INTRODUCTION OF “PERMANENT ESTABLISHMENT” CONCEPT IN UGANDA’S INCOME TAX LAW
Multinational enterprises doing business in foreign countries are typically subject to the domestic tax laws of the countries where they are engaged in business activities, and clear rules must exist to determine when such enterprises are taxable. It is a well-established principle of taxation that countries have the right to tax income generated in their territory by both residents and non-residents. Historically, taxing rights are based the existence of Permanent Establishment (PE) in a jurisdiction. Where no PE exists, then there are generally no rights to tax business profits of a foreign entity.
‘Permanent establishment’ (PE) is an important international tax concept that generally means a fixed place of business in another country or State. The fundamental characteristic of a PE is the absence of legal personality in a country other than that of its head office. Accordingly, the concept creates a minimum threshold below which the source country does not attempt to tax the business income of a foreign enterprise. That threshold is crossed when a foreign enterprise maintains either -
While the definition of PE in Double Taxation Agreements (DTAs) decides which State will have the right to tax a given income, the domestic law establishes its own tests to define how such rights to tax is exercised by the source State. Important to note however, is that inclusions or restrictions under domestic law will not apply where a DTA with appropriate wording is in place.?
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Uganda is defining a PE from a domestic perspective to apply in cases where a double taxation treaty is non-existent. The amendment to the Income Tax Act that was passed by Parliament has substituted the term “branch”, originally used under the provisions for international taxation to describe a non-resident person deriving profits from the country, with the term “permanent establishment”, and adopted with modifications, the PE definition as contained in Article 5 of the UN Model Tax Convention, which was also based on Article 5 of the OECD Model Convention, but contains several significant differences. Important to note is that the UN Model Convention generally favours retention of greater taxing rights for the host country of investment as compared to those of the “residence country” of the investor. It is also worth noting that the definition maintains the paradigm of physical presence as a requirement for a foreign enterprise to be considered as undertaking economic activities in a territory. This is no longer consistent with developments in the international tax space and a globalised world, in which technology has changed ways of conducting business through internet-based markets that no longer require physical presence to conduct business. E-commerce is heavily applied in selling products and services internationally and many multinational enterprises have digital solutions incorporated in their business model. This allows them to circumvent the fixed place requirement for constituting a PE for tax purposes. Therefore, a shift towards entrenching taxing rights where value is created by introducing the concept of a Virtual PE is worth studying.?
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In the amendment Act, a PE is defined to mean a fixed place of business through which the business of the enterprise is wholly or partly carried on. To ensure that every stage of an investment activity is covered, the definition extends to fragmented activities of a common project by aggregating the duration to create a PE. This is because it is a common practice for companies working on projects that run for longer than the PE duration limit (3 months in Uganda), to break up the various stages of the project or to split these requirements among different group companies to try to avoid the creation of a PE. This complexity in the determination of a PE will require URA to closely monitor the work performed by various entities in order to correctly assess the number of existing PEs and their respective timeline. The scope of the definition is therefore, extremely wide and is intended to provide more taxing rights to Uganda. This is part of a conscious effort to preserve taxation rights, while recognising that taxation should not deter investment as long as the investor has other incentives. In this regard, a fixed place of business is being defined to include -
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Based on the above inclusions, triggering a PE can occur either through a company’s physical presence in Uganda through a fixed place of business; or through the period of time during which the enterprise operates in Uganda. There is a three-month test for a building or construction site to constitute a PE, and this extends to assembly projects, as well as supervisory activities in connection with building sites and construction, assembly or installation projects. The furnishing of services by an enterprise through employees or other personnel results in a permanent establishment where such activities continue for a total of more than 183 days (6 months) in any twelve-month period commencing or ending in any year of income. As regards substantial equipment or machinery, the operation or availability for operation of such equipment for periods in aggregate amounting to more than three months in a year of income, constitutes a PE.
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However, there are specific activities which are not recognised as constituting a PE. These include the use of facilities for storing, displaying or delivering goods or merchandise of an enterprise. The reason for the exclusion is based on the fact that a PE arises when the place of business is used for enterprising purposes and not for storing, displaying or mere delivery of goods. Activities which are temporary, preparatory or auxiliary in character, do not trigger a PE even if the activity is carried on through a fixed place of business. A preparatory activity is an activity carried out in advance of the principal or core activity of the entity, in order to prepare for its implementation and performance. An auxiliary activity corresponds to an activity which supports the principal activity without directly being part of the activity. The reason for their exclusion could be found in the difficulties connected with the attribution of profits to such marginal business activities (that in most cases generate losses rather than profits). It is often difficult to distinguish between activities which have a preparatory or auxiliary character and those which do not. The decisive criterion is whether the activity of the business in itself forms “an essential and significant part of the activity of the enterprise as a whole”. Each individual case will have to be examined on its own merits.
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Chargeable income of a PE in Uganda
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Under DTAs, the profits of an enterprise should be attributed to a PE on the basis of the “separate enterprise” concept which attempts to treat a PE as if it were independent from the enterprise of which it is part, and the application of the arm’s length principle. In other words, DTAs require that the PE must be treated as if it were a separate enterprise, which it is not. This is intended to provide a limit to the consequences of applying domestic law, and to ensure that only the profits attributable to the PE are taxed in the host State. Afterall, a taxpayer should not be worse off as a result of the operation of a DTC than it would be under domestic law.
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In legal terms, a PE is not a separate legal person and accordingly, there can be no legally binding contracts between a PE and other parts of the enterprise. There can be no separate ownership of assets by the PE or by its head office; and no payments can be made between the PE and its head office since the funds paid belong, in law, at all times to the same person. Strictly speaking, no profit can be realised on any dealings between a PE and its head office. There is, therefore, a fundamental tension between the legal position of a PE and the separate enterprise concept. On the one hand there is the “legal fact” that the PE is a part of the same enterprise; on the other hand, there is the “fiscal fiction” that the PE is a separate enterprise.
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For the purposes of determining the taxable profits of an enterprise, the amendment to the ITA on the one hand, gives a PE absolute independence as a distinct and separate entity (i.e. a legally separate person) from its non-resident parent, but on the other hand, any transactions between the PE and its foreign parent shall be based on the arm’s length principle, as if the two were associates, i.e. a combination of an underlying separate enterprise concept and arm’s length principle. This provision embraces a restricted independence for the PE under which it treats it as independent but also gives some recognition to the fact that it is not a separate entity and is part of the enterprise as a whole.
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A PE in Uganda will be taxable only on its income derived from, and attributable to activities which occur in Uganda. The tax treatment of income generated by a PE depends on the nature of income i.e. whether it is a business income, a capital gain or income from shipping and Air transport, dividend, Royalty, fees for Technical Services etc. Specifically excluded from the income of a PE are incomes from the head office by way of royalties, fees or other similar payments in return for the use of patents or other rights; commission for specific services performed or for management; or interest on moneys lent to the head office of the permanent establishment or any of its other offices.
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The law as enacted denies a deduction for any payments to the head office or with another PE of the same head office or with other persons or organisations connected to the head office or its permanent establishments, whether these are located inside Uganda or abroad, on account of royalties, interest, commissions, management fees, technical assistance services and fees for the use or assignment of patents or rights. This is because as a developing country, the tax administration typically lacks the necessary resources to deal with lengthy and complex tax disputes associated with non-deductibility of such payments that the PE makes to the head office.
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Deductions or expenses which are incurred for the purposes of the business of the PE qualify as allowable deductions. However, transactions carried out with the head office or with another PE of the same head office or with other persons or organisations connected to the head office or its permanent establishments, whether these are located inside Uganda or abroad, are subject to the rules governing related-party transactions as provided in the Act i.e. arm’s length transactions.
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Finally, PEs are required to undertake separate accounting, as well as to fulfil other filing and formal accounting obligations to which corporate taxpayers are subject.
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Regional Tax Manager & Head of Tax - Africa | Master in Tax and Customs Administration
10 个月Always refreshing listening to your insightful analysis especially when it comes to taxation landscape in Uganda.