Permanent Establishment

A permanent establishment is a fixed place in a particular jurisdiction which represents a business in that jurisdiction that results in income or value-added tax liability. A permanent establishment is a common term in any income tax treaties and European Union Value Added tax systems and hence is recognized as a very important international tax concept.

In the following sections, we will explore more about the notion of permanent establishment and define the importance of understanding it by an enterprise looking for global expansion.

As soon as you decide that your business requires a global presence and you are ready to have a permanent establishment in another country, the first thing you may need to determine is if outsourcing a function to another country is the right path for your enterprise or do you need to incorporate a company in another country.

We will look at the different aspects of a permanent establishment by going through the following questions:

What is the relation between a permanent establishment and international tax treaties?

What exactly is a permanent establishment?

What does a permanent establishment does not mean?

The role of a permanent establishment in construction projects.

How is a permanent establishment associated with agents?

The effects of COVID-19 and permanent establishment?

What is the point of having a permanent establishment?

What are the regulatory aspects of a permanent establishment internationally?

How profits are attributed to a permanent establishment.

What is the relation between a permanent establishment and international tax treaties?

The definition of a permanent establishment is subject to the tax law of each jurisdiction which is usually influenced by a bilateral tax treaty entered into between two jurisdictions. A jurisdiction here can be a country, state, province, territory, or an autonomous region. Here, we identify the two jurisdictions as residence country and source country The residence country is where the enterprise is originally based from and the source country is where the activity is being carried out.

Defining the permanent establishment is usually done by tax treaties themselves influenced by the concepts included in either of the two models of international tax treaties – the OECD model tax convention on income and on capital(the OECD model) and the united nations model double taxation convention between developed and developing countries.

Expressing the purpose of international tax treaties in a summary, Michael Lennard, Chief of International Tax Cooperation and Trade in the Financing for Development Office (FDO) of the United Nations, gave a statement that “ “whether and to what extent, in respect of particular income profits or gains, the source country (the host country of investment) will relinquish its taxing rights. If it does, the residence country of the investor may fully tax the profits of the investor”. Therefore, a permanent establishment is a principal mechanism through which a source country can acquire tax from an enterprise based in a residence country.

The key area of focus is the requirements of the OECD Model or specifically, article 5 that defines the concept of permanent establishment as well as different aspects associated with it.

Being implemented in as many as 3000 tax treaties internationally, the OECD model is the most common mechanism of defining a permanent establishment. Furthermore, the OECD has an Inclusive Framework on Base Erosion and Profit Shifting (BEPS) and the associated BEPS Action Plan that has been signed up by more than 80 countries. It has also recently modified the definition of a permanent establishment.

A significant fact to note here is that for a permanent establishment to have a legal effect in a country, each individual country has to incorporate the definition of a permanent establishment in their domestic law. Therefore, you will need to consult a professional, acquainted with the laws of the source country, to determine if your enterprise can have a permanent establishment in that country.

What exactly is a permanent establishment?

According to the artcile5(1) of the OECD Model, the following statement outlines the concept of the permanent establishment – “The term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on”. Understanding this statement along with the commentary on this article, three key elements are established that are mentioned below:

  • Existence of a “place of business”. The facilities must be “at the disposal” of the enterprise. This means that even if an enterprise is conducting regular meetings at a customer’s premises, it will not be counted as a permanent establishment as the enterprise is not liable for the facilities meaning the facilities are not at the disposal of the enterprise.
  • A permanent location should be there for the “place of business”. According to this, there must be a connection between the premises and some geographical position, as well as a ‘degree of permanence’ to that location.
  • The operations of a business are carried out, fully or partially, through that fixed place.

Some locations are specified as prima facie PEs. This list captures:

  • A branch
  • A warehouse
  • A factory
  • A mine or place of extraction of natural resources
  • A place of management

Even if they are listed as an example, each location must fulfil the standard definition of a permanent establishment.

What does a permanent establishment does not mean?

Despite meeting the basic criteria of having a permanent establishment in a source country, there are certain activities that are ‘exempted’ from the application of the permanent establishment rules.

Under Article 5(4), If a location has been labelled as a Permanent Establishment but is being used by the enterprise for activities that are “incidental, preparatory, or ancillary” character, it will not be recognized as a permanent establishment. These activities include:

  • The use of a storage facility solely for the delivery of goods to customers
  • The maintenance of a stock of goods owned by the enterprise, held solely for processing by another enterprise
  • The maintenance of a fixed place of business solely for the purpose of purchasing goods, or merchandise, or of collection of information for the enterprise
  • Any other activity of an incidental, preparatory, or ancillary nature

Collectively, all these activities are referred to as “ancillary activities”.

However, a noteworthy aspect here is that a change has been made recently to the exclusion rules of a permanent establishment. This has been a result of the BEPS Action Plan and is known as the ‘anti-fragmentation’ rule.

The primary reason behind this change is that many enterprises have leveraged the concept of ancillary activities in the past to get an exception to ‘fragment’ their business into separate entities. This was done in order to claim that the business is completely ancillary.

According to the new rule, even if the activities of a permanent establishment appear preparatory or auxiliary, when viewed in isolation, it is not enough.

If these activities “constitute complementary functions that are part of a cohesive business operation “, they will not be recognized as solely ancillary, and the exception would not be applied.

The role of a permanent establishment in construction projects

According to Article 5(3) “A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months.” this necessitates that even is a construction project meets the core definition of a permanent establishment, it has to meet a duration threshold.

The primary reason behind this is that some businesses have tried to leverage the old conditions to get around this in the past. Essentially, a construction project was usually split into multiple smaller projects with the same effect which otherwise would have lasted more than 12 months. The new test requires that contracts have to be considered as a whole to determine whether a PE exists.

How is a permanent establishment associated with agents?

It is a common thought that the existence of a permanent establishment can be avoided by having an agent in the source country. In this, as the enterprise will not be involved directly in the source country and all the functionalities will be carried out by an agent, it might seem that the enterprise has no permanent establishment in the source country.

But, according to the Article5(5), a “dependent agent” can constitute a permanent establishment if are regularly entering into contracts under the name of the enterprise and acting as an authority for the enterprise in the source country. 

The relationship between an agent and a permanent establishment has been further defined under the BEPS Action 7. This includes that the permanent establishment is not only constituted by someone who signs the contracts in place of the enterprise but even if an agent is representing the enterprise for the negotiation or formation of contracts which are formally concluded by the enterprise, it will also constitute a permanent establishment.

The effects of COVID-19 and permanent establishment?

To define the impact of the COVID-19 crisis and the Tax treaties, the OECD Secretariat had released an analysis. A key consideration in this analysis was if the new remote working situations will be considered as a permanent establishment. The concept of ‘home offices’ in foreign countries is being considered here which means that remote working professionals are being considered as ‘dependent agent permanent establishments’ due to their presence in another country.

In the perspective of the OECD, a temporary office in another country can not be considered as permanent and ‘at the disposal’ of the enterprise which are the key factors for recognizing a permanent establishment of an enterprise. Moreover, the OECD has also expressed their view with respect to an agent or employee overseas that such agents or employees lack the authority or the habitual character to be considered as a dependent agent for an enterprise.

What is the point of having a permanent establishment?

As soon as you identified that your enterprise includes a permanent establishment in a source country, the following things must be considered;

  • Filing a tax return;
  • Attribution of Profits. You will need documentation justifying why profits were attributed in that way;
  • Working out which types of tax apply. In addition to corporate income tax, you need to consider the possibility of turnover (i.e., sales) taxes or withholding tax;
  • Compliance obligations. Having a PE in a source country may also result in a range of other non-tax compliance obligations.

How are profits attributed to a permanent establishment?

According to the OECD model Article 7, the profits of a business are taxable in the resident country of the business unless there is a permanent establishment. In that case, the profits attributed to the permanent establishment may be taxed in the source country.

So, the question arises, how to attribute profits to a permanent establishment?

After the permanent establishment is deemed to exist in a source country due to certain activities and no exclusion applies, the permanent establishment is treated as a “separate and independent enterprise” and subject to this fact, profits are attributed to the permanent establishment.

Therefore, after a permanent establishment is recognized due to certain activities outlines in Article 5(4) that are not preparatory or auxiliary in nature, determining the profit attribution to the permanent establishment is done by analysing the revenues and expenses incurred by that permanent establishment, treating it as an independent enterprise. This task is more complex than it sounds which is why it requires expert accounting advice.


A permanent establishment is crucial for enterprises that have a global presence. It is the primary mechanism which exposes your organisation to corporate income tax, value-added tax, filing tax returns, and compliance with a range of other obligations.

Therefore, recognizing the imperativeness of a permanent establishment, the following steps must be taken care of:

  • Evaluate the activities of your enterprise and determine if they fulfil the general rules of being a permanent establishment. Remember that ‘dependent agents’ can also be a permanent establishment
  • If activities fulfil the basic criteria of being a permanent establishment, determine if they meet the exception criteria by falling under the ‘ancillary activities’ category.
  • For a permanent establishment, identify your tax and compliance obligations in the source country
  • Where income tax is owed, ensure you apply the correct model of profit attribution.

Another key consideration while following these steps should be that the international laws governing permanent establishment have had recent reforms. For instance, the BEPS Action Plan is moving towards the prevention of ‘islanding’ parts by the enterprises for tax purposes.

We hope that this information was useful for you. However, the definition of a permanent establishment differs from country to country and you should consult a professional who knows the local laws of a jurisdiction, relevant to your needs.