Definition
A “Permanent Establishment” (PE) is a concept in international taxation that allows a country to tax the business profits of a foreign enterprise if it has a lasting or significant presence in that country. According to the Model Tax Convention drawn up by the Organization for Economic Cooperation and Development (OECD), a PE is defined as a “fixed place of business through which the business of an enterprise is wholly or partly carried on.”
Examples
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Branch Office: A foreign company’s branch office operating in another country is often considered a PE. This means that the profits attributable to the branch are subject to taxation in the host country.
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Factory or Workshop: If a foreign manufacturer sets up a factory or workshop in another nation, the factory is treated as a PE, thus the profits generated by the manufacturing processes there can be taxed locally.
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Mine, Oil or Gas Well: Any foreign company engaged in extracting natural resources, such as owning and operating a mine, oil or gas well, in a host country will create a PE, leading to tax obligations in that country.
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Construction Site: A building site, construction, or installation project constitutes a PE if it lasts for more than a specified threshold period, generally 6-12 months depending on the specific tax treaty.
Frequently Asked Questions (FAQs)
What is a double taxation agreement (DTA)?
Double Taxation Agreements (DTAs) are treaties between two or more countries to avoid or mitigate the double taxation of income earned in each jurisdiction. DTAs allocate taxation rights and provide methods to eliminate or reduce double taxation, often by granting tax credits or exemptions.
How does a permanent establishment affect taxation?
A permanent establishment can trigger tax obligations in the host country. The profits attributable to the PE are generally subject to local corporate taxes. The primary residence country of the business will usually offer tax relief or credits to avoid double taxation.
What are common criteria for a PE?
Common criteria include having a fixed place of business, duration of activities exceeding certain thresholds, and specific installations such as branches, offices, factories, and places of extraction of natural resources.
Can a PE be established without a physical presence?
Yes. Certain activities carried out by dependent agents or personnel in a country on behalf of a foreign enterprise can result in a PE, even without a physical office or location.
Is a liaison office considered a permanent establishment?
Generally, a liaison office limited to non-business activities like market research, information gathering, or promotional/advertising purposes is not considered a PE. However, this can vary by jurisdiction and specifics of the activities conducted.
Related Terms
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Double Taxation Agreement (DTA): Treaties that define how income earned in multiple jurisdictions will be taxed and how to mitigate double taxation.
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Tax Residency: The country where a company or individual is considered a resident for tax purposes.
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Arm’s Length Principle: A principle stating transactions between connected parties should be conducted as if they were unrelated, to ensure fair market value prices.
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Source of Income: The location or activity from which income is derived, impacting where income is taxed.
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Withholding Tax: Tax deducted at source on payments made to non-residents, such as interest, dividends, and royalties.
Online References
- OECD Model Tax Convention
- Internal Revenue Service (IRS) - Permanent Establishment
- Deloitte - Guide to Permanent Establishment
Suggested Books for Further Studies
- “International Taxation in a Nutshell” by Richard L. Doernberg
- “Principles of International Taxation” by Lynne Oats and Michael Lang
- “Taxation of International Business” by John P. Stokdyk
- “Concept of Permanent Establishment in the OECD Model Tax Convention” by Suresh Samuel Sharma
Accounting Basics: “Permanent Establishment” Fundamentals Quiz
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