Khaleej Times, Tuesday, Jan 17, 2023 | Jamadi Al Thani 24, 1444
What is permanent establishment, and how it attracts tax
Emirates:
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.
The fixed or permanent place used to keep, store, display or deliver the goods
of a non-resident person, shall not be assumed PE of the non-resident person.
However, if the non-resident or its related party has another PE in the UAE
which has business cohesive/integrated operations with this fixed or permanent
place, and on an overall basis, activities of all operations are not being used
for preparatory or auxiliary activities for the non-resident in the UAE, then it
will be assumed that non-resident has PE in the UAE.
Non-resident persons may source their income from any country without setting up
fixed establishments like appointing an agent and processing all transactions
through the agent. To counter this risk “Dependent Agent” concept has been
introduced.
Where the “fixed or permanent place of business” test fails, PE can also be
established based on the dependent agent. The results of the dependent agent
test shall be positive, where the person (company or individual) habitually
concludes or negotiates contracts that a non-resident person concludes without
material modification. However, if the person is working independently and
conducting business or business activity on behalf of a non-resident person in
the normal course of business, it will not constitute a PE of the non-resident
person in the UAE. So, we can say PE will not be established merely based on the
independent agent but exclusive agent.
The subsidiary will be considered a separate legal entity, however, if the
subsidiary acts as a dependent agent of the parent company, then the subsidiary
will become a PE of the parent company.
We need to wait for the Cabinet decision, which will clarify the nexus of the
non-resident person in the UAE that will create PE of the non-resident person.
If you need more clarification about the presence of PE in the UAE, you should
seek professional advice. Depending upon the circumstances, you will be advised
to create a subsidiary or enter a short-term contract to avoid creating an
inadvertent PE.