International Taxation & ‘Service’ Permanent Establishment: What the UN Model Tax Treaty says?

Permanent Establishment (PE) is a tax concept, in the context of Cross-Border business expansion. This is a complex concept primarily arising from the ‘Source Taxation’ principles.?

In this article, I intend to discuss the Service PE and its (tax) implications.?

The popular Article 5 of the OECD (Organisation for Economic Co-operation and Development) Model Tax Treaty on PE is, unusually, silent on this. However, the UN Model Tax Treaty (meant to be between Developed and Developing Countries) did mention, albeit in very brief, about the ‘Service PE’.?

UN Model Treaty Article 5 Paragraph 3(b) says:

“The furnishing of services, including consultancy services, by an Enterprise through employees or other personnel engaged by the Enterprise for such purpose, but only if activities of that nature continue within a Contracting State for a period or periods aggregating more than 183 days in any 12-month period commencing or ending in the fiscal year concerned.”?

This means a ‘Service PE’ may exist if a Company/Enterprise resident in one country provides ‘Services’ in another country for more than a certain period of time (usually more than 183 days, in total, in a year) through its employees or other individuals.

So, even if the Enterprise did not have its own employees in another country, and ‘used’ the independent personnel (for example, on a freelance temporary contracting basis) there to provide ‘Services’ for a period of time exceeding 6 months – this may trigger existence of a PE, for tax purposes, in the other jurisdiction.?

Most Double Tax Treaties (DTTs), between developed and other countries, are commonly based on OECD Model Treaty (which does not mention ‘Service PE’), with some ‘tweaks’ and ‘departures’. However, some jurisdictions’ DTTs did include a few provisions of UN Model as well including Service PE.

For example, DTT between Norway and Nepal does include the concept of Service PE, in line with UN Model, which was agreed and signed back in 1996. This is the second DTT (after India which was first agreed in 1987) Nepal entered into.?

More recently, some countries (including Saudi Arabia, for example) have been keen to include the Virtual Service PE in the UN and OECD Model Tax Treaties.?

As a temporary measure, United Kingdom (UK) has 'unilaterally' introduced (from April 2020) a 2% ‘Digital Services Tax’ (DST) on the revenues made by the ‘Digital Services Companies’ from their UK user base (subject to thresholds and conditions). This effectively brings in, with their users in the UK, Social Media Companies, Search Engines and Online Marketplace to the UK tax radar, through a Service PE equivalent (probably unintended by the Businesses!) in the UK.?

However, OECD’s plans to reform International Corporate Tax, announced in July 2021, means the UK’s DST is likely to be withdrawn by the end of 2023, in order to facilitate adoption of OECD’s ‘Pillar One’ model (globally uniform tax reforms) in 2024. UK has committed to a 15% minimum level of global tax on large businesses, to complement OECD’s ‘Pillar Two’ proposal, which may come into effect as early as April 2024.

Tax?

Where a PE exists, in another country, such country extends its right to tax on the profits made by the PE, but only to the extent that profits are generated from the assets/resources used, risks borne and activities performed by the PE in that country.?

Double Tax (How to Eliminate)?

PE is not a separate legal entity and is part of the main Enterprise resided in another country. Hence, the profits made by the PE may also be part of the ‘total profit pot’ of the Enterprise, liable to tax in the ‘resident’ country, resulting in double taxation!

Where double tax arises, in two countries, on the same profits, tax paid in the country where the PE is may be credited/relieved against the tax due and payable in the ‘resident country’ where the main Enterprise is (subject to restrictions).?

Disclaimer:

No responsibility, no advice, general comments, personal opinion only?

10 Dec 2023