
• उत्पादन गरिएका सामानको बिक्री (Sales of manufactured goods – sales from factory)
• खरीद गरिएका सामानको बिक्री (Trading of goods)
• उत्पादन गरिएका सामानको स्थानान्तरण (Transfer of manufactured goods)
• पेशागत सेवा बिक्री (Professional services)
• सेवा बिक्री (Sale of services)
(४) खरीद वा उत्पादन जहाँसुकै भए तापनि बिक्रीको कार्य नेपालमा भएमा त्यो व्यवसाय हुन्छ ।
(५) नेपाली आयातकर्तालाई बिक्री गरेकै आधारमा बिक्रीको कार्य नेपालमा भएको मानिदैन, त्यसैले त्यो नेपालको व्यवसाय हुँदैन।
(६) नेपालमै रहेको गोदाम वा नेपालभित्र अन्य व्यक्ति समक्ष राखिएको सामानको बिक्री वा नेपालमा खरीद गरेको सामान नेपाली आयातकर्तालाई नेपालमै उपलब्ध गराएमा त्यो नेपालमा गरिएको बिक्री कारोबार हो, नेपालमा सञ्चालित व्यवसाय हो ।

लगानी, रोजगारी वा विशेष व्यवसायको सन्दर्भमा स्थायी संस्थापन

(१) स्थायी संस्थापन हुनका लागि व्यवसाय अनिवार्य हुनु पर्छ। गैर बासिन्दा निकायको नेपालमा कुनै प्रकारको लगानी रहेको अवस्थामा सो लगानीकै आधारमा स्थायी संस्थापन सिर्जना हुनु हुँदैन।
• ऋण लगानी भएके आधारमा सो ऋणबाट प्राप्त ब्याजले स्थायी संस्थापन बनाउँदैन । तर, स्थायी संस्थापनको ब्याज आय भने स्थायी संस्थापनको व्यावसायिक आय हुन्छ ।
• सुरक्षण (Securities) वा स्थिर सम्पत्ति (Immovable Assets) मा गरिएको लगानी भएके आधारमा सो सुरक्षणबाट प्राप्त प्रतिफलले स्थायी संस्थापन बनाउँदैन। तर, स्थायी संस्थापनको प्रतिफल आय सोही स्थायी संस्थापनको व्यावसायिक आय हुन्छ ।
• ऋणपत्र, सुरक्षण (Securities) वा स्थिर सम्पत्ति (Immovable assets) बिक्रीको लाभका आधारले स्थायी संस्थापन बनाउँदैन। तर, स्थायी संस्थापनले पाएको लाभ आय सोही स्थायी संस्थापनको व्यावसायिक आय हुन्छ।
(२) स्थायी संस्थापन निकायको मात्र हुने हुनाले कुनै विदेशी प्राकृतिक व्यक्तिको रोजगारी वा व्यवसायले निजको नाममा कनै स्थायी संस्थापन सिर्जना हुँदैन।
(३) आयकर कानून वा नेपालपक्ष भएका कर सन्धिमा वेग्लै आधारमा कर लाग्ने व्यवस्था गरिएका व्यावसायिक क्रियाकलापका आधारमा स्थायी संस्थापन सिर्जना हुँदैन। त्यस्ता विशेष व्यवसायका मूल लगानी बिक्री हुँदा प्राप्त हुने लाभमा पनि कानून वा कर सन्धिमा भाएको व्यवस्था वमोजिम मात्र करारोपण हुन्छ ।
• आयकर ऐन, २०५८ को दफा ६७ र दफा ७० तथा कर सन्धिहरूका धारा ८ अनुसार अन्तर्राष्ट्रिय उडान गर्ने हवाइजहाजको उडान आय स्थायी संस्थापनको आय हुँदैन।
• आयकर ऐन, २०५८ को दफा ६७ र दफा ७० अनुसार नेपालमा स्थापित सञ्चार उपकरणले गरेको व्यावसायिक क्रियाकलापको आय स्थायी संस्थापनको आय हुँदैन। नेपालमा हुने रोमिङ्ग सेवामा नेपाली दूरसञ्चार सञ्चालककै उपकरण प्रयोग हुने हुनाले रोमिङ्ग सेवाका कारण पनि स्थायी संस्थापन सिर्जना हुँदैन।
• आयकर ऐन, २०५८ को दफा २ को उपदफा (कक) वा कर सन्धिहरूका धारा १२ बमोजिम रोयल्टी आय प्राप्त गरेकै आधारमा स्थायी संस्थापन सिर्जना हुँदैन। तर स्थायी संस्थापनले आर्जन गर्ने रोयल्टी आय भने सोही स्थायी संस्थापनको व्यवसायको आय हुन्छ।

The Meaning of Place of Business

Here we will discuss in line with the nature of cross-border transactions. Over time, two types of cross-border transactions have emerged:

Doing business with a country

This involves foreign companies being engaged in business transactions with the residents of a country, wherein these companies conduct their business activities without setting up a business presence in this country, for instance, selling products to its residents, but transferring the titles, risks and rewards outside the country. In such a situation, the taxation mechanisms of foreign companies are usually straightforward. Such foreign companies are not taxable in the country in which purchasers of their products are located, since they neither have an official presence in it nor do they undertake any business activities in it.

Doing business in a country

This situation envisages the presence of a company in a country that is not its country of residence. In this case, the company undertakes business activities in the foreign country by establishing its formal presence in it. The activities of such a company may be conducted by its employees or an agent, or from a fixed base through which it operates in the country. The taxation-related implications of these cross-border transactions are complex. The main questions that arise are two-fold:
(a) Which country has the right to tax the business profits earned by the foreign company through its formal presence in a country?
(b) If the country in which a foreign company has a formal presence has the right to tax the business profits earned by it by utilizing the country’s resources, how can the proportion of profits to be taxed be determined?
This is where the international tax concepts of PE and profit attribution come into play. These determine the right of a country to tax the profits of a company that is the resident of another country. They lay down the principles and factors to be considered for the constitution of a PE, and the consequent profit attribution methods and the taxation mechanisms it should use to avoid double taxation. The PE concept is recognized by most countries and has been incorporated by them in their domestic tax provisions and international tax treaties.

Structure of Definition of PE

Structure of Article 5

Structure of Model DTAA

Article 5(1) defines a permanent establishment and lays down the basic rule that a business activity carried on through a fixed place of business would constitute the PE of the tax payer. Article 5(2) mentions several examples of fixed place of business. These examples could also be said to form the ‘positive list’. Article 5(3) includes certain construction related activities and service related activities within the scope of PE if such activities continue for certain period. Article 5(4) mentions that a PE shall be deemed not to include certain activities. These could be said to form the ‘negative list’. Article 5(5) stipulates rules for determining when an enterprise represented by an agent would have a PE. Article 5(6) deals with the case of an enterprise carrying on insurance business. Article 5(7) and Article 5(8) set out rules in respect of an enterprises represented by an agent or an enterprises related to it.

The Fallback Issue

There can be debates on whether if the test for PEs other than Fixed Place PE is not satisfied, one should fall back to the Fixed Place PE or not? This is an interpretational issue but since the threshold for the test of Fixed Place PE is pretty higher than other forms of PE, this will not cause practical problem in most cases. Before discussing the forms of PE in detail it is necessary do discuss if the other forms of PEs (other than Fixed Place PE) provision is self standing or if one needs to check the provision of Fixed Place PE by resorting to the provision of Fixed Place PE? As we have understood the term PE generally means a fixed place of business through which the business of an enterprise is wholly or partly carried on. For a place to be a Fixed Place PE these tests should be satisfied:
(i) Disposal Test (ii) Permanence Test and (iii) Business Activity Test

However, not all forms of operations of foreign enterprise may fulfill all the three tests of being a Fixed Place PE but still may have an identifiable profit motive operation within a country that may not fall under definition of Fixed Place PE. There may be two views here:
1. Test a Project for other forms of PE and if it does not satisfy the those tests then fall back to Fixed Place PE for Fixed Place PE test
2. Test a Project for other forms of PE and if it does not satisfy those tests, then the operation doesn’t trigger a PE
This fallback issue has not been explored in detail in commentaries but in context of Project PE and Fixed Place PE, the following is inferred from commentaries from UN and OECD model DTAA:
The purpose of this provision (Project PE test) is to allow taxation of PE´s activities that do not last for an indefinite period of time. In this respect, a construction site is by definition not intended to be permanent. As per commentaries from UN Model DTAA, the traits of “Permanency Test” in context of a Project PE can be interpreted as follows:
1. Project PE includes activities that do not last for an indefinite period of time. A construction site is by definition not intended to be permanent.
2. While construction tasks usually have an undisputable location, certain works will not be performed at one specific place, because the site will be moved as the work proceeds (e.g. road construction or pipeline laying).

So a Project PE may not always fulfill the “Permanency Test” of a Fixed Place PE.
But to answer “Whether the provision of Project PE is self-standing or does one need to resort to the Fixed Place PE?”, we can view the following commentary committee UN Model DTAA: The Committee notes that there are differing views about whether paragraph for Project PE is a “self-standing” provision (so that no resort to paragraph for Fixed Place PE is required) or whether (in contrast) only building sites and the like that meet the criteria of paragraph for Fixed Place PE would constitute permanent establishments, subject to there being a specific six-month test. However, the Committee considers that where a building site exists for six months, it will in practice almost invariably also meet the requirements of paragraph for Fixed Place PE. In fact, an enterprise having a building site, etc., at its disposal, through which its activities are wholly or partly carried on will also meet the criteria of Fixed Place PE.
View One: Fallback may not be necessary as this idea is supported by the wording of “only” in the Model DTAA and the commentaries from UN Model and OECD Model DTAA and the anti-abuse provisions that were specifically introduced to precent the abuse of Duration Test.
View Two: Fallback may be necessary as the domestic laws may have different PE provisions that will bring interpretational issues, tax authorities will naturally look into testing all forms of permanent establishments based on the nature and functions of the business of the enterprise.
Conclusion: As we can observe even the expert committee of the OECD and UN have not been able to form a decisive view on fallback to the Fixed Place PE. There are clearly many interpretational issues in both view and basis for validity of both views.

OECD Model

India 1987

Norway 1996

Thailand 1998

Sri Lanka 1999

Mauritius 1999

Austria 2000

China 2001

Pakistan 2001

South Korea 2003

Qatar 2007

Bangladesh 2019

OECD Model

India 1987

Norway 1996

Thailand 1998

Sri Lanka 1999

Mauritius 1999

Austria 2000

China 2001

Pakistan 2001

South Korea 2003

Qatar 2007

Bangladesh 2019

Structure of ITA 2058

Section 2(aab): “Permanent establishment” means a place where any person carries on a business fully or partly, and the term includes the following place:
(1) A place where any person carries on a business fully or partly, through any agent except a general agent who acts independently in the ordinary course of carrying on business,
(2) A place where any person’s main equipment or main machinery is situated or used or installed,
(3) One or more than one place in any country where any person has delivered technical, professional or consultancy service through an employee or in any other manner for more than ninety days at one or several times in a period of any twelve months, or
(4) A place where any person is involved in a construction, installation or establishment project and has carried out supervisory works of that project for a period of ninety days or more.

This definition is structured in a way that the definition of the permanent establishment includes an “Agency PE”, “Equipment PE”, “Service PE” and “Construction PE” but even if these PE are not triggered the test needs to fall back to the definition of a “Fixed Place” PE. So test for every form of PE is essential. This is quite different that the concept of the permanent establishment provided in the Model DTAA.

Entity

Resident Person

Manager

Repatriated Income

Foreign Permanent Establishment

Permanent Establishment

Associated Person

Tax to be Levied

Computation and Rate of Tax

Foreign Permanent Establishments

Return of Estimated Tax to be Paid

Income Return

Entity Tax

Entity

Resident Person

Manager

Repatriated Income

Foreign Permanent Establishment

Permanent Establishment

Associated Person

Tax to be Levied

Computation and Rate of Tax

Foreign Permanent Establishments

Return of Estimated Tax to be Paid

Income Return

Entity Tax

There is one caveat to this. The definition of permanent establishment as per Income Tax Act of Nepal and Commonwealth of Symmetrica doesn’t mentioned the word “fixed”. The definition reads “permanent establishment means a place where a person carries on business” but doesn’t mention the word “fixed” and further goes on to indicate other situations where PEs may be triggered viz. Agency PE, Equipment PE, Service PE and Construction PE. This will certainly bring confusion when there is no distinction between the meaning of “place” in Fixed Place PE and say a Service PE. However, in PE Directive 2077, the word “place” has been used in the context of Fixed Place PE to mean a “fixed place” and in the context of other PEs to mean simpy a “place”.

Pictorial Definition

1. Fixed Place PE

The term PE generally means a fixed place of business through which the business of an enterprise is wholly or partly carried on. The definition includes the following essential characteristics of a Fixed Place PE:
(a) Existence of “place of business” at the disposal of the foreign company
(b) “Fixed” place of business
(c) “Business of the foreign company” “carried out” through the fixed place of business

The business of an enterprise is carried on mainly by the entrepreneur or persons who are in a paid-employment relationship with the enterprise (personnel). These personnel include employees and other persons receiving instructions from the enterprise (e.g. dependent agents). The powers of such personnel in its relationship with third parties are irrelevant. It makes no difference whether or not the dependent agent is authorized to conclude contracts if he works at the fixed place of business […]. But a permanent establishment may nevertheless exist if the business of the enterprise is carried on mainly through automatic equipment, the activities of the personnel being restricted to setting up, operating, controlling and maintaining such equipment. Whether or not gaming and vending machines and the like set up by an enterprise of a State in the other State constitute a permanent establishment thus depends on whether or not the enterprise carries on a business activity besides the initial setting up of the machines. A permanent establishment does not exist if the enterprise merely sets up the machines and then leases the machines to other enterprises. A permanent establishment may exist, however, if the enterprise which sets up the machines also operates and maintains them for its own account. This also applies if the machines are operated and maintained by an agent dependent on the enterprise.

A permanent establishment begins to exist as soon as the enterprise commences to carry on its business through a fixed place of business. This is the case once the enterprise prepares, at the place of business, the activity for which the place of business is to serve permanently. The period of time during which the fixed place of business itself is being set up by the enterprise should not be counted, provided that this activity differs substantially from the activity for which the place of business is to serve permanently. The permanent establishment ceases to exist with the disposal of the fixed place of business or with the cessation of any activity through it, that is when all acts and measures connected with the former activities of the permanent establishment are terminated (winding up current business transactions, maintenance and repair of facilities). A temporary interruption of operations, however, cannot be regarded as a closure. If the fixed place of business is leased to another enterprise, it will normally only serve the activities of that enterprise instead of the lessors; in general, the lessors permanent establishment ceases to exist, except where he continues carrying on a business activity of his own through the fixed place of business.

In general, an fixed place PE would be:
• a physical location;
• fixed in position;
• of more than a temporary nature;
• at the disposal of an enterprise; and
• where the enterprise’s business is wholly or partly carried on.
– the existence of a “place of business”, i.e., a facility such as premises or, in certain instances, machinery or equipment;
– this place of business must be “fixed”, i.e., it must be established at a distinct place with a certain degree of permanence; and
– the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons (personnel) not “independent” of the enterprise conduct business in the State in which the fixed place is situated.

1.1. Disposal Test

Disposal test is the test for existence of “place of business” at the “disposal” of the foreign enterprise. The key words here are “place of business” at the “disposal”. The disposal test involves a two-fold analysis:

Existence of “place of business” [An Objective Test]
Place of business is at the “disposal” of the foreign enterprise [A Subjective Test]

1.1.1. Existence of “place of business” [An Objective Test]

Meaning of “place of business”: A ‘place of business’ is any premise, facility, machinery, etc., used by a foreign company to conduct its business in Nepal. The existence of a “place of business”, i.e. a facility such as premises or, in certain instances, machinery or equipment;

Normally, a place of business would postulate not merely a place but a place together with physical objects, which would be required to carry on business activity. It may be noted that a place of business could exist even if no employees are employed there. Illustratively, any equipment (such as, vending machines, telephone exchange, pipeline etc.) which is installed and which can function without the presence of any employee could constitute a PE provided the other conditions for a PE that are mentioned in Article 5(1) are satisfied. The place of management, though considered a PE, requires existence of an office or similar facility in order to constitute a PE and the management activities should be conducted through such fixed place. In other words, to constitute a PE, the existence of physical presence is must.

The term “place of business” covers any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose. A place of business may also exist where no premises are available or required for carrying on the business of the enterprise and it simply has a certain amount of space at its disposal.

It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise. A place of business may thus be constituted by a pitch in a marketplace, or by a certain permanently used area in a customs depot (e.g. for the storage of dutiable goods). Again, the place of business may be situated in the business facilities of 146 Article 5 Commentary another enterprise. This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise.

As noted above, the mere fact that an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business. No formal legal right to use that place is therefore required. Thus, for instance, a permanent establishment could exist where an enterprise illegally occupied a certain location where it carried on its business.

Whilst no formal legal right to use a particular place is required for that place to constitute a permanent establishment, the mere presence of an enterprise at a particular location does not necessarily mean that that location is at the disposal of that enterprise. These principles are illustrated by the following examples where representatives of one enterprise are present on the premises of another enterprise.

Example	Existence of Place of Business?
A first example is that of a salesman who regularly visits a major customer to take orders and meets the purchasing director in his office to do so.	In that case, the customer’s premises are not at the disposal of the enterprise for which the salesman is working and therefore do not constitute a fixed place of business through which the business of that enterprise is carried on (depending on the circumstances, however, paragraph 5 could apply to deem a permanent establishment to exist).
A second example is that of an employee of a company who, for a long period of time, is allowed to use an office in the headquarters of another company (e.g. a newly acquired subsidiary) in order to ensure that the latter company complies with its obligations under contracts concluded with the former company.	In that case, the employee is carrying on activities related to the business of the former company and the office that is at his disposal at the headquarters of the other company will constitute a permanent establishment of his employer, provided that the office is at his disposal for a sufficiently long period of time so as to constitute a “fixed place of business” and that the activities that are performed there go beyond the activities referred to in paragraph 4 of the Article.
A third example is that of a road transportation enterprise which would use a delivery dock at a customer’s warehouse every day for a number of years for the purpose of delivering goods purchased by that customer.	In that case, the presence of the road transportation enterprise at the delivery dock would be so limited that that enterprise could not consider that place as being at its disposal so as to constitute a permanent establishment of that enterprise.
A fourth example is that of a painter who, for two years, spends three days a week in the large office building of its main client.	In that case, the presence of the painter in that office building where he is performing the most important functions of his business (i.e. painting) constitute a permanent establishment of that painter.

1.1.2. Place of business is at the “disposal” of the foreign enterprise [A Subjective Test]

Meaning of “disposal” / Right to use the “place of business”: It is essential that the foreign company has the ‘right to use’ such a place of business, i.e., it should be at the disposal of the foreign company of one state to constitute a fixed place PE in other state.

The normal rule is that the place of business should be that of the non-resident enterprise and not of any one else. The requirement is that the place of business should be at the disposal of the enterprise. As a corollary, what is material is the right to use the place and not the manner in which such right has been secured; i.e., whether the place is owned, rented or otherwise at the disposal of the enterprise. The right to use could be legal right to use and factual right to use. The enterprise should have the premises or facilities at its disposal. This implies that the place should be available to the enterprises for carrying on its business without any hindrance. e.g. A chartered accountant or Advocate were to use the facilities of his client, it would be doubtful whether he could be considered to have the place at its disposal and consequently, it is not likely to be considered as his PE. It may be noted that mere user of a place of business would not be sufficient to constitute that place as a PE since there would not be a legal right. However, if the chartered accountant or advocate has entered into an arrangement with the client whereby the chartered accountant or advocate would handle the assignment from a particular place in the client’s premises, such place may be considered to be at its disposal and consequently, it may be considered to have PE. This may be so even if the assignment being handled is of that particular client. Similarly, a person who carries on business from a room in the house or a hotel where he is staying, may also be considered to have PE notwithstanding that there may not be a specific agreement between him and the landlord or the hotel to use the house or the hotel room for business, or that such user is contractually or legally prohibited.

Illustrations for “disposal test”

Situation	Is the disposal test satisfied?
1. A salesman regularly visits a major customer to take orders and meets the purchase director in his office:	Answer: Disposal test is not satisfied, since the customer’s premises are not at the disposal of the enterprise.
2. An employee of a company is allowed to use an office in the headquarters of another company for a prolonged period of time to ensure that the latter complies with its obligations under contracts concluded with the former.	Answer: Disposal test is satisfied, since the employee is carrying on activities related to the business of the former company from the office of the latter.
3. A road transportation company uses the delivery dock at a customer’s warehouse every day for a number of years to deliver goods purchased by the latter.	Answer: Disposal test is satisfied, since the company’s use of the delivery dock is limited to delivery of goods to customers and it cannot use the delivery dock for any other purpose.
4. A painter has been spending three days a week in the large office building of its main client for two years.	Answer: Disposal test is satisfied, since he is undertaking the main functions of his business from the office building.

In sync with international tax commentaries, that for a place of business in one State to be at the disposal of a foreign company in another state, it is essential for such a company to have a certain degree of control over the premise or space in the first mentioned state, so that it has unrestricted access to it and can use it, based on its requirements, to undertake its business activities in first mentioned state.

The OECD’s interpretation of Article 5 sheds light on the ambiguities of PE determination related to a fixed place. The interpretation includes a long section, for example, on whether an individual’s home office might constitute a PE for the individual’s employer. The passage emphasizes that such determinations “will depend on the facts and circumstance of each case.” In some cases, the business activities at the home office “will be so intermittent or incidental that the home will not be considered to be a location at the disposal of the enterprise,” and therefore won’t trigger a PE. In other cases, the home office will be “used on a regular and continuous basis for carrying on business activities for an enterprise,” and a PE may be deemed to exist. The lack of explicit thresholds, then, makes PE determinations fraught with risks for those unfamiliar with related domestic and international laws and guidance. Again, there is almost always room for interpretation. For example, companies that wish to mitigate their PE risk in a country by setting up a home office in lieu of a traditional office may run afoul of local authorities if those authorities deem the home office to be a fixed place of business that constitutes a PE. These shades of gray extend to countless other scenarios — for example to a company’s use of a customer’s premises or to a company performing activities in a country on a recurrent if relatively short-term basis. In such cases a company runs the risk of having to pay several years of historic corporate income taxes (on income that has already been taxed in the home country), along with penalties and interest.

Relevant Case Laws

(i) Formula One World Championship Ltd
(ii) E-Funds IT Solution
(iii) Adobe Systems Incorporated
(iv) Airlines Rotables Ltd
(v) Motorola Inc
(vi) Rolls Royce Plc
(vii) GE Energy Parts Inc
(viii) Esch Case
(ix) Production Resource Group

1.2. Permanence Test

The place of business must be “fixed”, i.e., it must be established at a distinct place with a certain degree of permanence. The permanence test involves a two-fold analysis:

Place of business is specific to geographic location [An Objective Test]
Permanency of the place of business [A Subjective Test]

1.2.1. Place of business is specific to geographic location [An Objective Test]

According to the definition, the place of business has to be a “fixed” one. Thus, in the normal way there has to be a link between the place of business and a specific geographical point. It is immaterial how long an enterprise of a Contracting State operates in the other Contracting State if it does not do so at a distinct place, but this does not mean that the equipment constituting the place of business has to be actually fixed to the soil on which it stands. It is enough that the equipment remains on a particular site (but see paragraph 20 below).

The mere fact that an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business. The place of business, however, has to be a “fixed” one. Thus, following the Commentaries to the UN Model Convention, there has to be a link between the place of business and a specific geographical point. However, no physical attachment to the soil is necessary, something that may be pertinent for assets that can be regarded connected to a certain site, as may be the case for drilling-rigs.

On the place of business, the enterprise must participate in the economic life and it should not limit the use of the place to that of a mere storage area. In each case, the Administrative Court of Appeal has concluded that the participation in the economic life requires that at least part of the activities is actually carried out in such place. The actual commercial or industrial activity must thus be geographically linked to that place. In this case therefore, it could be said that the court required part of the activity, although in our opinion not necessarily a core activity, to take place at this precise location.

The “location test” has its roots in the ‘base theory’, which requires a fairly fixed place of business in the other country. It should be linked to a specific geographical point in the Source State. Location test would exclude place of business that are mobile. At the same time, however, it would not exclude a movable place of business. Thus, a petroleum drilling rig may constitute a PE even if it is moved rather frequently from one location to another.

1.2.2. Permanency of the place of business [A Subjective Test]

Permanence Test is the test if the place constitutes a “Fixed place of business”. It is essential that there is a certain degree of permanence in relation to the business activities of a foreign company in the state, i.e., a fixed place PE in India should not be temporary or transitory in nature.

In case of permanence test, the place of business should have a certain degree of permanence. A place, which is purely of a temporary nature, would not constitute a PE. However, if the intention at the time when the place of business was set up for a fairly long time, it could constitute PE even if the activities terminated after a short period of time. The term “permanence” should be understood as continuing for an indefinite period and not something that would continue or last forever. In other words, it is not necessary that the right to use the place of business should be perpetual. While there is no specific time period that would bring in ‘permanence’, in several countries, even a period of six months may be sufficient to constitute a PE.

In a landmark decision i.e. CIT Vs. Vishakhapatnam Port Trust [(1983), 144-ITR-146 (AP)] on the subject of “Permanent Establishment”, the Andhra Pradesh High Court has observed as under: “The words “Permanent Establishment” postulate the existence of a substantial element of an enduring or permanent nature of a foreign enterprise in another, which can be attributed to a fixed place of business in that country. It should be of such a nature that it would amount to a virtual projection of the foreign enterprise of one country onto the soil of another country.” The UN Model not only re-affirms the concept but also supplements it with the new concept of a “fixed base”, to be used in the case of professional services or other activities of an independent character.

Since the place of business must be fixed, it also follows that a permanent establishment can be deemed to exist only if the place of business has a certain degree of permanency, i.e. if it is not of a purely temporary nature. 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). One exception has been 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). Another exception has been made where activities constituted a business that was carried on exclusively in that country; in this situation, the business may have short duration because of its nature but since it is wholly carried on in that country, its connection with that country is stronger. For ease of administration, countries may want to consider these practices when they address disagreements as to whether a particular place of business that exists only for a short period of time constitutes a permanent establishment.

Where a place of business which was, at the outset, designed to be used for such a short period of time that it would not have constituted a permanent establishment but is in fact maintained for such a period that it can no longer be considered as a temporary one, it becomes a fixed place of business and thus—retrospectively—a permanent establishment. A place of business can also constitute a permanent establishment from its inception even though it existed, in practice, for a very short period of time, if as a consequence of special circumstances (e.g.death of the taxpayer, investment failure), it was prematurely liquidated.

Domestic laws generally do not have any threshold relating to the presence of a foreign company in the country (whether it is permanent, temporary or transitory) for it to constitute a fixed place PE. As the permanency of the business would depend on the nature of the business. It can be dealt in following manners:
1. Normal Activities
The OECD’s Commentary indicates that, if a foreign company maintains a place of business in another country for a period of more than six months, this is likely to constitute its fixed place PE. Historically, having recognised that there is no threshold time period provided in domestic laws and tax treaties for constitution of a fixed place PE, the business activities of foreign companies should be present for a reasonable period of time for them to constitute a fixed place PE.
Relevant Cases:
(i) Visakhapatnam Port Trust
(ii) Subsea Offshore Ltd
(iii) Fugro Engineers BV
2. Recurring Activities
The OECD’s Commentary indicates that in such a situation, the number of times its place of business is used by a foreign company should be aggregated to determine existence of a fixed place PE.
3. Limited Duration Activities
A foreign company can constitute a fixed place PE if it is engaged in limited duration activities in a specific country, since all its economic activities are undertaken in this country. A foreign company can consitute a PE even if its activities in another State are undertaken only for a short period of time. This concept is based on the reasoning that that if a business is conducted in another State by a foreign company for a limited number period, during which it has complete control over and access to activities which essentially comprise of all the economic activities, this is sufficient for it to constitute a PE in that State.
Relevant Cases:
(i) Formula One World Championship Ltd

Illustrative Examples

Place of Business	Permanence Test
Place of Mine	5.2 This principle may be illustrated by examples. A mine clearly constitutes a single place of business even though business activities may move from one location to another in what may be a very large mine as it constitutes a single geographical and commercial unit as concerns the mining business.
Office Hotel, Street, Market, Fair	Similarly, an “office hotel” in which a consulting firm regularly rents different offices may be considered to be a single place of business of that firm since, in that case, the building constitutes a whole geographically and the hotel is a single place of business for the consulting firm. For the same reason, a pedestrian street, outdoor market or fair in different parts of which a trader regularly sets up his stand represents a single place of business for that trader.
Painter	5.3 By contrast, where there is no commercial coherence, the fact that activities may be carried on within a limited geographic area should not result in that area being considered as a single place of business. For example, where a painter works successively under a series of unrelated contracts for a number of unrelated clients in a large office building so that it cannot be said that there is one single project for repainting the building, the building should not be regarded as a single place of business for the purpose of that work. However, in the different example of a painter who, under a single contract, undertakes work throughout a building for a single client, this constitutes a single project for that painter and the building as a whole can then be regarded as a single place of business for the purpose of that work as it would then constitute a coherent whole commercially and geographically.
Geographical Coherence	5.4 Conversely, an area where activities are carried on as part of a single project which constitutes a coherent commercial whole may lack the necessary geographic coherence to be considered as a single place of business. For example, where a consultant works at different branches in separate locations pursuant to a single project for training the employees of a bank, each branch should be considered separately. However, if the consultant moves from one office to another within the same branch location, he should be considered to remain in the same place of business. The single branch location possesses geographical coherence which is absent where the consultant moves between branches in different locations.

1.3. Business Activity Test

Business Activity Test is the test for if the “Business of the foreign enterprise” carried out through the fixed place of business. For a foreign company to constitute a PE, its business activities should be undertaken at a fixed place of business. Even if a place of business is at the disposal of the company and the Permanence Test is satisfied, its PE cannot be constituted in India unless it engages in its business activities at this place.

A word on defining “business activities” that take place at a fixed place of business that constitutes a PE: The deciding factor in this kind of determination is whether the activities are related to the organization’s core business.

The mere existence of a fixed place of business or the ownership of assets (say, office and equipment) by itself would not be sufficient to constitute a PE. The place of business should actually carry on business activities. The activity performed through the place of business should be the business of the enterprise. This requires four separate tests to be satisfied.

Firstly, the activity conducted by the enterprise must be business under the domestic law of the State where the activity is performed. It should be distinguished from other income generating activities or investments.
Secondly, even if the activity is classified under the domestic law of business activities, it should be treated as business activity under the Article dealing with business profits (Article 7 in case of UN Model Convention).
Thirdly, the activity should not be of a preparatory or auxiliary character which is referred to in Article 5(4) of the Model.
Fourthly, the business activity must have a certain connection to the place of business.

According to the UN Commentaries on Article 5, “the words `through which´ must be given a wide meaning so as to apply to any situation where business activities are carried on at a particular location that is at the disposal of the enterprise for that purpose. Thus, for instance, an enterprise engaged in paving a road will be considered to be carrying on its business `through´ the location where this activity takes place.”

Illustrative Examples:

Situation	Business Activity Test is qualified?
A local subsidiary engages in back office work in Nepal for its overseas parent	Answer: It does not qualify the Business Activity Test to constitute a PE in the country, since no business activities of the foreign company are undertaken in Nepal Relevant Cases: (i) Morgan Stanley & Co
A foreign enterprise has its merchandise in warehouse of another company in Nepal	Answer: Since none of its business activities, which led to its growth in Nepal, are undertaken at the warehouse of the Nepali company, the warehouse does not constitute a fixed place PE in Nepal. Relevant Cases: (i) Airlines Rotables Ltd
A foreign enterprise has automated machine/equipment in Nepal	Answer: Automatic machines or equipment that do not require human intervention may constitute a fixed place PE of a foreign company in Nepal if the company operates and maintains this equipment for its business activities in Nepal. Relevant Cases: (i) Galileo International Inc
A subsidiary company in Nepal conducts its own business with the help and guidance from parent company	Answer: A Nepali subsidiary conducting its own business with the help and guidance of a foreign company or group company in Nepal, it cannot be a PE of the foreign company in the country. Relevant Cases: (i) Epcos AG
Leasing Activity through Fixed Base	Where tangible property such as facilities, industrial, commercial or scientific (ICS) equipment, buildings, or intangible property such as patents, procedures and similar property, are let or leased to third parties through a fixed place of business maintained by an enterprise of a Contracting State in the other State, this activity will, in general, render the place of business a permanent establishment. The same applies if capital is made available through a fixed place of business.
Leasing Activity without involvement in Operation	If an enterprise of a State lets or leases facilities, ICS equipment, buildings or intangible property to an enterprise of the other State without maintaining for such letting or leasing activity a fixed place of business in the other State, the leased facility, ICS equipment, building or intangible property, as such, will not constitute a permanent establishment of the lessor provided the contract is limited to the mere leasing of the ICS equipment etc. This remains the case even when, for example, the lessor supplies personnel after installation to operate the equipment provided that their responsibility is limited solely to the operation or maintenance of the ICS equipment under the direction, responsibility and control of the lessee. If the personnel have wider responsibilities, for example participation in the decisions regarding the work for which the equipment is used, or if they operate, service, inspect and maintain the equipment under the responsibility and control of the lessor, the activity of the lessor may go beyond the mere leasing of ICS equipment and may constitute an entrepreneurial activity. In such a case a permanent establishment could be deemed to exist if the criterion of permanency is met. When such activity is connected with, or is similar in character to, those mentioned in paragraph 3, the time limit of [six] months applies. Other cases have to be determined according to the circumstances.
Advertising and Warehousing	A word on defining “business activities” that take place at a fixed place of business that constitutes a PE: The deciding factor in this kind of determination is whether the activities are related to the organization’s core business. Typically, any preparatory or auxiliary functions such as advertising or warehousing do not constitute core business activities and therefore do not trigger a PE.

To apply the “business connection test” it is important to identify the party whose business is served by the place of business. In the extractive sector the activity performed through the place of business may not be the business of the contractor, but of the subcontractors. This may give rise to one or more overlapped PEs in the same situs. One from the contractor (each contractual area is independently managed through the corresponding JOA) and, subject to its own tests, a PE of the subcontractor or subcontractors performing activities in the contractual area. For example, the subcontractor itself would have a PE at the site if its activities there last more than [six] months.

For a place of business to constitute a permanent establishment the enterprise using it must carry on its business wholly or partly through it. As stated in paragraph 3 above, the activity need not be of a productive character. Furthermore, the activity need not be permanent in the sense that there is no interruption of operation, but operations must be carried out on a regular basis.

# Indicative List of Fixed Place PE

The term “permanent establishment” includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop, and f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.

This paragraph containing the indicative list of the fixed place PE is reproduced from Article 5, paragraph 2 of the OECD Model Convention, lists examples of places that will often constitute a permanent establishment. However, the provision is not self-standing. While paragraph 2 notes that offices, factories, etc., are common types of permanent establishments, when one is looking at the operations of a particular enterprise, the requirements of paragraph 1 must also be met. The paragraph therefore simply provides an indication that a permanent establishment may well exist; it does not provide that one necessarily does exist. This is also the stance of the OECD Model Commentary, where it is assumed that States interpret the terms listed “in such a way that such places of business constitute permanent establishments only if they meet the requirements of paragraph 1”.

As mentioned above, in subparagraph (f) the expression “any other place of extraction of natural resources” should be interpreted broadly. Some have argued that, for this purpose, a fishing vessel could be treated as a place of extraction or exploitation of natural resources since “fish” constitute a natural resource. In their analysis, although it is true that all places or apparatus designated as “permanent establishments” in subparagraphs (a) to (e) in paragraph 2 have a certain degree of permanence or constitute “immovable property”, fishing vessels can be considered as a place used for extraction of natural resources, which may not necessarily mean only minerals embedded in the earth. In this view, fishing vessels can be compared to the movable drilling platform that is used in offshore drilling operations for gaining access to oil or gas. Where such fishing vessels are used in the territorial waters or the exclusive economic zone of the coastal State, their activities would constitute a permanent establishment, situated in that State. However, others are of the view that such an interpretation was open to objection in that it constituted too broad a reading of the term “permanent establishment” and of the natural language of the subparagraph. Accordingly, in their opinion, any treaty partner countries which sought to advance such a proposition in respect of fishing activities, should make that explicit by adopting it as a new and separate category in the list contained in this Article. Consequently, the interpretation on the nature of this activity has been left to negotiations between Contracting States so that, for example, countries which believe that a fishing vessel can be a permanent establishment might choose to make that explicit in this Article, such as by the approach outlined in paragraph 13 of this Commentary. The interpretation as to the nature of this activity would, therefore, be left to negotiations between Contracting States.

What is the intention behind providing this indicative list, if this is to be viewed against the background of definition for Fixed Place PE?
The objective of providing a non-exhaustive list of the forms of establishment that could be likely be fixed place establishment is to provide guidance to the contracting states and authorities on what units of foreign enterprise are likely to satisfy the test of the fixed place PE that are discussed above. This paragraph contains a list, by no means exhaustive, of examples, each of which can be regarded, prima facie, as constituting a permanent establishment. As these examples are to be seen against the background of the general definition given in definition of Fixed Place PE, it is assumed that the Contracting States interpret the terms listed, “a place of management”, “a branch”, “an office”, etc. in such a way that such places of business constitute permanent establishments only if they meet the requirements of Fixed Place PE.

It has been necessary to include this indicative list because developing countries often wish to broaden the scope of the term “permanent establishment” and this indicative list although by no means being an exhaustive list, suggests the nature of units that may qualify as being the fixed place PE.

Relevant Cases:
(i) AB LLC and BD Holdings LLC

#Productive Character Test

It could perhaps be argued that in the general definition some mention should also be made of the other characteristic of a permanent establishment to which some importance has sometimes been attached in the past, namely that the establishment must have a productive character, i.e. contribute to the profits of the enterprise. In the present definition this course has not been taken. Within the framework of a well-run business organisation it is surely axiomatic to assume that each part contributes to the productivity of the whole. It does not, of course, follow in every case that because in the wider context of the whole organisation a particular establishment has a “productive character” it is consequently a permanent establishment to which profits can properly be attributed for the purpose of tax in a particular territory.

2. Project PE

As we have understood the term PE generally means a fixed place of business through which the business of an enterprise is wholly or partly carried on. For a place to be a Fixed Place PE these tests should be satisfied:
(i) Disposal Test (ii) Permanence Test and (iii) Business Activity Test

However, in case of PEs other than Fixed Place PE need not be viewed as fallback provision. Only the qualification of specific tests under different specific PE will lead to that specific PE being triggered. The definition of Project PE includes the following essential characteristics of a Fixed Place PE:
(a) Activity Test
(b) Duration Test

2.1. Activity Test

The Project PE clause included in tax treaties comprises, wherein (i) Building, construction or installation site (ii) Assembly projects (iii) Supervisory services

(i) Building, construction or installation site
According to the OECD’s Commentary, a ‘building, construction or installation site’ includes construction of roads, bridges or canals; renovation (involving more than just maintenance or redecoration) of buildings, roads, bridges or canals; laying of pipelines, and excavation and dredging. It also states that the term ‘installation project’ is not restricted to installation of a construction project, but also of new equipment such as a complex machine in an existing building or outdoors.

(ii) Assembly projects
Typically, ‘assembly’ means the act or process of fitting together the parts of a machine or equipment. The Indian judiciary has observed that where a series of processes and activities are involved and a combination of various components lead to the creation of an article, this is tantamount to ‘manufacture’ and cannot be considered as merely a simple assembly.

(iii) Connected Supervisory services
Supervisory services need to be provided for a building site and construction or installation services for the constitution of a Construction PE in Nepal. A ‘supervisory’ role involves observation and direction, i.e., when a foreign company has the power to observe and direct a Nepali company in relation to its connected activities, this may lead to constitution of the former’s supervisory PE in Nepal. Consulting services provided by a foreign company in relation to its connected activities in Nepal are not eligible for constitution of a PE. In this context, the term ‘consulting’ refers to a situation, wherein a foreign company provides expert advice to a Nepali organization. Supervisory functions may include consultancy services, since the foreign company is empowered to provide advice or its opinion to a Nepali enterprise and direct it to follow this. In a consulting role, the foreign company is restricted to providing expert advice, and the decision of whether it will implement this rests with the Nepali company. Here distinction is necessary between “supervisory services” and “consulting services”. Article 5, paragraph 3, subparagraph (b) deals with the furnishing of services, including consultancy services, the performance of which does not, of itself, create a permanent establishment in the OECD Model Convention. Many developing countries believe that management and consultancy services should be covered because the provision of those services in developing countries by enterprises of industrialized countries can generate large profits.

#Coherence of Activity

The Commentary on Article 5 of the OECD Model (the UN Model does not contain this Commentary) contains some additional criteria for establishing the commercial coherence of “connected projects” within the alternative services PE rule, which could also be considered to be relevant in addressing the commercial coherence or fixed place of business under Article 5(1). This Commentary states that the reference to “connected projects” is intended to cover cases where the services are provided in the context of separate projects carried on by an enterprise but these projects have a commercial coherence. The determination of whether projects are connected will depend on the facts and circumstances of each case but factors that would generally be relevant for that purpose include:
— whether the projects are covered by a single master contract;
— where the projects are covered by different contracts, whether these different contracts were concluded with the same person or with related persons and whether the conclusion of the additional contracts would reasonably have been expected when concluding the first contract;
— whether the nature of the work involved under the different projects is the same;
— whether the same individuals are performing the services under the different projects.

The question arose as to whether the installations of an enterprise, which were established on the territories of two different municipalities, constituted a single PE or two PEs. The Council of State held that the installations must be connected and form an integrated economic unit to be considered a single PE11. In the case at hand, the Luxembourg steelmaker Arbed had factories on the territory of one municipality and mines on the territory of another one. The factory and the mines, even though not adjacent to each other, were related by way of various means of communication and transport (e.g., mine galleries, rail tracks, and canals).

#Sub-contracting Work

Many foreign companies sub-contract construction activities. In this scenario, for a Construction PE to be constituted in Nepal, it needs to be determined whether the time spent by the sub-contractor needs to be aggregated with that spent by the foreign company.
According to the OECD’s Commentary, where work is subcontracted under a comprehensive project-related work schedule, the work carried out by the subcontractor should be aggregated with that undertaken by the main contractor, in order to determine whether this makes it eligible for constitution of a PE in Nepal. Typically, where a sub-contractor is independently responsible and liable for activities it undertakes in India under the sub-contract arrangement, the time spent by it may not be aggregated with that of the main contractor for the purpose of determining its eligibility for constitution of a PE in India. Alternatively, where the main contractor is responsible for execution of a project (including that of the sub-contractor), the time spent by the subcontractor should be included for determination of a Construction PE in Nepal.
Relevant Cases:
(i) Pintish Bamag

#Pipeline

As above mentioned, cables or pipelines that cross the country would be considered to be a PE if these facilities are used to transport property belonging to other enterprises. For the customer of the operator of the cable or pipeline (the enterprise whose product is transported from one place to another) who does not have the cable or pipeline at its disposal, the cable or pipeline cannot be considered a PE.

In a decision of the German Bundesfinanzhof (Federal Tax Court) in the Pipeline Case (No. IIR 12/92 dated 30 October 1996), a Netherlands company owned an underground pipeline for transporting third-party customers’ crude oil and petroleum products. That pipeline was situated in the Netherlands and Germany. The pipeline was operated by the Netherlands company remotely from the Netherlands, without having any personnel in Germany. The Court concluded that since transportation of crude oil and petroleum products was the core business of the Netherlands company, the said transportation activity could not be regarded as an auxiliary activity for the purposes of determining the Netherlands company’s PE in Germany and as a consequence the Dutch company had a PE in Germany in respect of the portion of the pipeline crossing German territory. In the Court’s view, for a PE to exist, it was not necessary that the pipeline had to be operated by personnel belonging to the Dutch company in Germany. Even a fully automated installation could be regarded as a PE.

2.2. Duration Test

The difference between the basic rule in Article 5 (1) and Article 5 (3) of the UN Model is that the latter provides an explicit definition of the duration, turning the “permanence test” of the basic rule into a “duration test”, as a construction site is by its very nature temporary.

The start of the duration test is relevant in this short-term works context where a single day’s difference could lead to the establishment of a PE. The issue is to decide when a construction or installation actually starts and terminates. With respect to drilling rigs, normally its relevant work commences at the well “spud day”, when the process of beginning to drill a well starts and ends when the well has been completed.

Tax treaties with Nepal typically provide for a duration threshold for the activities mentioned above for constitution of a Construction PE in Nepal. This duration test is a mandatory test. A Construction PE cannot be constituted if a foreign company undertakes such activities, but the threshold rules are not satisfied. According to the OECD’s Commentary, the Duration Test for a Construction PE is mandatory for every site or project being implemented in Nepal. However, if the activities performed at various sites are a part of a single project, such a project is considered for the purpose of constitution of a PE. The duration of a project is calculated from the date on which the first preparatory activities required for the project work commence or when a site becomes available for the project work. Usually, ‘solar days’ are calculated and taken into consideration to determine the duration of a project. It is important to note that while determining the duration of activities, temporary interruptions such as bad weather and shortage of raw material should not be excluded. As regards whether the time threshold needs to be looked at every financial year, time period should be kept in mind over the entire duration of a project and not just during a financial year. Furthermore, it should be noted that stressed that the duration should end once the project is completed or when the contractor’s responsibility comes to an end.
Relevant Case Laws:
(i) Krupp Uhde GmBH

#Why Duration Test?

A few developing countries oppose the six-month (or 183 days) thresholds altogether. They have two main reasons: first, they maintain that construction, assembly and similar activities could, as a result of modern technology, be of very short duration and still result in a substantial profit for the enterprise; second, and more fundamentally, they simply believe that the period during which foreign personnel remain in the source country is irrelevant to their right to tax the income (as it is in the case of artistes and sportspersons under Article 17). Other developing countries oppose a time limit because it could be used by foreign enterprises to set up artificial arrangements to avoid taxation in their territory. However, the purpose of bilateral treaties is to promote international trade, investment, and development, and the reason for the time limit (indeed for the permanent establishment threshold more generally) is to encourage businesses to undertake preparatory or ancillary operations in another State that will facilitate a more permanent and substantial commitment later on, without becoming immediately subject to tax in that State.

The [six] month test applies to each individual site or project. In determining how long the site or project has existed, no account should be taken of the time previously spent by the contractor concerned on other sites or projects which are totally unconnected with it. A building site should be regarded as a single unit, even if it is based on several contracts, provided that it forms a coherent whole commercially and geographically. Subject to this proviso, a building site forms a single unit even if the orders have been placed by several persons (e.g. for a row of houses).

#The Abuses to Duration Test

The [six] month threshold has given rise to abuses; it has sometimes been found that enterprises (mainly contractors or subcontractors working on the continental shelf or engaged in activities connected with the exploration and exploitation of the continental shelf) divided their contracts up into several parts, each covering a period less than [six] months and attributed to a different company, which was, however, owned by the same group. Apart from the fact that such abuses may, depending on the circumstances, fall under the application of legislative or judicial anti-avoidance rules, these abuses could also be addressed through the application of the anti-abuse rule of paragraph 9 of Article 29, as shown by example J [and example N] in paragraph [182] of the Commentary on Article 29. Some States may nevertheless wish to deal expressly with such abuses. Moreover, States that do not include paragraph 9 of Article 29 in their treaties should include an additional provision to address contract splitting. Such a provision could, for example, be drafted along the following lines:

For the sole purpose of determining whether the [six] month period referred to in paragraph 3 has been exceeded,
a) where an enterprise of a Contracting State carries on activities in the other Contracting State at a place that constitutes a building site or construction [assembly] or installation project [or supervisory activities in connection therewith] and these activities are carried on during one or more periods of time that, in the aggregate, exceed 30 days without exceeding [six] months, and
b) connected activities are carried on at the same building site, or construction[, assembly] or installation project [or supervisory activities in connection therewith,] during different periods of time, each exceeding 30 days, by one or more enterprises closely related to the first-mentioned enterprise, these different periods of time shall be added to the period of time during which the first-mentioned enterprise has carried on activities at that building site or construction [assembly] or installation project [or supervisory activities in connection therewith].

For the purposes of the alternative provision found in paragraph 52, the determination of whether activities are connected will depend on the facts and circumstances of each case. Factors that may especially be relevant for that purpose include:
— whether the contracts covering the different activities were concluded with the same person or related persons;
— whether the conclusion of additional contracts with a person is a logical consequence of a previous contract concluded with that person or related persons;
— whether the activities would have been covered by a single contract absent tax planning considerations;
— whether the nature of the work involved under the different contracts is the same or similar;
— whether the same employees are performing the activities under the different contracts

If States wish to treat fishing vessels in their territorial waters as constituting a permanent establishment (see paragraph 6 above), they could add a suitable provision to paragraph 3, which, for example, might apply only to catches over a specified level, or by reference to some other criterion.

3. Service PE

Tax treaties provide that the Service PEs of foreign companies can be constituted in Nepal if these enterprises provide services in Nepal through their employees or other personnel working under their control and supervision for a period exceeding the threshold delineated in specific tax treaties.
(i) Activity Test
(ii) Duration Test

3.1. Activity Test

Service PE of a foreign enterprise is triggered in Nepal through 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 (for the same or connected project) within the country for a period or periods aggregating more than a defined period. The activity test is that the nature of the activity should be of “furnishing of services” (including consultancy services).

3.2. Personnel Test

The activity of furnishing service may be made through (i) employees or (ii) other personnel, engaged by the enterprise for such purpose.

As per the tax treaties, a Service PE can be constituted if services are provided by “other personnel” who are not a company’s employees but are under the control and supervision of a foreign company. The term “other personnel” has not been defined in the commentaries from UN and OECD. It generally refers to people who work under the directions of a foreign company. The term “other personnel” can be interpreted to mean persons (other than employees) engaged or appointed by a foreign company. Similarly, it can also be interpreted that the term “other personnel” refers to persons over whom the foreign company has a certain degree of control. Therefore, services provided by such personnel in Nepal on behalf of a foreign company can constitute a PE of the company in Nepal, depending on the nature of services they provide.
Relevant Cases:
(i) E-Funds IT Solution
(ii) Lucent Technologies

3.3. Duration Test

To determine whether a Service PE of a foreign company can be constituted in Nepal, it is essential to compute the number of days its employees have been present in the country, in order to determine whether the threshold mandated in the tax treaties has been complied with.
Solar Days mechanism is used to calculate this duration rather than Workforce Days. Workforce days refers to the calculation of the presence of a foreign company in India, based on its number of employees in the country as well as the duration of their presence (in days) in it. According to the concept of solar days, only the number of days the employees of a foreign company have been present in Nepal is considered, irrespective of its number of employees in the country. According to this method, part of a day, the day of arrival, the day of departure and all other days spent by an employee in Nepal including Saturdays and Sundays national holidays;
holidays before, during and after the activity and short breaks) are taken into consideration in this calculation.

#Service PE Issue List

Exception to Stewardship and Deputation Functions

Stewardship-related activity
Stewardship-related functions refer to the activities of a foreign company that are undertaken with the primary objective of protecting its interests. M/S Dit (International … vs M/S Morgan Stanley & Co. Inc on 9 July, 2007 These can include a wide range of activities, depending on the requirements of the Indian group company, for example:
• Monitoring the activities of the Indian group company in order to ensure its compliance with the group’s policies
• Conducting checks on quality of goods and services and reviewing business activities to ensure that the output meets the requisite requirements
• Guiding the Indian group company on conduct of its business activities
As observed by the Indian judiciary, the stewardship related activities of a foreign company in India should not constitute its Service PE.

Secondment of Employees
Due to globalization, companies set up offices and facilities in foreign countries. Secondment or deputation of employees to these countries by such companies is a popular method used to ensure that the businesses of their group companies in these countries are on par with their organizations’ global policies. Secondment means deputation of employees by a foreign company to its Indian group company, based on the latter’s requirements. Some of the key features of a secondment arrangement:
• Seconded employees are released from a foreign company for the period of the secondment and such a company can neither allocate work to the employees nor impose any lien or restrictions on them during this period.
• Seconded employees work solely under the direction, control and supervision of the Indian company, and they only undertake activities for it.
• The Indian company is responsible for work undertaken by a seconded employee, including for the risks and rewards.
• The Indian company is also responsible for appraisals as well as payment of salary, social security contributions, bonuses, etc., to the seconded employees. If such payments are made by the foreign company, the Indian company has to reimburse the amount on a cost-to-cost basis.
• The Indian company has to indemnify any loss that may arise to it due to the activities of a seconded employee.
• Seconded employees are governed by the same disciplinary policies that are applicable for the Indian company’s own employees.
• The Indian company is responsible for withholding tax on salary payments to seconded employees.
Typically, under a secondment arrangement, an Indian company is the ‘economic employer’, while the foreign one continues to be such employees’ ‘legal employer’.
Alternatively, seconded employees can be transferred to the payroll of Indian companies. In this situation, the Indian company becomes these employees’ economic and legal employers.
The Indian judiciary observed in the case of Centrica India Offshore (P) Ltd. (Del HC) (2014) that seconded employees were entitled to participate in foreign companies’ retirement and social security plans as well as other benefits according to the applicable policies of these organizations, and their salaries should be paid by the foreign companies, which would claim this money from the assessees. The Court also observed that reimbursement of salaries to a foreign company was not a decisive factor. Subsequently, the Delhi High Court observed that such seconded employees render services to Indian companies on behalf of foreign companies, and therefore, their presence in India can lead to the constitution of a Service PE in the country. The Special Leave Petition filed by Centrica in relation to the decision of the Delhi HC was dismissed by the Supreme Court. Similarly, in the case of Morgan Stanley, the Supreme Court observed that the Service PE of a foreign company can be constituted in India as the agent retains lien over it. A similar observation was made in the case of JC Bamford Investments. However, in the case of Tekmark Global Solutions LLC (Mumbai ITAT)(2010), the foreign company deputed certain personnel to the Indian company. These employees worked under the control and supervision of the Indian company. The Mumbai Tribunal held that for all practical purposes the deputed personnel are to be considered the employees of the Indian company, and therefore, should not constitute a PE of the foreign company. The Mumbai Tribunal also held that reimbursement of expatriate costs (on an actual cost basis without any mark-up) should not be taxable in the hands of the foreign company.

Is duration test applied on activity within Nepal or presence of employees/personnel in Nepal?

<…>

Is the physical presence of employees/personnel in Nepal necessary?

In its recent decision, the Bangalore Tax Tribunal observed that a Service PE can be constituted even if a foreign company provides services from another country to an Indian enterprise. However, in this case, its employees’ presence in India should not breach the threshold mandated in the relevant tax treaty. In this decision, the Bangalore Tax Tribunal has deviated from the basic requirement for constitution of a PE in India – the presence of employees and a fixed base in the country.
Relevant Cases:
(i) ABB FZ LLC

ABB FZ-LLC v. Deputy Commr. of Income tax (International Taxation), [2017]
The Tribunal held that in the present age of technology, where the services, information, consultancy, management, etc. can be provided through various virtual modes (e.g., email, internet, video conference, remote monitoring, remote access to desktop), the physical presence of the foreign taxpayer’s employees is not relevant for determining the existence of a Service P.E. in the source country. The decision of the Tribunal implies that the place of performance of services is not relevant for determining the source of income. Rather it is the place of final consumption/utilization of such service that determines its source. Instead of an income tax, which compensates a service provider for its actions performed at the location where employees are based, the activity is subject to consumption tax, which is based on the place of consumption. Recent E.U. proposals to tax the income of U.S.-based digital companies, such as Amazon and Google, reflect a similar approach.

U.N. Maintains Traditional Approach but Concedes to Minority
The U.N. Committee acknowledged that the growth of technology has made it possible to furnish services without any physical presence in the source country and, for that reason, did not reject outright the minority view. Rather, the U.N. Committee required countries adopting the minority view to seek agreement through a mutual agreement procedure under Article 25 (Mutual Agreement Procedure) when the treaty partner followed the majority view of physical presence.

Saudi Arabia
In 2016, Saudi Arabia adopted the minority view and formally implemented guidelines to recognize the existence of a Service P.E. without the presence of employees in Saudi Arabia. Under the Saudi guidelines, a nonresident is deemed to have a Service P.E. in Saudi Arabia if

it furnishes services to a person in connection with the latter’s activity in Saudi Arabia, and
under the contract, the duration of services rendered exceeds the threshold period under the applicable tax treaty (predominantly a 183-day limit).

In effect, Saudi Arabia does not require the physical presence of employees to establish a Service P.E. with respect to the provision of cross-border services. The validity of such internal guidelines may be questionable in a treaty context, since they reflect a unilateral interpretation of that tax treaty whereas the provisions of the entire treaty represent the benefit of a bargain.

In USA
Under current U.S. domestic law, it is likely that U.S. courts would emphasize the place of performance of services instead of the place of consumption to determine the source of income. In a landmark case, Piedras Negras Broadcasting Co. v. Commr.,8 the U.S. Court of Appeals for the Fifth Circuit addressed the source of income arising from the sale of radio time and the dissemination of advertisements by a radio station located in Mexico. Despite the fact that 90% of the station’s listener response came from U.S. and 95% of its income came from U.S. advertisers, the court held that a nonresident is not considered to have performed services in the U.S. without some physical presence in the U.S. and made the following observations:
We think the language of the statutes clearly demonstrates the intendment of Congress that the source of income is the situs of the income-producing service. The repeated use of the words within and without the United States denotes a concept of some physical presence, some tangible and visible activity. If income is produced by the transmission of electromagnetic waves that cover a radius of several thousand miles, free of control or regulation by the sender from the moment of generation, the source of that income is the act of transmission. All of the respondent’s broadcasting facilities were situated without the United States, and all of the services it rendered in connection with its business were performed in Mexico. None of its income was derived from sources within the United States. The Court of Appeals emphasized the situs (i.e., the place of performance) of the services to determine the source of income. For services provided via e-mail, video conferencing, or other digital medium, it may be argued that the source of income arising from that service is its situs (i.e., the place of performance). If other U.S. courts follow the rationale of the Court of Appeals, then it is likely that services provided electronically from outside the U.S. would not be taxed in the U.S. In any event, this is the current state of U.S. domestic law. Since an income tax treaty generally cannot increase tax, a treaty resident presumably always maintains the right to elect to apply U.S. domestic law instead of a treaty. However, since the I.R.S. generally does not permit “cherry picking” of provisions, the treaty resident must choose between applying the treaty in its entirety or not at all.

Conclusion
The Service P.E. clause was first inserted in the U.N. Model Tax Convention in 1980, when electronic commerce was unheard of. It is therefore understandable that the drafters did not intend to impose tax on services provided with no physical presence in the source country. However, with advances in technology, the concept of a fixed base seems to be out of touch with today’s business practices. Jurisdictions such as India, Saudi Arabia, and South Africa are changing the face of the old provision. Soon it may no longer be recognizable.

Day Count Issue

The issue with respect to determination of service PE based on calculation of a relevant period for presence of employees in a particular jurisdiction, has been a matter a matter of debate before the courts. The issue for consideration was whether the threshold has to be calculated on the basis of the ‘entire period for which services have been furnished in a source state although such period may span across various years. The Supreme Administrative Court of Austria held that the threshold has to be calculated on the basis of the entire period of services rendered even though it may span across various years. However, the Madras High Court in the case of Bangkok Glass Industry Co. Ltd. observed that the ’18-day’ threshold has to be determined based on the relevant fiscal year of source state. The Mumbai Tribunal in the instant case read the provisions of Service PE clause of the tax treaty harmoniously with the provisions of the Act and held that the expression any 12-month period’ has to be construed to mean the previous year’ or ‘financial year’.

Relevant Cases:
(i) Linklaters Llp, Mumbai vs Dcit (It)

Business Travelers Issue

Many US-based entities send employees abroad with no intention of setting up a legal presence outside the US. These organizations should be aware that their business travelers who spend long periods in a particular country —six months or more as a rule of thumb — could potentially run the risk of triggering a PE for the organization, depending on the nature of their activities and other factors. Business travelers without a work permit are only permitted to engage in certain activities in-country, depending on local immigration laws. Permitted activities typically include client visits and attending trade events or trainings. Undertaking core business activities typically isn’t permitted. Given these restrictions, the risk of a business traveler triggering a PE for his or her employer is typically far lower than the risk of triggering personal tax residency in the target country. Employers looking to skirt PE laws by sending nominal business travelers to engage in core activities should keep in mind that PE determination is based on actual activities, not simply an employment contract or other formal description of duties.

Technician Temporarily Provides Technical Services

Your US-based software company sends a technician to perform installation and maintenance services in a developing country on a five-month assignment. While you don’t normally provide these services, the client negotiated to receive them as part of a large initial contract. You assume you are in no danger of creating a taxable presence in the target country due to the following factors:

The assignment is less than six months.
Your technician will not be establishing a fixed place of business, but will be performing services strictly in the client’s offices.
Your technician will not actually be developing and selling software (your core business), just installing and temporarily maintaining it.
There is no tax treaty in place between the US and the target country, but domestic tax laws do not mention the provision of technical services as constituting a permanent establishment.

Despite the above sound reasoning, local authorities may deem that the technical services you provide in the target country do in fact trigger a PE, since revenue can be attributed to those services. This scenario reflects the global trend of tax authorities in many developing countries interpreting existing PE legislation to include technical services, even though the legislation may not explicitly mention those services.

Sending a Sales Rep to New Market

Your small, US-based operation is considering expanding internationally for the first time. It believes an EU country is a particularly promising market and wants to send a trusted employee there to gather information and discuss options with local prospects. You decide to send one of your East Coast sales representatives to the country on a three-month fact-finding assignment. You assume you are in no danger of creating a taxable presence in the target country due to the following factors:

Your sales rep will stay in a hotel during the trip, and therefore will not establish a fixed place of business.
Your sales rep will remain on a US payroll.
Your sales rep will not be concluding any contracts or engaging in any revenue-generating activities.

Local tax authorities may be alerted to the presence of your employee through immigration services, with additional information obtained, for example from an email signature or business cards. This information will show that your employee’s title includes the word “sales.” In such cases, tax authorities may automatically deem that your organization has triggered a PE simply

due to the word “sales” in the job title. Even if your employee is not conducting any activities that would trigger a PE, it is up to you as the taxpayer and employer to prove to the local authority’s satisfaction that your expat employee is not actually engaging in sales activities and that you have not created a taxable presence.

Hiring a Local Liaison

Your US-based consulting company is supporting an important client in a South American country. Due to language barriers, cultural differences and other factors, you hire a citizen from the target country to act as a liaison between you and the client. You assume you are in no danger of creating a taxable presence in the target country due to the following factors:

You have not included “sales” in the local hire’s job title, and you are careful to include language in the worker’s job description indicating that he or she does not have the authority to enter into contracts, engage in any sales-related or revenue-generating activities or work from a home office.
You are not establishing a fixed place of business, and your worker will perform all duties at the client’s offices.

While you seem to have significantly lowered your risks through the careful drafting of the employment contract, tax authorities in many countries may deem these kinds of “relationship-building” activities as directly contributing to overall revenue generation. Your client liaison manager, therefore, may serve as one indicator to local tax authorities that your organization has triggered a PE.

4. Agency PE

For Agency PE to apply, all the following conditions must be met:
— a person acts in a Contracting State on behalf of an enterprise;
— in doing so, that person habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and
— these contracts are either in the name of the enterprise or for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or for the provision of services by that enterprise.

Even if these conditions are met, however, paragraph 5 will not apply if the activities performed by the person on behalf of the enterprise are covered by the independent agent exception of paragraph 6 or are limited to activities mentioned in paragraph 4 which, if exercised through a fixed place of business, would be deemed not to create a permanent establishment. This last exception is explained by the fact that since, by virtue of paragraph 4, the maintenance of a fixed place of business solely for the purposes of preparatory or auxiliary activities is deemed not to constitute a permanent establishment, a person whose activities are restricted to such purposes should not create a permanent establishment either. Where, for example, a person acts solely as a buying agent for an enterprise and, in doing so, habitually concludes purchase contracts in the name of that enterprise, paragraph 5 will not apply even if that person is not independent of the enterprise as long as such activities are preparatory or auxiliary.

The primary condition for constituting an Agency PE is the establishment of an ‘agency relationship’ between a foreign company (principal) and its representative in Nepal (agent), i.e., it is necessary that the agent will act on behalf of the foreign company in Nepal.
The Indian judiciary has observed that an agency relationship has the following characteristics: Bhopal Sugar Industries Ltd vs Sales Tax Officer, Bhopal
• An agent works in accordance with the principal’s authority while dealing with third parties.
• The activities undertaken by the agent are in relation to the business activities of the principal.
• The principal has a certain amount of control over the agent’s activities and can intervene in the performance of the agency function.
• Any loss incurred by the agent is indemnified by the principal.

4.1. Contract Concluding Agent

A dependent agent has the authority to conclude contracts on behalf of a foreign company if:
• such a contract is binding for the foreign company and the agent decides the final terms of the contract.
• an agent can act independently and finalize contracts on behalf of a foreign company.
• the agent is authorized to negotiate the terms of the contract, which are
binding on the foreign company. Furthermore, the Indian judiciary has observed that if a Limited Risk Distributor (LRD) does not have any authority to negotiate or conclude contracts on behalf of a foreign company in India, it does not constitute its Agency PE in the country.

Relevant Case Laws:
(i) Galileo International Inc and
(ii) Amadeus Global Travel Distribution SA (Del ITAT) (2011)
(iii) Varian India P.Ltd, Mumbai vs Assessee

The contract concluding agency relationship generally becomes relevant in models applied for sales of goods. Generally three models for supply of goods exists:

direct sale which is generally implemented through a marketing and sourcing agent,
commissionaire arrangement and
distributor arrangement

Agency PE is generally not triggered in any of the model applied for supply of goods. Where, for example, a company acts as a distributor of products in a particular market and, in doing so, sells to customers products that it buys from an enterprise (including an associated enterprise), it is neither acting on behalf of that enterprise nor selling property that is owned by that enterprise since the property that is sold to the customers is owned by the distributor. This would still be the case if that distributor acted as a so-called “low-risk distributor” (and not, for example, as an agent) but only if the transfer of the title to property sold by that “low-risk” distributor passed from the enterprise to the distributor and from the distributor to the customer (regardless of how long the distributor would hold title in the product sold) so that the distributor would derive a profit from the sale as opposed to a remuneration in the form, for example, of a commission.

The phrase “concludes contracts” focuses on situations where, under the relevant law governing contracts, a contract is considered to have been concluded by a person. A contract may be concluded without any active negotiation of the terms of that contract; this would be the case, for example, where the relevant law provides that a contract is concluded by reason of a person accepting, on behalf of an enterprise, the offer made by a third party to enter into a standard contract with that enterprise. Also, a contract may, under the relevant law, be concluded in a State even if that contract is signed outside that State; where, for example, the conclusion of a contract results from the acceptance, by a person acting on behalf of an enterprise, of an offer to enter into a contract made by a third party, it does not matter that the contract is signed outside that State. In addition, a person who negotiates in a State all elements and details of a contract in a way binding on the enterprise can be said to conclude the contract in that State even if that contract is signed by another person outside that State.

The phrase “or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise” is aimed at situations where the conclusion of a contract directly results from the actions that the person performs in a Contracting State on behalf of the enterprise even though, under the relevant law, the contract is not concluded by that person in that State. Whilst the phrase “concludes contracts” provides a relatively well-known test based on contract law, it was found necessary to supplement that test with a test focusing on substantive activities taking place in one State in order to address cases where the conclusion of contracts is clearly the direct result of these activities although the relevant rules of contract law provide that the conclusion of the contract takes place outside that State. The phrase must be interpreted in the light of the object and purpose of paragraph 5, which is to cover cases where the activities that a person exercises in a State are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, i.e. where that person acts as the sales force of the enterprise. The principal role leading to the conclusion of the contract will therefore typically be associated with the actions of the person who convinced the third party to enter into a contract with the enterprise. The words “contracts that are routinely concluded without material modification by the enterprise” clarify that where such principal role is performed in that State, the actions of that person will fall within the scope of paragraph 5 even if the contracts are not formally concluded in the State, for example, where the contracts are routinely subject, outside that State, to review and approval without such review resulting in a modification of the key aspects of these contracts.

The phrase “habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise” therefore applies where, for example, a person solicits and receives (but does not formally finalise) orders which are sent directly to a warehouse from which goods belonging to the enterprise are delivered and where the enterprise routinely approves these transactions. It does not apply, however, where a person merely promotes and markets goods or services of an enterprise in a way that does not directly result in the conclusion of contracts. Where, for example, representatives of a pharmaceutical enterprise actively promote drugs produced by that enterprise by contacting doctors that subsequently prescribe these drugs, that marketing activity does not directly result in the conclusion of contracts between the doctors and the enterprise so that the paragraph does not apply even though the sales of these drugs may significantly increase as a result of that marketing activity.

Illustrative Examples:

RCO, a company resident of State R, distributes various products and services worldwide through its websites. SCO, a company resident of State S, is a wholly-owned subsidiary of RCO. SCO’s employees send emails, make telephone calls to, or visit large organisations in order to convince them to buy RCO’s products and services and are therefore responsible for large accounts in State S; SCO’s employees, whose remuneration is partially based on the revenues derived by RCO from the holders of these accounts, use their relationship building skills to try to anticipate the needs of these account holders and to convince them to acquire the products and services offered by RCO. When one of these account holders is persuaded by an employee of SCO to purchase a given quantity of goods or services, the employee indicates the price that will be payable for that quantity, indicates that a contract must be concluded online with RCO before the goods or services can be provided by RCO and explains the standard terms of RCO’s contracts, including the fixed price structure used by RCO, which the employee is not authorised to modify. The account holder subsequently concludes that contract online for the quantity discussed with SCO’s employee and in accordance with the price structure presented by that employee. In this example, SCO’s employees play the principal role leading to the conclusion of the contract between the account holder and RCO and such contracts are routinely concluded without material modification by the enterprise. The fact that SCO’s employees cannot vary the terms of the contracts does not mean that the conclusion of the contracts is not the direct result of the activities that they perform on behalf of the enterprise, convincing the account holder to accept these standard terms being the crucial element leading to the conclusion of the contracts between the account holder and RCO. The wording of subparagraphs a), b) and c) ensures that paragraph 5 applies not only to contracts that create rights and obligations that are legally enforceable between the enterprise on behalf of which the person is acting and the third parties with which these contracts are concluded but also to contracts that create obligations that will effectively be performed by such enterprise rather than by the person contractually obliged to do so.

4.1.1. Authority Test

4.1.1.1. Objective Test

Against the requirement of a place of business under the basic rule, the agency rule requires the presence of an agent. Any person, whether an individual or a company, could be an agent. It is not necessary that the agent should be resident of the Source Country. The agent should be authorised to conclude contracts on behalf of the principal. The authority may be general or specific or limited. However, it should be such that the agent’s action would bind the enterprise. The authority should be with respect to business of the enterprise. Normally, solicitation of business and negotiation of contracts that are subject to the approval of the principal would not constitute agency PE. The authorisation should be construed in substance and not in form. Thus, if an agent has the authority to negotiate all parts of the contract in a manner, which is binding on the principal but the contract is signed outside the Source Country, the agent could be said to have the authority to conclude contract.

4.1.1.2. Subjective Test

Only agent who are dependent upon the principal may constitute a PE. The dependency would, generally, be commercial dependency. Thus, assurance as regards the agent’s expenses, minimum guaranteed remuneration, etc. would indicate commercial dependency. Another instance would be a case where the agent has only one principal and devotes all his time to this principal.

Dependency In Agency

Once it is established that a person is the agent of a foreign company, it needs to be ascertained whether it is a dependent agent of the foreign company. According to the OECD, the following principles are of importance while determining whether an agent is a dependent agent:

It is legally and economically dependent on its principal.
Its activities are conducted in the ordinary course of its business.
The following are the characteristics of an independent agent:

Legal independence

The degree of control exerted by principals on the conduct of the businesses of agents determines whether or not the agents are legally independent. This control should not be of a degree as that in an employer-employee relationship.
Agents must not be subject to detailed instructions and control with respect to the conduct of their business.
Principals should not be in a position to exert a decisive influence on the business of their agents.
Agents must be able to conduct their business according to their own viewpoints, competence and methodologies.

Economic independence

Agents should be able to conduct their businesses independently and not be dependent on their principals for their economic viability.
They should bear the risk of loss arising from their activities.
They should not be wholly and exclusively dependent on their principals. The number of principals represented by an agent determines its economic independence.
Ordinary course of business: Where an agent undertakes to conduct the activities of the principal in its normal course of business, this should not constitute a PE of the agent (foreign company) in Nepal.

Independency in Entire Business or Activity Specific: Another point for consideration is whether agents need to be independent of their principals only as regards their agency functions or their entire businesses. The Indian judiciary has a varied opinion on this. In its decision on Western Union Financial Services Inc., the Delhi Tax Tribunal observed that while determining the independence of agents, their entire business should be considered and not be determined activity-wise. A similar observation was made by the Mumbai High Court in the case of B4U International Holdings Ltd. (Mum HC) (2015). On the other hand, in its decision on Galileo International Inc., the Delhi Tax Tribunal observed that only those business activities, in respect of which services are provided to foreign companies, need to be considered while determining the independence status of agents.

The key points to consider the independency will depend on factors like:

Conduct of an agent vis-à-vis that of the principal
Comparison of an agent’s activities with those of other agents undertaking similar agency functions
Whether activities engaged in by agents are customary to their trade as brokers, commission agents, etc.
Agents should not undertake activities that form an economic component of the range of activities engaged in by their principals.

4.1.1.3. Functional Test

The authority to bind the principal should be for the purposes which are essential and significant to the principal’s business and not for administrative purposes such as conclusion of contracts for stationery, rent, office, cleaning or manpower contracts. Mere fact that the agent has the authority to conclude contract would result in agency PE.

4.1.2. Habitual Exercise Test

It is also necessary that the agent habitually exercise such authority. The term ‘habitually’ indicates that the authority should be used repeatedly and not merely in isolated instances.

The reference to contracts “in the name of” in subparagraph a) does not restrict the application of the subparagraph to contracts that are literally in the name of the enterprise; it may apply, for example, to certain situations where the name of the enterprise is undisclosed in a written contract.

The crucial condition for the application of Agency PE is that the person who habitually concludes the contracts, or habitually plays the principal role leading to the conclusion of the contracts that are routinely concluded without material modification by the enterprise, is acting on behalf of an enterprise in such a way that the parts of the contracts that relate to the transfer of the ownership or use of property, or the provision of services, will be performed by the enterprise as opposed to the person that acts on the enterprise’s behalf.

The requirement that an agent must “habitually” conclude contracts or play the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise reflects the underlying principle in Article 5 that the presence which an enterprise maintains in a Contracting State should be more than merely transitory if the enterprise is to be regarded as maintaining a permanent establishment, and thus a taxable presence, in that State. The extent and frequency of activity necessary to conclude that the agent is “habitually concluding contracts or playing the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise” will depend on the nature of the contracts and the business of the principal. It is not possible to lay down a precise frequency test. Nonetheless, the same sorts of factors considered in paragraph 6 would be relevant in making that determination.

4.2. Stock Maintaining Agent

An agency PE can be constituted if a dependent agent habitually maintains a stock of goods in Nepal and delivers this on behalf of the foreign company.
Under Article 5(b), agency PE could come into existence even if the agent has no authority to conclude contracts but he habitually maintains stock of goods from which he regularly delivers goods on behalf of the enterprise. Again, the term ‘habitually’ indicates that the stocking should be repeated. Also, the term ‘regularly’ indicates that the delivery should not be on an exceptional basis.

4.2.1. Stock Maintenance Test

Under Article 5(b), agency PE could come into existence even if the agent has no authority to conclude contracts but he habitually maintains stock of goods from which he regularly delivers goods on behalf of the enterprise. Again, the term ‘habitually’ indicates that the stocking should be repeated. Also, the term ‘regularly’ indicates that the delivery should not be on an exceptional basis.

4.2.2. Regular Delivery Test

From where the stock is being maintained, he regularly delivers goods on behalf of the enterprise. Again, the term ‘habitually’ indicates that the stocking should be repeated. Also, the term ‘regularly’ indicates that the delivery should not be on an exceptional basis.

4.3. Order Securing Agent

Following conditions need to be fulfilled to trigger Order Securing Agency relationship:
• Agents frequently accept orders on behalf of foreign companies.
• A substantial portion of their activities constitute those they undertake for foreign companies.
• Acceptance of an order by an agent is binding on the foreign company.
• Customers have a reasonable basis to believe that agents have the authority to enter and finalise contracts, which are binding on the foreign companies.

In the case of Rolls Royce Plc, the Indian judiciary observed that an Agency PE can be constituted if a dependent agent secures orders for the foreign company in India, and all orders are routed through the agent.

4.3.1. Order Securing Test

Agents frequently accept orders on behalf of foreign companies and Acceptance of an order by an agent is binding on the foreign company. Customers have a reasonable basis to believe that agents have the authority to enter and finalise contracts, which are binding on the foreign companies.

4.3.2. Composition of Order Test

A substantial portion of their activities constitute those they undertake for foreign companies.

5. Insurance PE

Various conventions concluded by OECD member countries include a provision which stipulates that insurance companies of a State are deemed to have a permanent establishment in the other State if they collect premiums in that other State through an agent established there— other than an agent who already constitutes a permanent establishment by virtue of paragraph 5 — or insure risks situated in that territory through such an agent. The decision as to whether or not a provision along these lines should be included in a convention will depend on the factual and legal situation prevailing in the Contracting States concerned. Frequently, therefore, such a provision will not be contemplated. In view of this fact, it did not seem advisable to insert a provision along these lines in the Model Convention.

5.1. Agency Test

Paragraph 6 of the United Nations Model Convention, which achieves the aim quoted above, is necessary because insurance agents generally have no authority to conclude contracts; thus, the conditions of paragraph 5, subparagraph (a) would not be fulfilled. If an insurance agent is independent, however, the profits of the insurance company attributable to his activities are not taxable in the source State because the provisions of Article 5 paragraph 7 would be fulfilled and the enterprise would not be deemed to have a permanent establishment.

Some countries, however, favour extending the provision to allow taxation even where there is representation by such an independent agent. They take this approach because of the nature of the insurance business, the fact that the risks are situated within the country claiming tax jurisdiction, and the ease with which persons could, on a part-time basis, represent insurance companies on the basis of an “independent status”, making it difficult to distinguish between dependent and independent insurance agents. Other countries see no reason why the insurance business should be treated differently from activities such as the sale of tangible commodities. They also point to the difficulty of ascertaining the total amount of business done when the insurance is handled by several independent agents within the same country. In view of this difference in approach, the question how to treat independent agents is left to bilateral negotiations, which could take account of the methods used to sell insurance and other features of the insurance business in the countries concerned.

5.2. Premium Collected / Risks Insured Test

An insurance enterprise of a Contracting State shall, except in regard to re-insurance, be deemed to have a permanent establishment in the other Contracting State if it collects premiums in the territory of that other State or insures risks situated therein through a person other than an agent of an independent status.

6. Specific PE Exclusions

Storage of goods and merchandise

Consignment stock

The stock of goods of a foreign company is at the disposal of and under the control and supervision of an Indian company. In the case of Airlines Rotables, the Delhi Tax Tribunal observed that since its warehouse and stock of goods were not under the control of the foreign company (so that it could expand its business), it could not constitute a PE in India.

Storage for processing abroad

The stock of goods of a foreign company is maintained in India for an interim period for the purpose of ‘processing’ these outside the country. The term ‘processing’ refers to the process by which some or all the essential characteristics of a product are altered.

Storage for delivery

The stock of goods of a foreign company is maintained in India, only for the purpose of delivery in the country; its sale- related activities are undertaken by the foreign company outside India. While this exclusion forms a part of the OECD’s MTC, the UN’s MTC excludes this from its list of PE exclusions, i.e., under the UN’s MTC, a company maintaining a stock of goods in a country for the purpose of delivery may constitute a PE in the country if all other conditions are satisfied. Since India follows a hybrid of the OECD’s MTC and the UN’s MTC, some of its tax treaties include this exclusion, while it is absent in others.

Storage for display

The stock of goods of a foreign company is maintained in India, only for the purpose of display in the country. This envisages a situation wherein all its other activities such as sale and delivery are undertaken outside India.

According to the Indian judiciary, the benefit of exclusions is only available if a foreign company undetakes storage of goods and merchandise for itself. Where such storage of goods is undertaken for and on behalf of any third party in India, it can be construed that the foreign company is undertaking business activities in the country, and therefore, may constitute a PE in it. In Re: Xyz/Abc, Equity Fund vs Unknown on 7 March, 2001

Purchasing activities

Activities related to purchase
Purchase of goods for processing

While the Mumbai Tax Tribunal Adit(It) Circle 3(2) v. Fabrikant And Sons Ltd. | Income Tax Appellate Tribunal | Judgment | Law | CaseMine held that such activities form a part of PE exclusions, according to the AAR, Columbia Sportswear Company vs Director Of I.T Bangalore on 30 July, 2012 (indiankanoon.org) functions undertaken by an LO, such as selection of vendors and quality control, do not qualify for PE exclusions, since these are in addition to the purchase function.
In the case of Nike Inc. (Karnataka HC)(2013), an LO had been set up in India for the purpose of identifying manufacturers and ensuring that goods were manufactured in India according to requirements. The taxpayer contended that its activities were ancillary and auxiliary to the activities of its HO and other group companies. According to the Karnataka High Court, the object of the transaction was to purchase goods in India for the purpose of export, and therefore, its income would not be deemed to accrue or arise in the country. Similarly, in the case of Mondial Orient Ltd (Karnataka HC)(2014), the Karnataka High Court was of the opinion that the object of the company’s Branch Office BO) was to undertake activities such as as product design and development, sourcing, merchandising, follow up, quality control, factory evaluation and shipping co-ordination to ensure purchase of goods in India for the purpose of export, and therefore, no income was deemed to accrue to or arise for it in the country

Other activities

Collection of information
Research & Development (R&D)

India’s tax treaties have a residuary PE exclusionary clause, according to which if a foreign company undertakes any other activity (not mentioned in the PE exclusions list), which is preparatory or auxiliary in nature, at a fixed place of business in India, this does not constitute its PE in the country. The term ‘preparatory and auxiliary’ has not been defined in the OECD’s MTC or UN’s MTC or its commentaries. When this came up for adjudication before the Indian judiciary in the case of UAE Exchange Centre Ltd. (Del HC) (2009), the Delhi High Court held that the term ‘auxiliary’ denotes aid or support. A similar view was taken by the Delhi Tax Tribunal in the case of BKI/Ham VOF (Del ITAT) (2001), wherein it was of the opinion that the term ‘auxiliary’ meant ‘subsidiary or ancillary’. The Indian judiciary has held that collection of information in India for the purpose of relaying it to the HO of a foreign company or its group companies outside India constitute preparatory and auxiliary activities, and therefore, should not lead to constitution of its PE in India Sojitz Corporation v. Assistant Director of Income-tax (International Taxation) | Income Tax Appellate Tribunal | Judgment | Law | CaseMine Sumitomo Corporation vs Deputy Commissioner Of Income Tax on 31 May, 2007 (indiankanoon.org), provided collection of information is not its core business activity. Similarly, it held that where an LO is engaged in identifying customers, studying products available in India and arranging negotiations between a foreign company in India (without participating in it), such activities can be construed as preparatory and auxiliary in nature, and therefore the company cannot constitute a PE in India. Mitsui And Co. Ltd. vs Assistant Commissioner Of Income … on 8 February, 2008 (indiankanoon.org) Furthermore, training of agents in India in relation to the required standard of services and administrative procedures have been held to be preparatory and auxiliary in nature.Western Union Financial Services … vs Additional Director Of Income Tax on 10 March, 2006 (indiankanoon.org)

It is often difficult to distinguish between activities which have a preparatory or auxiliary character and those which do not. The decisive criterion is whether the activity of the business in itself forms “an essential and significant part of the activity of the enterprise as a whole”. Each individual case will have to be examined on its own merits. “As a general rule, an activity that has a preparatory character is one that is carried on in contemplation of the carrying on of what constitutes the essential and significant part of the activity of the enterprise as a whole. […] An activity that has an auxiliary character, on the other hand, generally corresponds to an activity that is carried on to support, without being part of, the essential and significant part of the activity of the enterprise as a whole.

Combination of these activities

Combination of one or more of the activities listed above. Typically, when a foreign company undertakes a combination of preparatory and auxiliary activities at its fixed base in India, this does not make it eligible to constitute a PE in the country. However, if it combines a preparatory and auxiliary activity with its core business activity, i.e., it undertakes business activities such as sale of goods in India, and this is combined with a supporting activity, for instance, maintenance of stock for delivery of goods, this would lead to its being eligible to constitute a PE in the country.

Preparatory and Auxiliary Activities

As the OECD’s interpretation notes, “it is often difficult to distinguish between activities which have a preparatory or auxiliary character and those which have not.” Again, each case must be reviewed individually when determining whether a given activity triggers a PE. The OECD’s interpretation explains that “the decisive criterion [when determining whether an activity is preparatory or auxiliary in nature] is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole.”

Generally speaking, here are some activities that may be considered preparatory or auxiliary and therefore may in some cases not constitute a PE:

Conducting market research
Performing marketing activities
Gathering information
Developing trade contacts
Answering product inquiries

People often ask for a list of borderline activities that may be misinterpreted as preparatory or auxiliary but are in fact typically deemed to be core activities that constitute a PE when performed through a fixed place of business. Here is a list of examples of these kinds of activities (the list is of course not exhaustive):

Participating in the sales process (the greater the extent to which the on-the-ground activities lead to the conclusion of the sales process, the greater the PE risk)
Performing management functions
Conducting post-sales operations such as customer service, repair and maintenance
Performing a function closely related to the main business of the enterprise.

This paragraph lists a number of business activities which are treated as exceptions to the general definition laid down in paragraph 1 and which, when carried on through fixed places of business, are not sufficient for these places to constitute permanent establishments. The final part of the paragraph provides that these exceptions only apply if the listed activities have a preparatory or auxiliary character. Since subparagraph e) applies to any activity that is not otherwise listed in the paragraph (as long as that activity has a preparatory or auxiliary character), the provisions of the paragraph actually amount to a general restriction of the scope of the definition of permanent establishment contained in paragraph 1 and, when read with that paragraph, provide a more selective test, by which to determine what constitutes a permanent establishment. To a considerable degree, these provisions limit the definition in paragraph 1 and exclude from its rather wide scope a number of fixed places of business which, because the business activities exercised through these places are merely preparatory or auxiliary, should not be treated as permanent establishments. It is recognised that such a place of business may well contribute to the productivity of the enterprise, but the services it performs are so remote from the actual realisation of profits that it is difficult to allocate any profit to the fixed place of business in question. Moreover subparagraph f) provides that combinations of activities mentioned in subparagraphs a) to e) in the same fixed place of business shall be deemed not to be a permanent establishment, subject to the condition, expressed in the final part of the paragraph, that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. Thus the provisions of paragraph 4 are designed to prevent an enterprise of one State from being taxed in the other State if it only carries on activities of a purely preparatory or auxiliary character in that State. The provisions of paragraph 4.1 (see below) complement that principle by ensuring that the preparatory or auxiliary character of activities carried on at a fixed place of business must be viewed in the light of other activities that constitute complementary functions that are part of a cohesive business and which the same enterprise or closely related enterprises carry on in the same State.

As a general rule, an activity that has a preparatory character is one that is carried on in contemplation of the carrying on of what constitutes the essential and significant part of the activity of the enterprise as a whole. Since a preparatory activity precedes another activity, it will often be carried on during a relatively short period, the duration of that period being determined by the nature of the core activities of the enterprise. This, however, will not always be the case as it is possible to carry on an activity at a given place for a substantial period of time in preparation for activities that take place somewhere else. Where, for example, a construction enterprise trains its employees at one place before these employees are sent to work at remote work sites located in other countries, the training that takes place at the first location constitutes a preparatory activity for that enterprise.

Subparagraph a) relates to a fixed place of business constituted by facilities used by an enterprise for storing, displaying or delivering its own goods or merchandise. Whether the activity carried on at such a place of business has a preparatory or auxiliary character will have to be determined in the light of factors that include the overall business activity of the enterprise. Where, for example, an enterprise of State R maintains in State S a very large warehouse in which a significant number of employees work for the main purpose of storing and delivering goods owned by the enterprise that the enterprise sells online to customers in State S, paragraph 4 will not apply to that warehouse since the storage and delivery activities that are performed through that warehouse, which represents an important asset and requires a number of employees, constitute an essential part of the enterprise’s sale/distribution business and do not have, therefore, a preparatory or auxiliary character.

Subparagraph a) would cover, for instance, a bonded warehouse with special gas facilities that an exporter of fruit from one State maintains in another State for the sole purpose of storing fruit in a controlled environment during the custom clearance process in that other State. It would also cover a fixed place of business that an enterprise maintained solely for the delivery of spare parts to customers for machinery sold to those customers. Paragraph 4 would not apply, however, where an enterprise maintained a fixed place of business for the delivery of spare parts to customers for machinery supplied to those customers and, in addition, for the maintenance or repair of such machinery, as this would go beyond the pure delivery mentioned in subparagraph a) and would not constitute preparatory or auxiliary activities since these after-sale activities constitute an essential and significant part of the services of an enterprise vis-à-vis its customers.

Where, for example, an logistics company operates a warehouse in State S and continuously stores in that warehouse goods or merchandise belonging to an enterprise of State R to which the logistics company is not closely related, the warehouse does not constitute a fixed place of business at the disposal of the enterprise of State R and subparagraph b) is therefore irrelevant.

Where, for example, an investment fund sets up an office in a State solely to collect information on possible investment opportunities in that State, the collecting of information through that office will be a preparatory activity. The same conclusion would be reached in the case of an insurance enterprise that sets up an office solely for the collection of information, such as statistics, on risks in a particular market and in the case of a newspaper bureau set up in a State solely to collect information on possible news stories without engaging in any advertising activities: in both cases, the collecting of information will be a preparatory activity.

If an enterprise with international ramifications establishes a so-called “management office” in a State in which it maintains subsidiaries, permanent establishments, agents or licensees, such office having supervisory and co-ordinating functions for all departments of the enterprise located within the region concerned, subparagraph e) will not apply to that “management office” because the function of managing an enterprise, even if it only covers a certain area of the operations of the concern, constitutes an essential part of the business operations of the enterprise and therefore can in no way be regarded as an activity which has a preparatory or auxiliary character within the meaning of paragraph 4.

Also, where an enterprise that sells goods worldwide establishes an office in a State and the employees working at that office take an active part in the negotiation of important parts of contracts for the sale of goods to buyers in that State without habitually concluding contracts or playing the principal role leading to the conclusion of contracts (e.g. by participating in decisions related to the type, quality or quantity of products covered by these contracts), such activities will usually constitute an essential part of the business operations of the enterprise and should not be regarded as having a preparatory or auxiliary character within the meaning of subparagraph e) of paragraph 4. If the conditions of paragraph 1 are met, such an office will therefore constitute a permanent establishment.

— Example A: RCO, a bank resident of State R, has a number of branches in State S which constitute permanent establishments. It also has a separate office in State S where a few employees verify information provided by clients that have made loan applications at these different branches. The results of the verifications done by the employees are forwarded to the headquarters of RCO in State R where other employees analyse the information included in the loan applications and provide reports to the branches where the decisions to grant the loans are made. In that case, the exceptions of paragraph 4 will not apply to the office because another place (i.e. any of the other branches where the loan applications are made) constitutes a permanent establishment of RCO in State S and the business activities carried on by RCO at the office and at the relevant branch constitute complementary functions that are part of a cohesive business operation (i.e. providing loans to clients in State S).

— Example B: RCO, a company resident of State R, manufactures and sells appliances. SCO, a resident of State S that is a wholly-owned subsidiary of RCO, owns a store where it sells appliances that it acquires from RCO. RCO also owns a small warehouse in State S where it stores a few large items that are identical to some of those displayed in the store owned by SCO. When a customer buys such a large item from SCO, SCO employees go to the warehouse where they take possession of the item before delivering it to the customer; the ownership of the item is only acquired by SCO from RCO when the item leaves the warehouse. In this case, paragraph 4.1 prevents the application of the exceptions of paragraph 4 to the warehouse and it will not be necessary, therefore, to determine whether paragraph 4, and in particular subparagraph 4 a) thereof, applies to the warehouse. The conditions for the application of paragraph 4.1 are met because
— SCO and RCO are closely related enterprises;
— SCO’s store constitutes a permanent establishment of SCO (the definition of permanent establishment is not limited to situations where a resident of one Contracting State uses or maintains a fixed place of business in the other State; it applies equally where an enterprise of one State uses or maintains a fixed place of business in that same State); and
— The business activities carried on by RCO at its warehouse and by SCO at its store constitute complementary functions that are part of a cohesive business operation (i.e. storing goods in one place for the purpose of delivering these goods as part of the obligations resulting from the sale of these goods through another place in the same State)

No PE by virtue of Relationship

Article 5(8) clarifies that the company which controls, or is controlled, by another company which is resident of the source state would, by itself, not constitute either company a PE of the other. Thus, a subsidiary company would not constitute a PE of the holding company merely because it is controlled by the holding company or a holding company would not constitute a PE of the subsidiary company merely because it controls the subsidiary company.

It is generally accepted that the existence of a subsidiary company does not, of itself, constitute that subsidiary company a permanent establishment of its parent company. This follows from the principle that, for the purpose of taxation, such a subsidiary company constitutes an independent legal entity. Even the fact that the trade or business carried on by the subsidiary company is managed by the parent company does not constitute the subsidiary company a permanent establishment of the parent company.

A parent company may, however, be found, under the rules of paragraphs 1 or 5 of the Article, to have a permanent establishment in a State where a subsidiary has a place of business. Thus, any space or premises belonging to the subsidiary that is at the disposal of the parent company […] and that constitutes a fixed place of business through which the parent carries on its own business will constitute a permanent establishment of the parent under paragraph 1, subject to paragraphs 3 and 4 of the Article (see for instance, the example in paragraph 15 above). Also, under paragraph 5, a parent will be deemed to have a permanent establishment in a State in respect of any activities that its subsidiary undertakes for it if the conditions of that paragraph are met (see paragraphs 82-99 above) , unless these activities are limited to those referred to in paragraph 4 of the Article or unless paragraph 6 of the Article applies.

The Committee notes that determining whether or not a permanent establishment exists on a separate entity basis may entail vulnerability to abusive arrangements. Whilst premises belonging to a company that is a member of a multinational group can be put at the disposal of another company of the group and may, subject to the other conditions of Article 5, constitute a permanent establishment of that other company if the business of that other company is carried on through that place, it is important to distinguish that case from the frequent situation where a company that is a member of a multinational group provides services (e.g. management services) to another company of the group as part of its own business carried on in premises that are not those of that other company and using its own personnel. In that case, the place where those services are provided is not at the disposal of the latter company and it is not the business of that company that is carried on through that place. That place cannot, therefore, be considered to be a permanent establishment of the company to which the services are provided. Indeed, the fact that a company’s own activities at a given location may provide an economic benefit to the business of another company does not mean that the latter company carries on its business through that location: clearly, a company that merely purchases parts produced or services supplied by another company in a different country would not have a permanent establishment because of that, even though it may benefit from the manufacturing of these parts or the supplying of these services.

Person Closely Related to the Enterprise v Associated Enterprises

Paragraph [9] explains the meaning of the concept of a “person closely related to an enterprise” for the purposes of the Article and, in particular, of paragraphs 4.1 and 6. That concept is to be distinguished from the concept of “associated enterprises” which is used for the purposes of Article 9; although the two concepts overlap to a certain extent, they are not intended to be equivalent.

The first part of paragraph [9] includes the general definition of “a person closely related to an enterprise”. It provides that a person is closely related to an enterprise if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same persons or enterprises. This general rule would cover, for example, situations where a person or enterprise controls an enterprise by virtue of a special arrangement that allows that person to exercise rights that are similar to those that it would hold if it possessed directly or indirectly more than 50 per cent of the beneficial interests in the enterprise. As in most cases where the plural form is used, the reference to the “same persons or enterprises” at the end of the first sentence of paragraph [9] covers cases where there is only one such person or enterprise.

The second part of paragraph [9] provides that the definition of “person closely related to an enterprise” is automatically satisfied in certain circumstances. Under that second part, a person is considered to be closely related to an enterprise if either one possesses directly or indirectly more than 50 per cent of the beneficial interests in the other or if a third person possesses directly or indirectly more than 50 per cent of the beneficial interests in both the person and the enterprise. In the case of a company, this condition is satisfied where a person holds directly or indirectly more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company.

Other Important Concepts

Absence of Arm’s Length Relationship

Article 5(7) provides for an exception to agency rule PE. An enterprise is not deemed to have a PE in the Source Country merely because it carries on business in that country through a broker, general commission agent or any other agent of an independent status if such person is acting in the ordinary course of business.

The exception mentioned above would, however, not apply in a case where the activities of such person are devoted wholly or almost wholly on behalf of that enterprise and conditions are made or imposed between that enterprises and the agent in their commercial and financial relation which differ from those which would have been made between two independent enterprises.

The exception of paragraph 6 only applies where a person acts on behalf of an enterprise in the course of carrying on a business as an independent agent. It would therefore not apply where a person acts on behalf of an enterprise in a different capacity, such as where an employee acts on behalf of her employer or a partner acts on behalf of a partnership. As explained in paragraph 8.1 of the Commentary on Article 15, it is sometimes difficult to determine whether the services rendered by an individual constitute employment services or services rendered by a separate enterprise and the guidance in paragraphs 8.2 to 8.28 of the Commentary on Article 15 will be relevant for that purpose. Where an individual acts on behalf of an enterprise in the course of carrying on his own business and not as an employee, however, the application of paragraph 6 will still require that the individual do so as an independent agent; as explained in paragraph 111 below, this independent status is less likely if the activities of that individual are performed exclusively or almost exclusively on behalf of one enterprise or closely related enterprises.

Whether a person acting as an agent is independent of the enterprise represented depends on the extent of the obligations which this person has vis-à-vis the enterprise. Where the person’s commercial activities for the enterprise are subject to detailed instructions or to comprehensive control by it, such person cannot be regarded as independent of the enterprise.

It should be noted that, where the last sentence of paragraph 6 does not apply because a subsidiary does not act exclusively or almost exclusively for closely related enterprises, the control which a parent company exercises over its subsidiary in its capacity as shareholder is not relevant in a consideration of the dependence or otherwise of the subsidiary in its capacity as an agent for the parent. This is consistent with the rule in paragraph 7 of Article 5 (see also paragraph 113 below).

An independent agent will typically be responsible to his principal for the results of his work but not subject to significant control with respect to the manner in which that work is carried out. He will not be subject to detailed instructions from the principal as to the conduct of the work. The fact that the principal is relying on the special skill and knowledge of the agent is an indication of independence.

Limitations on the scale of business which may be conducted by the agent clearly affect the scope of the agent’s authority. However, such limitations are not relevant to dependency which is determined by consideration of the extent to which the agent exercises freedom in the conduct of business on behalf of the principal within the scope of the authority conferred by the agreement.

It may be a feature of the operation of an agreement that an agent will provide substantial information to a principal in connection with the business conducted under the agreement. This is not in itself a sufficient criterion for determination that the agent is dependent unless the information is provided in the course of seeking approval from the principal for the manner in which the business is to be conducted. The provision of information which is simply intended to ensure the smooth running of the agreement and continued good relations with the principal is not a sign of dependence.

Another factor to be considered in determining independent status is the number of principals represented by the agent. As indicated in paragraph 111, independent status is less likely if the activities of the agent are performed wholly or almost wholly on behalf of only one enterprise over the lifetime of the business or a long period of time. However, this fact is not by itself determinative. All the facts and circumstances must be taken into account to determine whether the agent’s activities constitute an autonomous business conducted by him in which he bears risk and receives reward through the use of his entrepreneurial skills and knowledge. Where an agent acts for a number of principals in the ordinary course of his business and none of these is predominant in terms of the business carried on by the agent, dependence may exist if the principals act in concert to control the acts of the agent in the course of his business on their behalf.

Ordinary Course of Action

An independent agent cannot be said to act in the ordinary course of its business as agent when it performs activities that are unrelated to that agency business. Where, for example, a company that acts on its own account as a distributor for a number of companies also acts as an agent for another enterprise, the activities that the company undertakes as a distributor will not be considered to be part of the activities that the company carries on in the ordinary course of its business as an agent for the purposes of the application of paragraph 6). Activities that are part of the ordinary course of a business that an enterprise carries on as an agent will, however, include intermediation activities which, in line with the common practice in a particular business sector, are performed sometimes as agent and sometimes on the enterprise’s own account, provided that these intermediation activities are, in substance, indistinguishable from each other. Where, for example, a broker-dealer in the financial sector performs a variety of market intermediation activities in the same way but, informed by the needs of the clients, does it sometimes as an agent for another enterprise and sometimes on its own account, the broker-dealer will be considered to be acting in the ordinary course of its business as an agent when it performs these various market intermediation activities.

The last sentence of paragraph 6 provides that a person is not considered to be an independent agent where the person acts exclusively or almost exclusively for one or more enterprises to which it is closely related. That last sentence does not mean, however, that paragraph 6 will apply automatically where a person acts for one or more enterprises to which that person is not closely related. Paragraph 6 requires that the person must be carrying on a business as an independent agent and be acting in the ordinary course of that business. Independent status is less likely if the activities of the person are performed wholly or almost wholly on behalf of only one enterprise (or a group of enterprises that are closely related to each other) over the lifetime of that person’s business or over a long period of time. Where, however, a person is acting exclusively for one enterprise, to which it is not closely related, for a short period of time (e.g. at the beginning of that person’s business operations), it is possible that paragraph 6 could apply. As indicated in paragraph 109 above, all the facts and circumstances would need to be taken into account to determine whether the person’s activities constitute the carrying on of a business as an independent agent.

The rule in the last sentence of paragraph 6 and the fact that the definition of “closely related” in paragraph 8 covers situations where one company controls or is controlled by another company do not restrict in any way the scope of paragraph 8 of Article 5. As explained in paragraph 117 below, it is possible that a subsidiary will act on behalf of its parent company in such a way that the parent will be deemed to have a permanent establishment under paragraph 5; if that is the case, a subsidiary acting exclusively or almost exclusively for its parent will be unable to benefit from the “independent agent” exception of paragraph 6. This, however, does not imply that the parent-subsidiary relationship eliminates the requirements of paragraph 5 and that such a relationship could be sufficient in itself to conclude that any of these requirements are met. 32. In the 2017 update, the Committee decided that the lack of an arm’s length relationship should not be a deciding factor in determining that an agent does not qualify as an agent of independent status and removed this requirement from the independent agent rule. In making its decision it was noted that removal of the arm’s length condition was made because prior to the 2017 update, it was easier to qualify as “an independent agent” under the United Nations Model Convention than under the OECD Model Convention.

The “Delivery” Issue

In the list of what is deemed not to constitute a permanent establishment in paragraph 4 (often referred to as the list of “preparatory and auxiliary activities”) “delivery” is not mentioned in the United Nations Model Convention, but is mentioned in the OECD Model Convention. Therefore a delivery activity might result in a permanent establishment under the United Nations Model Convention, without doing so under the OECD Model Convention;

In reviewing the United Nations Model Convention, the Committee retains the existing distinction between the two Models, but it notes that even if the delivery of goods is treated as giving rise to a permanent establishment, it may be that little income could properly be attributed to this activity. Tax authorities might be led into attributing too much income to this activity if they do not give the issue close consideration, which would lead to prolonged litigation and inconsistent application of tax treaties. Therefore, although the reference to “delivery” is absent from the United Nations Model Convention, countries may wish to consider both points of view when entering into bilateral tax treaties, for the purpose of determining the practical results of utilizing either approach.

PE v. Article 14

Article 14 (Independent personal services) has been retained, whereas in the OECD Model Convention, Article 14 has been deleted, and Article 5 addresses cases that were previously considered under the “fixed base” test of that Article. As noted below (in paragraph 15.1 and thereafter), while the United Nations Model Convention has retained Article 14, the present Commentary provides guidance for those countries not wishing to have such an article in their bilateral tax agreements;
Some countries have taken the view that Article 14 should be deleted and its coverage introduced into Articles 5 and 7. Countries taking such a view often do so because they perceive that the “fixed base” concept in Article 14 has widely acknowledged uncertainties and that the “permanent establishment” concept can accommodate the taxing rights covered by Article 14. T Many countries disagree with these views and do not believe they are sufficient to warrant deletion of Article 14. Further some countries consider that differences in meaning exist between the “fixed base” (Article 14) and “permanent establishment” (Article 5) concepts. In view of these differences, the removal of Article 14 and reliance on Articles 5 and 7 will, or at least may, in practice lead to a reduction of source State taxing rights. Considering the differences of views in this area, differences which could not be bridged by a single provision, the Committee considers that Article 14 should be retained in the United Nations Model Convention but that guidance in the form of an alternative provision would be provided in this Commentary for countries wishing to delete Article 14.

It should also be noted that the last part of Article 14, paragraph 1, subparagraph (b) has not been transposed into Article 5: (“… in that case, only so much of the income as is derived from his activities performed in that other State may be taxed in that other State”). The reason for this is that Article 7 provides its own attribution rules, which, in most cases, means that only the profits of an enterprise attributable to that permanent establishment (that is, the “physical presence” in subparagraph (c) of paragraph 3) may be taxed by the State where the permanent establishment exists. Where a “limited force of attraction” rule as provided in Article 7 has been adopted in bilateral treaties, other business activities of a same or similar kind as those effected through the physical presence permanent establishment may be taxed by the State where the permanent establishment exists, which can be justified as treating various forms of permanent establishment in the same way.

In the event of States agreeing to a limited force of attraction rule in Article 7 and also to deletion of Article 14, but not wishing to apply the limited force of attraction rule to cases formerly dealt with by Article 14, paragraph 1, subparagraph (b), it could explicitly be provided that such a rule did not apply to subparagraph (c) of paragraph 3 cases.

Subparagraph h), however, provides expressly that the term includes the performance of professional services and of other activities of an independent character. This provision was added in 2000 at the same time as Article 14, which dealt with Independent Personal Services, was deleted from the Convention. This addition, which ensures that the term “business” includes the performance of the activities which were previously covered by Article 14, was intended to prevent that the term “business” be interpreted in a restricted way so as to exclude the performance of professional services, or other activities of an independent character, in States where the domestic law does not consider that the performance of such services or activities can constitute a business. Contracting States for which this is not the case are free to agree bilaterally to omit the definition.

Ecommerce

There has been some discussion as to whether the mere use in electronic commerce operations of computer equipment in a country could constitute a permanent establishment. That question raises a number of issues in relation to the provisions of the Article.

Whilst a location where automated equipment is operated by an enterprise may constitute a permanent establishment in the country where it is situated (see below), a distinction needs to be made between computer equipment, which may be set up at a location so as to constitute a permanent establishment under certain circumstances, and the data and software which is used by, or stored on, that equipment. For instance, an Internet web site, which is a combination of software and electronic data, does not in itself constitute tangible property. It therefore does not have a location that can constitute a “place of business” as there is no “facility such as premises or, in certain instances, machinery or equipment” (see paragraph 6 above) as far as the software and data constituting that web site is concerned. On the other hand, the server on which the web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server.

The distinction between a web site and the server on which the web site is stored and used is important since the enterprise that operates the server may be different from the enterprise that carries on business through the web site. For example, it is common for the web site through which an enterprise carries on its business to be hosted on the server of an Internet Service Provider (ISP). Although the fees paid to the ISP under such arrangements may be based on the amount of disk space used to store the software and data required by the web site, these contracts typically do not result in the server and its location being at the disposal of the enterprise (see paragraph 10 to 19 above), even if the enterprise has been able to determine that its web site should be hosted on a particular server at a particular location. In such a case, the enterprise does not even have a physical presence at that location since the web site is not tangible. In these cases, the enterprise cannot be considered to have acquired a place of business by virtue of that hosting arrangement. However, if the enterprise carrying on business through a web site has the server at its own disposal, for example it owns (or leases) and operates the server on which the web site is stored and used, the place where that server is located could constitute a permanent establishment of the enterprise if the other requirements of the Article are met.

Computer equipment at a given location may only constitute a permanent establishment if it meets the requirement of being fixed. In the case of a server, what is relevant is not the possibility of the server being moved, but whether it is in fact moved. In order to constitute a fixed place of business, a server will need to be located at a certain place for a sufficient period of time so as to become fixed within the meaning of paragraph 1.

Another issue is whether the business of an enterprise may be said to be wholly or partly carried on at a location where the enterprise has equipment such as a server at its disposal. The question of whether the business of an enterprise is wholly or partly carried on through such equipment needs to be examined on a case-by-case basis, having regard to whether it can be said that, because of such equipment, the enterprise has facilities at its disposal where business functions of the enterprise are performed.

Where an enterprise operates computer equipment at a particular location, a permanent establishment may exist even though no personnel of that enterprise is required at that location for the operation of the equipment. The presence of personnel is not necessary to consider that an enterprise wholly or partly carries on its business at a location when no personnel are in fact required to carry on business activities at that location. This conclusion applies to electronic commerce to the same extent that it applies with respect to other activities in which equipment operates automatically, e.g. automatic pumping equipment used in the exploitation of natural resources.

Another issue relates to the fact that no permanent establishment may be considered to exist where the electronic commerce operations carried on through computer equipment at a given location in a country are restricted to the preparatory or auxiliary activities covered by paragraph 4. The question of whether particular activities performed at such a location fall within paragraph 4 needs to be examined on a case-by-case basis having regard to the various functions performed by the enterprise through that equipment. Examples of activities which would generally be regarded as preparatory or auxiliary include:
— providing a communications link—much like a telephone line—between suppliers and customers;
— advertising of goods or services;
— relaying information through a mirror server for security and efficiency purposes;
— gathering market data for the enterprise;
— supplying information.

Where, however, such functions form in themselves an essential and significant part of the business activity of the enterprise as a whole, or where other core functions of the enterprise are carried on through the computer equipment, these would go beyond the activities covered by paragraph 4 and if the equipment constituted a fixed place of business of the enterprise (as discussed in paragraphs 123 to 127 above), there would be a permanent establishment.

What constitutes core functions for a particular enterprise clearly depends on the nature of the business carried on by that enterprise. For instance, some ISPs are in the business of operating their own servers for the purpose of hosting web sites or other applications for other enterprises. For these ISPs, the operation of their servers in order to provide services to customers is an essential part of their commercial activity and cannot be considered preparatory or auxiliary. A different example is that of an enterprise (sometimes referred to as an “e-tailer”) that carries on the business of selling products through the Internet. In that case, the enterprise is not in the business of operating servers and the mere fact that it may do so at a given location is not enough to conclude that activities performed at that location are more than preparatory and auxiliary. What needs to be done in such a case is to examine the nature of the activities performed at that location in light of the business carried on by the enterprise. If these activities are merely preparatory or auxiliary to the business of selling products on the Internet (for example, the location is used to operate a server that hosts a web site which, as is often the case, is used exclusively for advertising, displaying a catalogue of products or providing information to potential customers), paragraph 4 will apply and the location will not constitute a permanent establishment. If, however, the typical functions related to a sale are performed at that location (for example, the conclusion of the contract with the customer, the processing of the payment and the delivery of the products are performed automatically through the equipment located there), these activities cannot be considered to be merely preparatory or auxiliary.

A last issue is whether paragraph 5 may apply to deem an ISP to constitute a permanent establishment. As already noted, it is common for ISPs to provide the service of hosting the web sites of other enterprises on their own servers. The issue may then arise as to whether paragraph 5 may apply to deem such ISPs to constitute permanent establishments of the enterprises that carry on electronic commerce through web sites operated through the servers owned and operated by these ISPs. Whilst this could be the case in very unusual circumstances, paragraph 5 will generally not be applicable because the ISPs will not constitute an agent of the enterprises to which the web sites belong, because they will not conclude contracts or play the principal role leading to the conclusion of contracts in the name of these enterprises, or for the transfer of property belonging to these enterprises or the provision of services by these enterprises, or because they will act in the ordinary course of a business as independent agent, as evidenced by the fact that they host the web sites of many different enterprises. It is also clear that since the web site through which an enterprise carries on its business is not itself a “person” as defined in Article 3, paragraph 5 cannot apply to deem a permanent establishment to exist by virtue of the web site being an agent of the enterprise for purposes of that paragraph.

The Committee of Experts notes that the OECD Commentary, in paragraph 124, draws a distinction between a contract with an Internet Service Provider and one with a place of business at the disposal of the enterprise. In this regard, the Committee recognizes that some businesses could seek to avoid creating a permanent establishment by managing the contractual terms in cases where the circumstances would justify the conclusion that a permanent establishment exists. Such abuses may fall under the application of legislative or judicial anti-avoidance rules.

BEPS Action Plan 7 Propositions

Whether an activity undertaken by a foreign company in another country is preparatory and auxiliary in nature, based on the nature of its business, e.g., whether storage and delivery of goods constitute the preparatory and auxiliary activity conducted by a foreign eCommerce business with warehouses, personnel and functions in India | BEPS AP 7 suggests that all exclusions in the definition of PE in MTC should be made subject to a ‘preparatory and auxiliary’ condition, i.e., exclusion will only be available if such activities are preparatory or auxiliary in nature, as against earmarked activities defined in existing tax treaties.

Exclusion will only be available if activities are preparatory and auxiliary in nature – on a stand-alone basis, as well as when undertaken as a combination of activities. For instance, in the example mentioned above, foreign eCommerce businesses with warehouses in India, with a significant number of people and other functions they conduct in the country, may not be eligible to claim PE exclusion, since these activities may constitute the core business activity of such companies.

Whether fragmentation of activities between different places of business or entities constitute preparatory and auxiliary activities | Anti-fragmentation rules have been proposed under BEPS AP 7 to address this issue, which restricts a foreign company and its group companies from fragmenting a cohesive business operation into several small operations in order to demonstrate that each of these is only engaged in a preparatory or auxiliary activity. Anti-fragmentation rules need to be complied with. These rules restrict division of a business activity into smaller and similar activities conducted by its group companies.