The Question Of What Constitutes A Permanent Establishment Is Of Crucial Importance In The International Taxation Of Business Profits.

2241 words - 9 pages

Q. The question of what constitutes a permanent establishment is of crucial importance in the international taxation of business profits. Explain why this is so and critically examine recent developments in the interpretation of the concept.A. Introduction: Importance of permanent establishment.The term permanent establishment (PE) of a non-resident is a key concept in the typical double tax treaty, and in the OECD model tax treaty. The existence of a PE is necessary for a source country to tax business profits of a resident of another country. If an enterprise fails to classify as a PE its profits will be exempt from income tax in the country of source and would only be subject to fiscal compliance in the country of residence. There are certain countries which may impose a withholding tax on specific categories of business incomes earned by non-residents who are not classified as PE; however these withholding taxes can be precluded through international accords.Although definitions of PE might vary across countries to take into account the enacting country's specific circumstances, most states draw on the general principle of the OECD model which defines PE in Article 5 Paragraph(1) as "A fixed place of business through which the business of an enterprise is wholly or partly carried on". Fixed in the sense that a physical building or property is used to carry out the enterprises business and it should be foreseeable that the enterprise's use of such property is more than temporary. However, as the essay progresses we will see that merely having a physical place of operation is not sufficient to constitute a PE, certain other criteria also needs to be satisfied. For example a property owned solely for the use of storage or for collecting information would not constitute a PE .Historically, the concept of PE answered the internationally-felt need for ascertaining the taxability or foreign commercial activity in the source state. The PE principle provides sufficient evidence that a foreign enterprise's business within the source country was substantial enough to justify the imposition of fiscal compliance burdens on the foreign company in that country.This concept satisfied the requirement of certainty and predictability of tax law as it provided multinational companies with relatively clear rules to determine in advance whether and in what way their activities abroad would be taxed by foreign tax authorities. Furthermore, the PE principle presented states with an internationally equitable rule for sharing the benefits of cross-border commerce, so that importing countries can reap the benefits of opening their doors to foreign business. The rationale is simple if the resident country is benefiting from operations undertaken in country X, country X should surely be allowed some benefit as well.Having laid down the general concept behind PE we will now look into some of the recent developments and proposals relating to the interpretation of PE...

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