Permanent Establishment under the OECD Model Tax Convention


One of the biggest issues in domestic and cross border transactions is the taxing rights of the states. Scholars agree that the international concept on those taxing rights gives directory to most domestic law to reflect on their tax laws and agreements. In that respect the definition of permanent establishment (hereafter PE) is an important concept. As most countries asses taxing rights to a connection between the taxpayer and the taxable activities within their territory, it is PE’s existence that determines whether, or not, the state of certain country has right to tax on the taxpayers profits. The necessity of definition of PE is mostly due to avoid international double taxation on the foreign company’s profit that is subject to taxation. So for the benefit of the countries there have been a couple of international concepts for the PE for countries to use as a model. The Organization for Economic Co-Operation and Development (hereafter OECD) introduced one as the OECD Model Tax Convention on Income and Capital (hereafter OECD Convention). It was largely established to protect the OECD member countries from being subject to double taxation but nowadays the OECD Convention concept has influenced most, if not all, of the country’s domestic laws concerning PE definitions.

Article 5 of the OECD Convention gives a definition on what is PE and whether PE exists at the country in question. Even though the OECD Convention has been revised several times, the latest being in July, 2010 [1] , due to the necessity of time and development in international transactions there still remains problems in the interpretations of the article in practice. This paper aims to analyze the definition of the PE and compare the changes made in the latest OECD Convention taking into account several cases which raised questions in the interpretation of the article.

The first part of the paper will examine the definition of PE given in the OECD Convention in detail, heavily discussing the interpretations given in the Commentary of OECD Convention (hereafter OECD Commentary). On the second part, I will discuss cases involving the questions that rose in practice and lastly will conclude on what problems may still rise in the interpretation of the Article 5 of the OECD Convention.

The Concept of Permanent Establishment under the Article 5 of OECD Convention

As I mentioned in the introduction the OECD Convention is a part of an international attributes to encourage cross border trade and investment. In his interview Jeffrey Owens, Director of the OECD Centre for Tax Policy & Administration, mentioned that the main objective of the OECD Convention is to remove tax as a barrier to trade by insuring to avoid double taxation, double non taxation and provide safe environment for tax payers and large enterprises [2] . So the in short OECD Convention is all about “setting the international rules, get a consistent application and resolving disputes [3] ". So when the large corporations engage in cross border trade they are subject to double taxation from the home country where the corporation reside and the resident country where the corporations certain activity takes place. In that respect usually the home country and the resident country engage in a double taxation treaty (hereafter DTT) which enables them to avoid double taxation. So when important concepts of the DTT are based on the international rule, in our case it’s the OECD Convention, it provides certainty for both home and resident countries.

Taking above in to an account PE is a very important concept in DTT as PE’s existence gives the resident state the right to tax on the business profits of the corporation of the home country on the activities carrying on in their territory. In general the concept serves to be a solution to guarantee legal certainty for the allocation of taxing rights between the relevant States. Usually resident states have definition on PE on their domestic laws and that definition is used when there is no DTT’s between the countries but as mentioned earlier most, if not all, countries use the internationally recognized concept in their laws regarding PE, one of them being the Article 5 of the OECD Convention.

Article 5 of the OECD Convention gives the definition on what is PE and which things are considered PE. In their book Miller and B.Bus gives a very accurate diagram [4] summarizing the definition of PE on the Article 5 of OECD Convention. In the summary it shows that if Company A of the resident State A does a significant business activity which is to found a fixed place of business in State B or that business activity is done by the services of a ‘dependent agent’ then the State B has the right to tax that activity on the grounds that the Company A has a PR in State B. It points out certain key terms on the definition of PE under the Article 5. But Article 5 of the OECD Convention itself is mainly divided into 4 parts - 1. Definition 2. What are included 3. What are not included 4. Guidance to a different type of PE. The classical definition of those key terms has not changed since 1977. If to put it in a box it would show as follows:



Paragraph 1

The term “permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on [5] .


So the key words are “fixed place of business" and “business of an enterprise is wholly or partly carried on". The OECD Commentary comments that to fulfill above concept it has to contain certain conditions [6] :

There has to a ‘place of business [7] ’ taking examples such as premises or, in certain circumstances machinery or equipment;

The place of business must be “fixed" meaning it must be established at a distinct place with a certain degree of permanence;

The business of the enterprise must be carried out through this fixed place of business. Meaning that it should be persons who, in one way or another, are dependent on the enterprise (personnel) that conducts the business of the enterprise.

The OECD Commentary further clarify that to be a PE it does not necessarily have to have the legal rights for the place of business meaning a permanent establishment could exist where an enterprise illegally occupied a certain location where it carried on its business. So ‘a fixed place of business’ is a somewhat a permanent place which can be addressed [8] where a person or a personnel that has connection to the enterprise conducts the enterprise business. Furthermore, the Commentary demands that term ‘fixed’ has to have a link to specific geographical point [9] but not necessarily fixed to the soil which is making the term ‘fixed’ to contain temporal meaning (like specified in the paragraph 3) also and opening more possibilities such as ‘moving business’. Further questions shall be discussed later in the paper.



Paragraph 2 and 3

The term “permanent establishment" includes especially:

a) a place of management;

b) a branch;

c) an office;

d) a factory;

e) a workshop, and

f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.

And a building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months.


OECD Convention used wording ‘the term permanent establishment especially includes’ and based on the OECD Commentary because of the phrase used ‘only if they meet the requirements of paragraph 1 [10] ’ it seems that paragraph 2 does not extend the scope of definition of PE on paragraph 1 but merely gives an example on what can be as typical examples. Paragraph 3 deals with building site or construction or installation project and under the OECD Commentary of 1977, it includes the construction of roads, bridges, canals, laying pipe-lines, excavating and dredging. The term also includes planning and supervision of the above mentioned but only if its carried on by the building contractor and not carried on by another enterprise whose only function is planning and supervision [11] . In his commentary Baker suggests that the paragraph 3 is in relation to the PE of contractors who carry out the work involved in the construction or installation project rather than the owners of the land or premises on which the project is carried out [12] . Meaning that if an owner of land or premises employs a contractor to construct a building on the site, the project lasting for more than 12 months; it is the contractor who has a PE and not the landowner.



Paragraph 4

The term “permanent establishment" shall be deemed not to include:

a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;

b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;

c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise;

e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;

f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.


Paragraph 4 lists number of examples that is not to be considered as PE even if the activity is carried out by fixed place of business. OECD Commentary states that these lists of business activity is treated as an exemption from the general definition given in paragraph 1 and the common feature of these activities are preparatory or auxiliary activities [13] .


Guidance to a different type of PE

Paragraph 5 – 7

5. Notwithstanding the provisions of paragraphs 1 and 2, where a person — other than an agent of an independent status to whom paragraph 6 applies — is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.

6. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business.

7. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.


Paragraph 5 and 6 gives guidance to a type of PE that can be considered a PE by the use of ‘Agents’. So according to the OECD Commentary on paragraph 5, persons who can create ‘Agency PE’ are either individuals or companies [14] . It also explains that the term ‘person’ can include any entity that is not incorporated can be treated as a body of corporate of tax purposes [15] . In the Commentary it regards them as a dependent agent, whose existence can create a deemed PE without there being a fixed place of business [16] . The main concept of being a dependent agent is that the person has to have an authority to conclude a contract in the name of the enterprise [17] . In summary, the action of binding the enterprise in a contract must be used often, meaning that one off transaction cannot be considered of bringing PE into existence and the contracts concerned must be generally with customers rather than internally within the enterprise or being limited to just hiring stuff [18] .

Paragraph 6 concerns itself with term ‘independent agent’ and where it’s used in other State. As paragraph 5 lists the essential elements of Agency PE, it excluded the person who works for its own or other enterprise making it an independent agent and gives an example like broker or general commission agent. The OECD Commentary furthers states that a person will only have independent status if it is independent both legally and economically, and it acts in its ordinary course of business when acting on behalf of the enterprise [19] . Commentary also states several factors [20] to prove the person’s independence and if to meet these factors then the considered independent agent does not constitute a PE of the enterprise. But then an agent who concludes contact in the name of the enterprise but meet the criteria of the paragraph 6 does not constitute a agent PE then it can be concluded that the difference between dependent agent and independent agent cannot be factored by only on the factor of ‘concluding contract in the name of the enterprise’ [21] .

Paragraph 7 considers the possibility of subsidiary of a parent company being a PE in the State. OECD Commentary reflects that generally as subsidiary is considered independent of its parent company, it’s not considered to be a PE for its parent company. But if the parent company can have a PE in a state where the subsidiary resides on the grounds that it fulfills the requirements of paragraph 1 and 5. Thus, any premises belonging to the subsidiary that is at the disposal of the parent company and that constitutes a fixed place of business through which the parent company can carry its business can be considered a PE for the parent company [22] . The same principals apply for the multinational group of companies but the relationship of each pair of companies is to be considered separately [23] .

Related Cases and Issues

Recent two cases regarding PE are Knights of Columbus v R [24] and American Income Life Insurance Company v Canada [25] . Undoubtedly these are one of the most known cases which raised questions regarding the definition of PE and what it entails. The cases were decided in Canada by the Tax Court of Canada by the same judge [26] . The key issues regarding PE on the cases were [27] :

What is fixed place of business? Whose place of business?

What constitutes a dependent agency? What is meant by the authority to conclude contracts and are temporary insurance agreements separate contracts?

What is the relationship, and meaning should be ascribed to an inconsistent use of clauses in a country’s treaty network?

So the facts in the cases are the two USA insurance companies conducted a business through a hierarchy of agents in Canada. The responsibilities of those agents were contacting potential clients, soliciting insurance applications and collecting initial premiums for temporary insurance. There were no authority given to the agents to change insurance policies and most agents worked from their homes which were not used by the USA companies. The USA companies provided materials and guidance to the agents and remunerated them on commission basis. So the main questions regarding the facts are does the USA companies have a PE in Canada and can it be considered Agent PE in Canada taking account the activities of the agent. The judge [28] ruled that USA companies did not have “fixed place of business" in Canada on the grounds that even though the agents homes/offices were both permanent and a place of business, the USA companies did not have those homes/offices at their disposal. In Miller’s view [29] to be considered a fixed place of business they have to have premises at the disposal to carry out their business and as the companies could not use the homes/offices any time they want it meaning they were not fixed place of business. Also other conclusion was that there was no “Agency PE" in Canada. As the agents were legally and economically independent and they did not have authority to make a contract on behalf of the companies. In other words they were not a dependent agency meaning they cannot be agency PE for the USA companies. Elliffe states that decision of above cases where important to not only to Canadian but also to international perspective as it provides a good guidance on what exact criteria is needed to be fulfilled in order to establish the authority to conclude contracts which very important in determining whether you have a dependent Agent PE. Also the case law illustrates a good analysis on what constitutes as fixed place of business PE.

Also one of the most talked about issues regarding the PE is e-commerce. It has been a rising issue for past 5 years since ever increasing developments in the area of information and technology. As the internet and other IT technology grows the physical goods have been replaced by digitized goods (e-commerce), labor performed in specific place no longer necessarily requires a physical presence and the service provider and customers does not need to be in one place to commerce making the mobility of the economic activity to grow faster through the same IT developments [30] . After much research and discussions OECD Convention included commentary regarding e-commerce. The OECD Commentary questions if mere use in electronic commerce operation of computer equipment could constitute as a permanent establishment and makes a clear distinction between tangible computer equipment (e.g. a server) and intangible software and data (e.g. a web site) for the purposes of Article 5 of OECD Convention [31] .Yet, although a server as such cannot be a PE itself, the place where it is stored, together with the server, may constitute a place of business [32] . If so, in case of web sites, can the user’s computer itself could be regarded as a “facility" as it tangible and harbors the website itself? According to the Commentary, the existence of premises is not a precondition for the constitution of a PE [33] . It is important to note that the comments discussed above apply where the enterprise operating the website and the internet service provider are located in countries that have a DTT based on the OECD Convention as entirely different rules can apply if there is no treaty to rely upon.

Furthermore, the concept of ‘server PE’ has been attracting attention for some time.