The concept of a Permanent Establishment (PE) is the core threshold used in international tax law to determine whether a country has the legal right to tax the business profits of a foreign enterprise.
Defining a Permanent Establishment
Under Article 5 of the Model Conventions, a foreign company is not subject to local corporate income tax unless its presence in the host country rises to the level of a PE. A PE is defined as a fixed place of business through which the business of an enterprise is wholly or partly carried on.
Categories of Permanent Establishments
- Fixed Place PE: A physical presence such as a management branch, an office, a factory, a workshop, or a mine/oil well.
- Construction/Project PE: A building site, construction, assembly, or installation project, but only if it lasts longer than a specified duration (typically 6 months under the UN model or 12 months under the OECD model).
- Service PE: The furnishing of services by a foreign enterprise through employees in the host country, if those activities continue for a cumulative period exceeding a specific threshold (e.g., more than 91 days in any 12-month period).
- Dependent Agent PE: When a person acts on behalf of a foreign enterprise and habitually exercises an authority to conclude contracts in the host country, the foreign company is deemed to have a PE, even without a physical office.
Attribution of Profits
Once a PE is established, the host country can only tax the profits that are directly attributable to that specific PE. The PE must be treated as a distinct and separate enterprise operating at arm’s length from its foreign head office.
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