UAE: History of Permanent Establishment (PE), and its Definition in Proposed Corporate Tax Regime

As discussed in our previous article, we have highlighted that with few exceptions, tax residents would be subject to corporate tax (CT) for their worldwide income while non-residents would be subject to CT on the taxable income from their permanent establishment (PE) in the United Arab Emirates (UAE); and Income which is sourced in the UAE.

The permanent establishment is a very important concept in the corporate tax world and a key determinant for the application of corporate tax. The PE is usually a fixed 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 sourced.

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 the 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, and it required two conditions to tax the income in the state.

• A fixed location in the other state; and
• The enterprise has an intention to continue performing business activities at that location.

In 1909, the word PE was used in the German double taxation act to stop double tax between the German states, and 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 Capita (OECD Model) and the United Nations Model Double Taxation Convention between Developed and Developing Countries (United Nations model).

The OECD model is by far the most common basis for defining PE internationally and is implemented in nearly 3000 tax treaties. The UAE, being a member of OECD, has proposed to develop its CT regime based on the OECD Model. Article 5 of the OECD model conventions deals with PE, and the same basis has been proposed to determine PE in the UAE as well. The PE of a foreign company in the UAE would be assessed based on the following two principles as given in the proposed public consultation document.

• Fixed place of business test
• Dependent agent test

Fixed Place of Business Test

The proposed document states that:

“A foreign company will have a PE in the UAE if it has a “fixed place” in the UAE through which the business of the foreign company is wholly or partly carried on”.

The fixed establishment includes a place of management, branch, office, factory, workshop, real property and building sites where activities would be 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 PEs. Generally, 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 place where the goods of the foreign company are used to store, display and deliver or make them available to another person for processing may not be considered the PE of the foreign company.

Dependent Agent Test

There is a risk that foreign companies may source their income from any country without setting up fixed establishments there like appointing an agent and processing all transactions through an agent. To eliminate this risk, "Dependent Agent" concept was introduced.

Where the "fixed place of business" test fails, and PE can be established based on the dependent agent also. it would be assumed that the dependent agent has met where the business travellers or UAE-based person act on behalf of the foreign company in the UAE, and habitually exercise, the authority to conclude the contracts in the UAE on behalf of the foreign company without the material intervention of the foreign company, it may constitute a PE in the UAE. However, if the person is working independently, and carrying out the foreign company business in the UAE like a normal business, it would not constitute a PE in the UAE.

The subsidiary by itself will be considered a separate legal entity, however, if the subsidiary is acting as a dependent agent of the parent company, then the subsidiary would be treated like a permanent establishment.

If the individual is acting in the UAE on behalf of the foreign company and executing the contacts habitually in the name of the foreign company, then the individual would constitute a PE of the foreign company in the UAE.

If you have a doubt about the presence of PE in the UAE, you should seek professional advice. Depending upon the circumstances, you would be advised to create a subsidiary or enter a short-term contract to avoid creating an inadvertent PE.?

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official but a personal opinion of the writer based on the public consultation document on corporate tax. For any queries/clarifications, please write to him at?[email protected] .