What is permanent establishment, and how it attracts tax

Permanent Establishment (PE) is an especially important concept in corporate tax and a key determinant for applying corporate tax.

The PE is usually a fixed or permanent place of business, other than a subsidiary in any other country or state, and the income from the PE is usually subject to tax in the same state or jurisdiction from where the income is being derived.

The original concept of PE can be traced back to Germany. In 1845, the concept was first seen in the Prussian Industrial Code, but it was not used for tax purposes at that time.

Later in 1869, Prussia and Saxony (two German states) concluded the first-ever tax treaty, which specified the conditions for taxation as a stehendes Gewerbe (standing operation).

According to article 2(1) of the treaty signed between two German states, a non-citizen was taxable in a state where an enterprise used a gewerblichen oder Handels-Anlage (business establishment). The Prussian concept of a standing operation was a general limitation of source-state taxation as it required a fixed location and intention to perform the business activities in the state to tax income in the state.

In 1909, the word PE was used in the German double taxation Act to stop double tax between the German states. In 1928, the League of Nations developed a model to tackle cross-border double taxation and to counter tax evasion. Since then, extensive work has been done on the tax treaties under the OECD Model Tax Convention on Income and on Capital (OECD model) and the United Nations Model Double Taxation Convention between Developed and Developing Countries (United Nations model).

The OECD model is the most common basis for defining PE internationally and is implemented in nearly three thousand tax treaties. Article 5 of the OECD model conventions deals with PE, and the same basis has been used to determine PE in the United Arab Emirates (UAE).

Article 14 of the law says that a non-resident shall have a PE in the UAE if the nonresident person has (i) a fixed or permanent place of business in the UAE, (ii) a person who conducts business or business activity on behalf of a non-resident person in the UAE or (iii) any other form of nexus in the UAE as specified in a decision issued by the Cabinet.

If there is a fixed or permanent place in the UAE through which the business of the non-resident person, or any part thereof, is conducted, it shall be assumed that the non-resident person has PE in the UAE. The fixed or permanent place includes the place of management, branch, office, factory, workshop, land, building and other real property.

The building sites, construction projects, place of assembly or installation or supervisory activities in connection therewith shall be considered PE if these are carried out for more than six months. Installations and structures used in the exploration of natural resources, as well as mines, oil or gas wells, quarries, and other places of extraction of natural resources will also be considered PE. Preparatory or auxiliary activities like limited marketing and promotional activities, performing market research and attending seminars or conventions etc do not fall under the definition of PE.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official opinion of the Khaleej Times but a personal opinion of the writer. For any queries/clarifications, please write to the writer at mahar@kresscooper.com