Permanent Establishment (PE) Concept in Corporate Tax Planning

Cross border trade

Income tax treaties begin with the recitation that they are entered into between countries for the purposes of avoiding double taxation of international income flows, and the prevention of fiscal evasion with respect to taxes on income and capital gains.

Permanent Establishment (PE) is a key concept in international corporate tax planning, used by tax authorities to determine the taxable presence of a foreign company in a jurisdiction. The idea behind PE is that a company should be taxed in the country where it conducts business, rather than solely in the country of its headquarters.

Article 5 of OECD Model for Tax Convention defines PE as a fixed place of business through which the foreign company carries out its activities. This can include a branch office, factory, places where natural resources are extracted, warehouse, or even a dependent agent who has the authority to conclude contracts on behalf of the foreign company.  In addition, UN Model deem PE to exist for an enterprise of one country performing services (including consultancy services) in the other country for more than six months or for a related party within any 12-month period. A PE only exists if the foreign company has a substantial degree of economic presence in the jurisdiction, which is typically demonstrated by the level of business activities conducted through the PE.

Article 5 (3) of OECD model asserts that a building site or installation project is considered a permanent establishment if it last more than twelve months. It then goes on to provide examples of activities that do not constitute a permanent establishment, such as storing, displaying, or delivering goods, maintaining a stock of goods for storage or delivery, maintaining a fixed place of business for purchasing goods or collecting information, or carrying out any other activity of a preparatory or auxiliary character.

The concept of PE is important for companies that operate in multiple countries, as it determines the extent to which they will be taxed in each jurisdiction. For example, if a company has a PE in a foreign country, it may be required to pay taxes on its profits generated in that country, even if the profits are repatriated to the headquarters. This can have a significant impact on the overall tax liability of the company, and is an important factor to consider when planning international tax strategies.

The PE concept is typically established through tax treaties between countries, which outline the conditions under which a PE is considered to exist. These treaties aim to avoid double taxation, as well as to ensure that foreign companies are taxed fairly in the jurisdiction where they conduct business.

In order to effectively plan for PE, companies need to understand the tax laws and regulations of each jurisdiction in which they operate. This involves considering factors such as the level of business activities conducted in each jurisdiction, the tax rates applicable to the company, and the tax treaties in place between the countries. Companies can also use transfer pricing strategies to allocate profits and minimize their tax liability in each jurisdiction.

In conclusion, the concept of Permanent Establishment is a critical component of international corporate tax planning, and companies that operate in multiple countries need to be aware of its implications. By understanding the tax laws and regulations in each jurisdiction, and by using effective tax planning strategies, companies can minimize their tax liability and maximize their profitability.

Author: Edwin Opiyo