International Tax: Taxation of Nonresidents (PEs of Nonresidents)

ITP

  • BRANCH (PERMANENT ESTABLISHMENT) VS SUBSIDIARY
    • Taxable income:
      • Subsidiary (established in country A) of a nonresident: separate legal entity; resident in country A; taxed by country A on worldwide income
      • Branch (carries on business in country A) of a nonresident enterprise: part of the enterprise; nonresident in country A; taxed by country A only on the domestic source income attributable to the branch
    • Interest expenses incurred by the nonresident to finance its the activities of its subsidiary/branch:
      • Subsidiary: nondeductible; because they are separate legal entities.
      • Branch: usually deductible
    • Repatriation of funds
      • Subsidiary: distributes dividend; country A may impose a withholding tax on a gross basis
      • Branch: transfers funds offshore; no tax
        • To treat subsidiaries and branches equally with respect to repatriation of funds:
          • Some countries have adopted special branch taxes (Canada and the US)
          • Other countries impose a slightly higher rate of tax on nonresidents carrying on business in the form of branch
  • THE OECD MODEL TAX CONVENTION
    • Art 5 (Permanent Establishment)
      • 5(1): For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

      • 5(2): The term “permanent establishment” includes especially:

        1. a place of management
        2. a branch
        3. an office
        4. a factory
        5. a workshop, and
        6. a mine, an oil or gas well, a quarry or any other place of extraction of natural resources
      • 5(3): A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months.

      • 5(4): Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include:

        1. the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise
        2. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery
        3. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise
        4. the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise
        5. the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity
        6. the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e),
      • provided that such activity or, in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character

      • 5(4.1): Paragraph 4 shall not apply to a fixed place of business that is used or maintained by an enterprise if the same enterprise or a closely related enterprise carries on business activities at the same place or at another place in the same Contracting State and

        1. that place or other place constitutes a permanent establishment for the enterprise or the closely related enterprise under the provisions of this Article, or
        2. the overall activity resulting from the combination of the activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, is not of a preparatory or auxiliary character,
      • provided that the business activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, constitute complementary functions that are part of a cohesive business operation.

      • 5(5): Notwithstanding the provisions of paragraphs 1 and 2 but subject to the provisions of paragraph 6, where a person is acting in a Contracting State on behalf of an enterprise and, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are:

        • a. in the name of the enterprise, or
        • b. for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or
        • c. for the provision of services by that enterprise,
      • that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business (other than a fixed place of business to which paragraph 4.1 would apply), would not make this fixed place of business a permanent establishment under the provisions of that paragraph.

        • Commentary:
          • a), b) and c) may:
            1. legally bind enterprise A to the third parties
              • contracts are concluded with clients by an agent/partner/ employee of enterprise A so as to create legally enforceable rights and obligations between A and these clients
            2. or not legally bind A to the third parties
              • a “commissionnaire” (C) dan third parties conclude under a commissionnaire arrangement with a foreign enterprise (A). In that arrangement, C will act on behalf of A; then C will enter into a contract on behalf of itself (no rights and obligations between A and third parties, although in the end A will transfer its ownership of property directly to the third parties)
          • “in the name of” in a): may be stated explicitly or undisclosed the contract.
      • 5(6): Paragraph 5 shall not apply where the person acting in a Contracting State on behalf of an enterprise of the other Contracting State carries on business in the firstmentioned State as an independent agent and acts for the enterprise in the ordinary course of that business. Where, however, a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent within the meaning of this paragraph with respect to any such enterprise.

      • 5(7): The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.

      • 5(8): For the purposes of this Article, a person or enterprise is closely related to an enterprise if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same persons or enterprises. In any case, a person or enterprise shall be considered to be closely related to an enterprise if one possesses directly or indirectly more than 50 per cent of the beneficial interest in the other (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) or if another person or enterprise possesses directly or indirectly more than 50 per cent of the beneficial interest (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) in the person and the enterprise or in the two enterprises.

    • Art 7 (Business Profits)
      • 7(1): Profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits that are attributable to the permanent establishment in accordance with the provisions of paragraph 2 may be taxed in that other State.

      • 7(2): For the purposes of this Article and Article [23 A] [23 B], the profits that are attributable in each Contracting State to the permanent establishment referred to in paragraph 1 are the profits it might be expected to make, in particular in its dealings with other parts of the enterprise, if it were a separate and independent enterprise engaged in the same or similar activities under the same or similar conditions, taking into account the functions performed, assets used and risks assumed by the enterprise through the permanent establishment and through the other parts of the enterprise.

      • 7(3): Where, in accordance with paragraph 2, a Contracting State adjusts the profits that are attributable to a permanent establishment of an enterprise of one of the Contracting States and taxes accordingly profits of the enterprise that have been charged to tax in the other State, the other State shall, to the extent necessary to eliminate double taxation on these profits, make an appropriate adjustment to the amount of the tax charged on those profits. In determining such adjustment, the competent authorities of the Contracting States shall if necessary consult each other.

      • 7(4): Where profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.

Source:

  1. Brian J. Arnold, International Tax Primer (4th ed. 2019)
  2. The OECD Model Tax Convention
  3. Commentary on the OECD Model Tax Convention

 

1. Foto_AGUS DWI PUTRA

Hi, this article is summarised from Brian J. Arnold’s “International Tax Primer”. If you wish to read the book, please click FREE PREVIEW from Amazon.

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