• The Concept of the (Neither) Permanent (nor an) Establishment and the (Destination Favourable) Attribution of Profits

    By Giannis Psarakis

    28-03-2019

    The concept of the permanent establishment is fast approaching its hundredth year. When it was firstly shaped, it was destined to serve specific policies by tackling certain inconveniences. In order to achieve that, the economic climate (the business status quo) had to be taken into account, so as for the given regulation to be adjusted. All the above happened and the result was brilliant. Though, things have not remained the same throughout this century; after all, should this have happened, it would have been alarming. It is oxymoron - but also true - that nowadays, a permanent establishment does neither need to be permanent, nor even an establishment. Arguably, a sceptical approach, indicatively focused on the condition of the permanence and the fixedness for establishing a PE, through its history, may demonstrate that the time passage has led to a dysfunction. A new nexus is imperatively needed. This article ends with a thought-provoking question, regarding the need of a new method for the calculation of tax liability when a permanent establishment is ascertained; given that the policy - which dictates the measures deployed - cannot be but closely related to the problems it aspirates to solve. Having said that, not only have the problems changed, but they have also proliferated; so maybe the policy (and as a consequence the fundaments of the measures deployed) must also be differentiated.

    1. Introduction

    1.1. Essential Remarks

    The concept of the Permanent Establishment (hereafter: PE) constitutes the outcome of the work made by the League of Nations, aiming at developing a method which would solve the problem of double taxation, when two States are entitled, according to their own national tax legislation, to levy income tax to a specific taxpayer. The problem was so dense, that there were cases where double taxation was amounting to an effective percentage of 100% or more, of the total revenue1. If no action was to be taken, international commerce had no rational reason to exist, let alone expand. That is why the International Chamber of Commerce (ICC) was the one that took the initiative and asked for the League of Nations’ action so as to – later on - adopt its resolution.

    Besides that, regarding the States’ position, international commerce’s collapse would deprive income taxation from such activities, as there would not be any (or in any case there would be a dramatic reduction of them) income to constitute the base for such taxation. It is for one State’s benefit to settle for the restriction of its power to tax, rather than not compromising and thus not gaining any income taxes at all. Regarding the merchandisers’ side, it is already clear that the avoidance of double taxation is of vital importance. In other words, it is more than obvious that a remedy which would tackle the problems of double taxation was a ‘win-win … – win’ matter (i.e. State A-State B-merchandisers).

    Consequently, the goal was to find a measure for double taxation to be eradicated. The notion of the permanent establishment, as analysed below, seemed to be – and indeed was, at that time – not only an effective remedy, but also a means which delivered not an arbitrary, but, on the contrary, a fair enough allocation of taxing rights2. We talk about a ‘dichotomy’ notion, which attributes the power to tax to a certain State, according to several criteria. From now on, each State will not decide merely on its own whether it is entitled or not to levy income tax to a specific taxpayer. Hence, an article of a Convention for the avoidance of double taxation has just been born. The State is still sovereign, given that it deliberately chose to sign it, as previously it realized that double taxation ends up in being detrimental for its ‘bottom line’ results. From now on, it depends on the bilateral agreement, to determine which State will be entitled to tax (and, in the follow, have the opportunity to decide whether it will tax the taxpayer at all and in which way). Bilateral agreements incorporated the notion of PE, confining, that way, their power to tax. Let me elaborate on this a little further:

    Assuming that State A adopts a residence based taxation, whilst State B a source based one; what the notion of PE does, is to add a negative prerequisite for State’s A power to tax, while adding a positive one, regarding State’s B power to tax. Eventually, the situation has been shaped as follows: residence based State A is entitled to tax a certain revenue, not only when the conditions of its own tax legislation are met, but also something else should be absent (negative requisite); a PE in another State. That constitutes a compromise for State A. On the other hand, source based taxation adopted by State B, would normally end up levying income tax on a legal entity, only on the basis that the source of income originates from its soil. However, State B, also compromises from its side; there should not only exist an income in the source country (i.e. State B)- which was adequate for the national tax system - but also a PE should be present thereon, constituting a positive requisite.

    In both cases, the satisfaction of the conditions set on their own national tax legislation, is not enough; we also need an extra condition. And, as it is well known, the addition of one condition (either a negative or a positive one) for the imposition of the rule, makes the former harder to be satisfied. Where an enterprise is a resident of one State with income originating in another state (source country), international tax rules provide that the source country has the taxing rights over such income, only if it is established that the enterprise has a PE in the source country. Accordingly, the residence State has the taxing rights over such income, only if it is not established that the enterprise retains a PE in the source country. To cut the long story short, the definition of the PE included in tax treaties, is crucial in determining whether a non-resident enterprise must pay income tax in another State.

    1.2. Exploring the ‘Premises’

    But how did the framers of the PE notion arrive at that mechanism? It seemed fair that the prevalent principle of residence based taxation could be overlooked, in cases where one enterprise's presence in a foreign jurisdiction, was revealing a considerable penetration into a foreign market, i.e. noticeable benefits3. Amongst others, it could be noted that the following argument played also a determining role to their decision: it would be ‘unfair’ not to return a certain amount of money to the country, the citizens of which4 expended some considerable wealth to a taxpayer of another State, that way lowering the potency of a national economy. Thus, a number of criteria was set up, in order to describe this demanded quality (extent) of presence, that, in the follow, could lead to the conclusion of the necessitated significant economic presence in the aforementioned foreign market. Subsequently, the criteria set out in Article 5(1) of the OECD Model Convention on Income and on Capital (hereafter: MC) amounted to a situation which required the existence of a fixed place of business (through which the business of an enterprise would wholly or partly carried on), so as to be possible to conduct activities that can rise to the level of a PE.

    At this point, a prompt needs to be done, since a scrutinizing examination of the concept can only be conducted against the backdrop of its historic evolution. The scenery is set at around 1920 and apart from the fact that economic cross-border activities were mainly trade of goods, the means of production were of considerable size and quite difficult to be transferred, hence requiring to be established at a certain fixed place so as for the producing procedure to begin. The ‘fixedness’ was the only possible way to truly penetrate a foreign market (apparently, except for the agency case, which still also required a physical presence). Any other way that could justify the transition from the residence based taxation, was rather impossible5. Thus, the economic environment of the early twentieth century, played a determining role on the PE’s strong reliance on physical presence.

    Besides that, and bearing in mind that the desideratum was this significant penetration (significant economic presence) into a foreign market, it was going without saying – on those days – that duration (permanence) was also a sine qua non condition. Therefore, the sum of the criteria set out, were amounting to a ‘permanent establishment’6. Hence, given the business environment and the general conditions, the content of a permanent establishment would lead to a significant penetration in a foreign market and vice versa; the significant penetration into a foreign market could not happen without a permanent establishment. Albeit, nowadays, the latter is not without exception.

    The aforementioned analysis of the climate into which the PE concept was crafted, is crucial to perceive the following: the specialists who first shaped the definition of the PE, were bearing in mind that the crucial factor, meaning the considerable penetration into a foreign economy, necessarily demanded a fixed place of business. So, the very starting point to determine whether a permanent establishment exists, is (or should be, or was) a ‘fixed’ place of business. However, it is imperative that we keep in mind the more profound requisite simmering beneath the surface, which is the significant economic presence7. And, in addition to that, we may keep in mind that whilst significant economic presence without a fixed place (through which the business of an enterprise is wholly or partly carried on) was completely out of question, it nowadays tends to be a relatively common case.

    2. Main Analysis

    2.1. The Prerequisites: Elaborating the ‘fixed’ place Condition

    The interpretation of the ‘fixed’ term, is among the most intriguing matters overtime. Initially, as stated above, it was rather certain that a contemporary and moving from place to place business, could not lead to a PE (as it was impossible to succeed significant benefits, i.e. economic presence, via these characteristics)8. After all, the name of the concept is making it crystal clear; not just a mere establishment, but a permanent one.

    Thus, as the PE’s prerequisites were crafted, this term splits, basically, into two conditions; we are talking about both the duration test and the location one. However, as years were passing by, and business models were constantly evolving, these conditions were being more and more mitigated. It would not be exaggerating to claim that, were the prerequisites to be employed exactly as they used to be interpreted in the past, a noticeable percentage of the latest cases which affirm PE, would negate its own existence9. For the above reason, it is extremely interesting to keep track of the progress the interpretation of these prerequisites has made - trying to keep in pace with the modern ways of doing business - accompanied by some clarifying examples of judicial precedents.

    2.2. The Location Test

    While in its early days, the existence of a PE was not answered in the affirmative without the presence of a steady, connected to a specific geographical point, place of business – e.g. a street vendor normally would not accumulate income of significant value, so as to trigger an exception to the rule of residence based taxation – the evolution of how business is being conducted, led to a more lenient, still pragmatic, view of the Courts. Thus, nowadays, in some situations, it suffices a connection with a specific geographic region (situs), within the borders of which, the business will be held. No matter if – which does occur - the place of business can be transferred, from time to time, into different sections of the same geographic region. However, it is indispensable that this region can be seen as one and only place of business, with commercial and geographic coherence. Indeed, there are many cases that - assuming that we read them with business logic - constitute a sole place of business, no matter how immense they may be. Finally, whereas in its early days the PE concept necessitated literally a fixed place of business, the evolution of the business models, led to the realization that we could not remain stuck to a dogma that was constructed under different facts10. The notion that a place of business must be tied to a specific location has been subjected to gradual erosion.

    In my view, this ‘erosion’ is heading towards the right direction, though. Otherwise, supposing that the transfer of the place of business would undeniably lead to the negation of a PE, an absurdum would potentially occur. To set it clearly, on the basis that what was crucial for the attribution of tax power to a foreign State, was the significant economic presence of a foreign taxpayer within its soil, the following can be concluded: this condition is satisfied in a tremendously better way, if so big a site of business (lato sensu) is, that it is necessary (for the stricto sensu place of business) to be transferred within its borders. Certainly, the borders should be delineated by business logic, with the employment of which the whole site must be suitable to be truly seen as one place of business11. This has to occur, especially, when by the nature of the business involved, it cannot be conducted without the transfer of the place of business (stricto sensu)12. It seems that, in these cases, the length of the area is absolutely relative and what finally does matter, is the nature of the business. What seems to remain crucial, though, is the most possible exact definition of the area in which the business will be confined. This limitation of the area connotes, after all, a severe comprehensive - ex ante - plan, which is a characteristic that behooves any severe business project. If leniency, as far as the location test is concerned, was not approved, there would be cases where, albeit companies would have a considerable presence in a foreign market or even would reap substantial benefits from an activity in a foreign State, the latter would not have the opportunity to enjoy a fair share of tax revenue. Besides that, there are competition law concerns, as companies involved in certain factors of the economy relating to ‘movable’ activities by nature, would avoid PE impacts, accidentally rather than because of a reason which really advocates for that ‘discriminating’, against the source country, tax treatment.

    In these regards, it was stated that in spite of the fact a business' activity took place in an approximately 200 square miles area, it did not constitute an obstacle to the location test13. The ruling referred to the use of a rig to drill seventeen wells in a geographically integrated area of the US continental shelf. Nevertheless, the French Conseil d’ Etat made an even more noticeable approach14. When it comes to mere drilling of consecutive wells, the location test generates no hurdles, however extended the area might be. Basically, the problem, in the view of the Conseil d’ Etat, is transferred to the duration test.

    All the same, what really illustrates the awkwardness of the location test in the nowadays economy, are the IP cases (servers). As it is clearly stated in the Commentary of the OECD Model Tax Convention on Income and on Capital15, even a server, under specific circumstances, does create a PE. As it is already known, whilst a website – which constitutes a combination of electronic data and software i.e. intangible – cannot by notion generate a fixed place of business, a server – computer equipment, hardware i.e. tangible16 – may create a PE. However, for a foreign company to be deemed to have a PE where the server lies, the disposal test must also be satisfied (as well as all the requirements of Article 5 (1) MC); a whichever hosting arrangement between the company and the Internet service provider (ISP), does not suffice. The content of the arrangement must result in a pragmatic situation of having the server (through which the website is used) at its disposal, e.g. by owning or leasing and operating the server.

    A step beyond was made by the Central Economic Administrative Court (Tribunal Económico Administrativo Central) in 201217, in the renowned Spanish ‘Dell Case’ : the existence of a website (i.e. intangible) directed at the Spanish market18, suffices to create a PE, no matter whether the server – which may not even meet the disposal test – lies in a foreign country. Virtual presence was ought to be sufficient to create a PE as the final objective of Article 5(1) MC should always be taken into account19. Nonetheless, the Spanish Supreme Court20 was less radical and tried to mitigate the consequences of a such ruling:

    Once established that the appellant enjoys a permanent establishment in Spain, the question on the permanent of establishment of the website becomes irrelevant. … a ‘website’, as that combination of software and electronic data does not constitute something tangible and, therefore, cannot be deemed as a fixed place of business. On the contrary, the server where the website is stored and through which is regarded as a fixed place of business is accessible, in a computer and, as such, physically present, so that the place where is located does constitute a fixed place of business21.

    For the sake of a comprehensive analysis, the following has to be referred as well: the commercial coherence should be accompanied by a ‘meter per meter’ approach. Thus, in the case where an employee is travelling between different branches of a Bank throughout a Stateto provide the clerks with further education, there is no PE, even if there is a comprehensive plan of action. The spatial coherence, due to the considerable distance between the different branches of the Bank, is negated. Ideally, there should not be but ‘small gaps’ in which no business activity is conducted22.

    To sum up, it is understood that the need for fixedness has become (in fact, it always was, as the ultimate desideratum was the significant economic presence and the fixedness was just a sign of it) a relative one. The Mumbai Tribunal has set it clear: the prerequisite of the fixed on the soil place of business is not absolute; a PE can also exist in a transferred unit23.

    2.3. The Duration Test

    Albeit Article 5(1) MC does not stipulate it directly, the MC commentary refers to the prerequisite of a ‘duration test’. It seems rational that the framers of the PE concept were bearing in mind that a business activity – even in a fixed place of business - could not lead to significant benefits for an enterprise, unless this undertaking would last for an adequate amount of time. When the notion was shaped, commercial activity of e.g. one month, could hardly generate any quotable profits. Hence, it necessitated a certain duration of this activity, as business used to roll in a much slower pace than nowadays. Subsequently, duration also seemed to be a sine qua non condition, regarding the satisfaction of a PE.

    Relatively, the prevalent opinion is that - in most cases - a six-month period is adequate in order for the duration test to be satisfied. Nonetheless, every case is unique and an assessment on a case–by–case basis is absolutely essential. What I am implying is that a six-month period is just indicative and what eventually matters is the period during which a business activity is able to attain a considerable amount of penetration into a foreign market; after all, that was finally crucial for the framing of the PE concept. Indeed, the OECD Commentary suggests that the requirement of permanence should be considered as fulfilled, based on ‘the nature of business’ which is being carried on24.

    Nonetheless, the six-month period rule, does not come without exception. After all, persistence to this rule, would exclude from PE those business activities which, by nature, are not being conducted but only during certain periods per year (i.e. seasonal activities). What is more interesting, is that exactly this model of function is in favour of their bottom line results and is a part of a logic business plan. For instance, a water sports business does not function throughout the year, but e.g. from June to August. If we were assuming that there is not a PE in such cases and we were demanding that this business should function for e.g. a period from February to August (i.e. 6 months), this would be preposterous, for the following reason: a more profitable business would not be seen as a PE, while a less profitable one (assuming that during no productive months there will only be functional expenses and no profits) would be confronted as such. Consequently, the nature of the business activity will definitely play a determining role, regarding the condition of duration for PE purposes. In some cases, in which a two-month per year function is commercially consistent, it will not deter the existence of a PE. Most importantly, if that was the case, this would lead to a never-PE-result, for certain absolutely characteristic commercial activities, just for the reason that they are exercised exactly as they ought to be. Having said that, what might be crucial for this type of business, is the periodicity of the activity; for how many repetitive periods (e.g. years) it takes place. Hence, short-term but recurrent activities should be scoped in combination with the number of times during which the place of business is used for that activity, which may extend over a number of years.

    For instance, in the renowned case Fowler v. MNR, the maintenance of a stand at the Pacific National Exhibition from which knives were sold for a three-week period annually over a period of about 16 years was enough to create a permanent establishment25.

    A brick in the wall of the interpretation of the ‘permanence’ notion, can be added by Article 5(3) MC, which ascertains the permanence condition - for the construction clause - in twelve months. The rationale behind that provision is that a construction activity is per se of limited time, so we could never refer to duration literally, regarding this type of business. At the same time, a year of business in the construction sector, guarantees a considerable presence into a foreign market. Therefore, the twelve-month period, seemed to be a fair deal26.

    Related to the duration, a Swedish Administrative Court of Appeals27 has issued a decision in a case regarding PE matters, involving a German company that was considered to have a fixed place of business in Sweden, since a part of the company’s core business was being carried out in Sweden. In more detail, the case concerns a German company that developed and sold software for tire inflation pressure systems. The company operated for a three to four-month period annually, conducting tests in winter conditions in the Swedish north and bringing all the equipment (e.g. cars etc.) from Germany. This data (i.e. the test results) was then studied in Germany, so as for the software to be developed and produced. The testing period was around 3 to 4 months, however the company was on site only for a few weeks at a time. The findings of the Court were that the company regularly conducted business from the same place in Sweden and had established a fixed place of business in Sweden, through which a part of the company’s core business was carried out; even if it would last for 3-4 months per year. What needs to be pointed out is that, given that what was crucial for the enterprise was the harsh winter of Sweden, it would be irrational to demand a period beyond this season, so as to ascertain a PE28.

    Moreover, India, as usual, provides us with some really illuminating cases of judicial precedents. Relatively, a court in Delhi29 observed that if the place of business is available to the taxpayer for the period in which its independent work can be completed, it shall give rise to a PE. The argument of the activity’s nature is once again of vital importance. There is not a ‘one-size-fits-all’ solution; the determination of PE is a fact-specific exercise, needing careful analysis based on each case’s peculiarities. For instance, in the above-mentioned case, requiring more time than the necessary for the specific business activity, would lack, amongst others, business logic.

    The most emblematic example of the relativity of the prerequisite of duration, comes also from India and has to do with the F1 Grand Prix30. The aforementioned decision touched numerous crucial aspects of the PE concept. Among them, it stated that the three-day-period Grand Prix event, was adequate to meet the ‘duration’ test. The nature of the activity played again a crucial role. As the Court stated:

    Having regard to the nature of the preceding discussion, it is evident that though FOWC's access or right to access was not permanent, in the sense of its being everlasting, at the same time, the model of commercial transactions it chose is such that its exclusive circuit access - to the team and its personnel or those contracted by it, was for up-to six weeks at a time during the F1 Championship season. This nature of activity, i.e racing and exploitation of all the bundle of rights the FOWC had as CRH, meant that it was a shifting or moving presence: the teams competed in the race in a given place and after its conclusion, moved on to another locale where a similar race is conducted.

    In the era that the PE’s definition was crafted, the nature of business was not extended to a spectrum of activities which could result in significant economic results in relatively short periods. Hence, in those days, there was no problem or any huge complexity with the duration test. There was not any business activity lasting for e.g. a couple of months, which was able to amount to a significant presence in a foreign market. In the overwhelming majority of cases, the minimum period during which an essential penetration into a foreign market could happen, did not surpass the six-month-rule. Nevertheless, the situation has utterly changed and even a three-day-period would suffice.

    In means of illustration, if the quantity of the required penetration - in each different case - which gives rise to a PE, is the result of an equation or of a mere mathematical function, the duration of the activity is the Z factor, while the nature of business activities constitutes the Y factor. Now let’s assume that the desired penetration result for PE purposes is 60 units. The nature of the activity part (Z factor) was, back then, able to amount, in the best case, up to 10 units (the units here are revealing the ‘aggressiveness’ and intensity with which an enterprise can gain benefits in correlation with time). So, the minimum number that the duration part could reach was 6. Having said that, nowadays, the efficiency of the nature of business part has increased; in other terms, the one factor of the equation (i.e. the nature) is completely different and absolutely varies. So, it can reach up to 20 units, that way sufficing a duration of 3, and so on.


    Figure 1 - Hypothesized Mathematical Function

    Furthermore, what also maybe needs to be referred, is the following: the duration ‘chronometer’ does not start during the time of the necessary, for the core business to be conducted, preparations and until they are fully completed. That means that even if a fixed place of business is ascertained for 7 months, but during the first 4 months there were only genuine preparatory activities, what finally matters is the last 3 months. After all, a PE necessitates that a part or the whole of the enterprise’s core business is carried through this fixed place of business. Nonetheless, these 4 months were necessary for this core business to start getting carried. It is contradictory to accept that the core business of the enterprise was conducted during the period in which these necessary activities were taking place. After all, a winning argument is drawn from Article 5(4) MC.

    2.4. Connection Between the two: Location and Duration Tests

    The prerequisites of the PE concept analysed in the previous sections of this article, are not irrelevant to each other. On the contrary, they are delicately connected with a logical coherence. Precisely, it was mentioned above that albeit the duration is not directly appearing to be among the prerequisites of the Article 5(1) MC, it constitutes a sine qua non condition for the completion of a PE. The rational explanation to that, was that a fixed place of business could not lead to the results which would justify the power of one State – other than the State of residence – to tax a foreign taxpayer, unless there is a duration, too. Consequently, what matters, is the duration of an already fixed (located or at least spatially deliminated) place of business. The location test comes first and then the duration test follows. For PE purposes, there is no need to check the duration, without having checked the prerequisite of the location, in the first place. By way of illustration and employing once again the ‘duration chronometer’, we would say that it stops counting when the potential PE is not fixed (located) anymore. Against this backdrop, it can easily be understood why the duration test is encapsulated in the location test, as implied, after all, by the MC Commentary.

    3. Final Remarks Leading to a Proposal

    3.1. Criticism

    The initial contributors of the PE concept, who set the fundaments of the notion, were shaping their action according to the special characteristics of the field it would be summoned to regulate. Penetration into a foreign market – except for the case of an agent - was equated with both a fixed place and permanence. Indeed at that time, it was not erroneous. Nonetheless, during our times, the situation has been - and is still being - exponentially changed. This should be taken into consideration when trying to adapt the rationales to the modern climate of business. The fundamental PE components were developed for an old-fashioned economy; place of business, location, and permanence. What was insufficient to create a nexus, now is ultra-adequate. As an illustration for the massive difference between business now and then, it suffices to bring to mind the relatively minuscule value of intangibles at that age, since property was notably connected to tangibles. E-commerce was not even among the realms of science fiction, since people were far from even imagining it. The list of the differences between the two economies, simply does not have an end. For that reason, as long as the necessitated nexus remains the notion of PE, it is indispensable that a ‘to and fro’ mental movement take place, so as to fit appropriately the fundaments of the notion - what the framers were truly intending to achieve- to the modern conditions.

    During this endeavour, jurisprudence and literature come to an agreement that the fixed location test (which connotes ‘establishment’) can be eventually satisfied by a spatially deliminated business (or mostly can be replaced by a ‘spatial delimination’ test). In addition to that, the duration test (which connotes ‘permanence’) has become rather relevant. Maybe, when we talk about a permanent establishment, we are not referring neither to any ‘permanent’ nor to any ‘establishment’.

    Still, the outdated status of the PE concept could also be enlightened by the following observation. Until now, inadequacies of the PE concept were mainly revealed as a result of the taxpayers’ deliberate transgression, planning their tax structure without any business logic, on the mere purpose of reducing their overall tax liability. Nonetheless, with the emerging evolution of e.g. e-commerce, tax avoidance will just be a result of their normal activity, just seeking to benefit from the opportunities provided by the digital era, without any principle purpose of avoiding taxation.

    To the question ‘how long (time) is long enough’, my opinion is that the right answer is ‘as much (penetration) as it takes’. The answer may seem paradoxal, but so is also the old-fashioned PE concept in the modern business environment. A new nexus is ultimately needed to correspond to this revolution31.

    3.2. The day After

    To the question whether the framework is effective and sustainable in the new age, the answer is negative. A new nexus must be employed to regulate new realities32. Physical presence is important only to the extent it reveals the said economic presence.

    Unilateral approaches have already taken place, addressing mainly e-commerce concerns, like the ‘significant economic presence’ (SEP), in India, with revenue or user-based threshold. The notion is also known in the realms of OECD, regarding BEPS Action 1. Moreover, concerning the EU, there is a commission recommendation relating to the corporate taxation of a significant digital presence (SDP). Initiatives like these are set on the right direction. In all likelihood, the next step will be to come up with an updated nexus, focusing on what the PE was– after all–intending to conceive. Would someone dig deeper, they would unearth the hidden notion behind a ‘fixed place of business’; a significant economic presence.

    Lastly, let me pose a question: should we go towards a more destination-based taxation, without giving the ultimate importance to where economic activities generating the profits are performed, ergo where the value is (deemed to be) created? It is a fundamental question.

    Policy, as well as international tax fundaments, are the means to serve specific needs. These specific needs have been changed, so have to be policy and fundaments. The anger and frustration of the citizens for the financial condition of their States, in combination with the low taxation and high profits of MNEs, constitute a true problem in the real world, no matter where ‘the value is added’3334.The tax must be related to the benefits a corporation receives from its access to a State; in many respects, the true benefits go far beyond the (deemed) value added thereon. After all, however low the contribution of a jurisdiction’s economy to the value creation may be, it has an augmented, sui generis and autonomous value: any profit addition to e.g. the product in a foreign jurisdiction, remains meaningless (i.e. has little or no point) without considering the fact of the final disposition. As it is quite aptly stated in an excerpt from a report on double taxation, submitted to the League of Nations in 1923:

    As the oranges upon the trees in California are not acquired wealth until they are picked, not even at that stage until they are packed, and not even at that stage until they are transported to the place where demand exists and until they are put where the consumer can use them.35

    For that reason, the final destination should play a crucial role to all that, without giving the absolute importance to the origin of each, separated, value addition step. All these stages, most certainly, contributed to the income collected; however they are all futile if the ‘last link in the chain’ is missing. Having said that, it seems that the following statement holds water: the destination State should be legitimated to enjoy not only all the value added within its jurisdiction (if any), but also a certain ‘piece of the pie’ of every profit addition step up to the product’s final disposition36. This way, not only will the social frustration be addressed, but also this will be achieved by a measure which - at the same time – does not lack political and economical fundaments37.

    Thus, the addition of a destination based taxation element, will cause the transfer of a certain percentage of the profit generated in each separate step, to the country of the final destination. Furthermore, it is immaterial whether an in-between-step (where value is added), is perceived to be related to a PE or not; this will not affect the final result, since exactly the same share for this specific addition, will be extracted – this time - from the resident State38. This happens because, lack of a PE regarding a certain value addition, this pie – from which the certain piece will be detached - will be subjected to the tax power of the residence State. The pie is the same, no matter if it is belongs to (i.e. subjected to income taxation) the residence country or to another (source) State. At this point, it is needless to say that it is of the utmost importance to discern between residence based, source based and destination-based taxation.

    Subsequently, what is proposed hereon is a system towards the addition of a destination-based taxation element and not of an exclusive use of it. Finally, the destination State will collect (assuming that it will be decided that it has the right to tax, which will be determined by the ‘PE’ rule or the rule which will presumably replace it) the profit deemed to be added thereon (if any), plus a ‘bonus’ percentage which will be detached and transferred from the value added at every step, except for the profit generated in the destination country, which has already been calculated. The mechanism is illustrated in the graphic below.


    Figure 2 - Proposed Attribution Mechanism

    Finally, this article goes far beyond denouncing the PE mechanism, as well as its creators. The intended policy was almost perfectly served by the content of the relative provisions. Nonetheless, if the world had not been subjected to radical changes and constant evolution in the course of a century, then we would have to admit that something went wrong; it would be extremely worrisome. As Tancredi points out in the Leopard: “If we want things to stay as they are, things will have to change”39. It is my firm conviction that the BEPS project was only a start of a paradigm swift towards a general reform of the fundamental tax principles40. The current intense activity is an omen that the contemporary framers will come up with a comprehensive solution which will correspond in the best possible way to the modern special needs; exactly as their predecessors succeeded.


    1. Especially if any additional tax (surcharge) was imposed ˙ See S. Simontacchi, Taxation of Capital Gains under the OECD Model Convention: With Special Regard to Immovable Property, p. 2, Kluwer Law International, 2007.
    2. As noted by J. Eisenbeiss, BEPS Action 7: Evaluation of the Agency Permanent Establishment, 44 Intertax 481, 493 (2016), ‘The PE, requiring a physical presence, was the best available proxy to guarantee that balance at a time where economic cross-border activity was mainly trade in goods’.
    3. See Reuven S. Avi-Yonah, All of a Piece Throughout: The Four Ages of U.S. International Taxation, 25 Virginia Tax Review 313, 323 (2005): ‘Permanent establishment limitation on source taxation likewise reflects Carroll's view that in the absence of a permanent establishment, the benefits accorded were too tenuous to justify taxation by the source state’.
    4. During those years, it was rather rare for a transaction to happen in State B between a merchandiser from State A and a buyer originating from a third State. However, this case has become more common nowadays.
    5. One could argue that the provision of the DAPE (Dependent Agent Permanent Establishment) of the Art. 5(5) MC, reveals that the fixedness was not necessarily perceived as a sine qua non condition for a significant economic presence to a foreign market. Indeed, it is not erroneous and it is worth considering when exploring the roots of the notion. Nonetheless, the fixedness prerequisite remained crucial for non-agent related PE cases; that was reasonable during that time, whereas nowadays in many cases it is obsolete. Besides that, even in DAPE concept, it was acknowledged as an exception to the literal notion of permanent establishment; ‘… shall be deemed to be …’ (OEEC 1956 1st report on PEs). For the history and rationales of Art. 5(5) MC, see Lang et al., Dependent Agents as Permanent Establishments, pp. 34-37, Linde Verlag, 2014.
    6. In a judicial interpretation ofthe ‘permanent establishment’ notion on 1962 [Sunbeam Corporation (Canada) Ltd. v. MNR, 62 DTC 1390 (SCC 1933)], the Supreme Court of Canada expressed as follows: ‘… the word establishment contemplates a fixed place of business of the corporation, a local habitation of its own. The word permanent means that the establishment is a stable one, not of a temporary or tentative character’.
    7. See India’s positions on 2017 Update to the OECD MC, Art. 5:

      ‘[14.7] India reserves the right to include a provision in Article 5 to the effect that an enterprise having a significant economic presence in a Contracting State, based on criteria identified in Chapter VII of the final report on Action 1 of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, will be deemed to have a permanent establishment in that State … [33.] India does not agree with the interpretation given in paragraph 42; it is of the view that a website may constitute a permanent establishment in certain circumstances where it leads to significant economic presence of an enterprise’.

    8. See para. 6 of the Commentaries on Art. 5 of the Tax Convention on Income and on Capital (Condensed Version 2017): ‘this place of business must be fixed, i.e. it must be established at a distinct place with a certain degree of permanence’.
    9. A characteristic example of that, can be found in the Supreme Court of India’s decision, (Formula One World Championship Ltd. Vs. Commissioner of Income Tax, International Taxation - 3, Delhi & Anr.˙Taxsutra.com): ‘Aesthetics of law and taxation jurisprudence leave no doubt in our mind that taxable event has taken place in India and non-resident FOWC is liable to pay tax in India on the income it has earned on this soil’. It seems that the PE concept is completely outdated.
    10. Keith R. Evans, Leased Equipment: When Does a Permanent Establishment Exist?, 50 Canadian Tax Journal 489, 497 (2002).
    11. We also talk about ‘Single geographical and commercial unit’, ‘one single project’, ‘commercial coherence’. See paras. 23-24 of the Commentaries on Art. 5 of the Tax Convention on Income and on Capital (Condensed Version 2017).
    12. Comparing to the lato sensu place of business, which is the delineated area.
    13. RS ltr. rul. 8526005, March 8, 1985.
    14. Supreme Administrative Court of France, vol. 21, no. 10 European Taxation 324-27, (CE 1981).
    15. See paras. 123-124 of the Commentaries on Art. 5 of the Tax Convention on Income and on Capital (Condensed Version 2017).
    16. See para. 123 of the Commentaries on Art. 5 of the Tax Convention on Income and on Capital (Condensed Version 2017): ‘… the server on which the web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server’.
    17. Resolution of the Central Economic Administrative Court (Tribunal Económico Administrativo Central-TEAC).
    18. See G. D. Sprague, Spanish Court Imposes Tax Nexus by Finding a 'Virtual PE', Tax Management International Journal, Vol. 48, 42 (2013).
    19. TEAC 15.3.2012, RG 2107-07.
    20. Spain v. Dell, appeal no. 182/2012. Equally available at: http://www.poderjudicial.es/search/index.jsp (accessed 7 June 2018).
    21. Francisco Antonio Vaquer Ferrer, The Concept of ‘Permanent Establishment’ at the Spanish Courts: Special Reference to the Roche and Dell Cases, 44 Intertax 673, pp. 679-683 (2016).
    22. We talk about the ‘geographical coherence’. See para. 25 of the Commentaries on Art. 5 of the Tax Convention on Income and on Capital (Condensed Version 2017).
    23. Renoir Consulting Ltd v. DDIT, 45 taxmann.com 112 (Mum 2014).
    24. See para. 28 of the Commentaries on Art. 5 of the Tax Convention on Income and on Capital (Condensed Version 2017).
    25. The Court was satisfied that a sales outlet remained at approximately the same location over such an extended period. Given the nature of the business in question, the mobility of the operation did not affect the existence of a permanent establishment in Canada.
    26. As the article stimulates ‘… constitutes a permanent establishment only if it lasts more than 12 months’. The word ‘only’, could have been omitted without affecting the main goal of this article. Thus, it seems to have an additional value on its own. In my point of view, this word was added on purpose and more specifically aiming at creating a certainty of law for construction activities lasting less than 12 months. Subsequently, activities of this type, do not amount to a PE if they last less than 12 months. Nonetheless, it contradicts with the modern approach of a PE, which sometimes ascertains a PE under Art. 5(1) MC even if there is only a duration of a couple of months. Consequently, for a further reason, while the context, once, used to be appropriate, nowadays it generates inner contradictions.
    27. Administrative Court of Appeal in Gothenburg (Kammarrätten i Göteborg), case number 2276-15.
    28. Furthermore, moving on to a less unquestionable matter (after all, the president of the Court disagreed with that) it was found that this specific activity, was of core importance, even if it consisted only of the collection of data from the harsh Swedish winter. According to the majority opinion, the tests in Sweden cannot be considered to be of a preparatory or auxiliary nature. The collection of data, seemed to be of so much importance for the whole procedure and the product, that it was deemed as one of the main business activities.
    29. Fugro Engineers BV v ACIT, 26 SOT 78 (Del. 2008).
    30. Formula One World Championship Ltd. Vs. Commissioner of Income Tax, International Taxation-3, Delhi &Anr. (SCOI 2017).
    31. Otherwise there will also be a risk in terms of the interpretation limits of the provisions made by the national Courts, even if teleological and historical (Art. 31 and Art. 32- respectively - of the Vienna Convention on the Law of Treaties, 1969) approach is employed, damaging this way the certainty of law, businesses’ tax planning and States themselves as well.
    32. Almost identical problems to the PE concept, are confronted by the US Courts. It is worthwhile attending the jurisprudence’s evolution between National Bellas Hess inc. v. Department of Revenue of the State of Ilinnois (386 U.S. 753, 1967), Quill Corp. v. North Dakota, (504 U.S. 298, 1992) where the Court did not directly overturn Bellas Hess jurisprudence, however held that ‘the Congress may be better qualified to resolve and the one that has the ultimate power to resolve’, and KFC Corp. v. Iowa Department of Revenue (Supreme Court of Iowa No. 09-1032, 2010) which recently stated that one should focus in the significant economic presence instead of the physical appearance, irrespective of any material connection. Bellas Hess and Quill cases are also accessible at https://www.oyez.org (accessed 7 June 2018), whereas the KFC case is accessible at https://caselaw.findlaw.com/ia-supreme-court/1550749.html (accessed 7 June 2018).
    33. For instance, in the video of the Public Accounts Committee Monday 12 November 2012, https://www.parliamentlive.tv/Event/Index/ab52a9cd-9d51-49a3-ba3d-e127a3af018c (accessed 7 June 2018), what has just been said is perfectly illustrated; technical reasoning of the attribution of profits as well as transfer pricing issues, go far beyond satisfying the common sense about the real fact of a fair return of the income collected in a foreign market. Technical reasoning – even if absolutely legal – does not suffice in the eyes of the deputies let alone in those of the people of each State.
    34. What J. Swharz, Value Creation: Old wine in new bottles or new wine in old bottles?, Kluwer International Tax Blog, 2018, http://kluwertaxblog.com/2018/05/21/value-creation-old-wine-new-bottles-new-wine-old-bottles (accessed 7 June 2018) states, seems to be completely relative: ‘It is disingenuous to present what is really a political debate about which country is entitled to tax as a matter of legal analysis. A more honest approach would be to accept the debate for what it is’. This dislike triggered some new initiatives. The spirit of a new nexus (as well as of a profits’ attribution rule) should take into consideration the fact that a foreign company which collects a particular amount of money deriving from another economy, should give a certain percentage back to the society, no matter whether value is deemed to be added inside its jurisdiction or not. After all, the final disposition is of such vital importance, that the final destination State could possibly be entitled to participate to a certain extent to the profits generated up to this final stage.
    35. Report on Double Taxation submitted to the Financial Commission, League of Nations Doc. E.F.S. 73 F.19, 20-23 (1923).
    36. This small piece refers to a certain percentage of the, profit’s in question, total sum. For this percentage to be found, it is essential that a specific analysis be done, which will probably end up in different rates, depending on the type of the business activity adding value to the final product.
    37. Towards a somewhat close direction, M. Brittin (president of EMEA business and operations for Google) declared that Google is going to pay in respect of sales to UK customers, maybe acknowledging that the profitability in the UK was not perfectly estimated, so far; http://www.bbc.com/news/business-35381130 (accessed 7 June 2018). Read also M. Stride (financial secretary to the Treasury - UK) declaring that tax on revenues is the ‘potentially preferred route to go’; https://www.ft.com/content/9bd2c65a-17fb-11e8-9e9c-25c814761640 (accessed 7 June 2018).
    38. Whereas it is absolutely necessary that there is a PE – or whatever takes its place in the future – in the State of the final destination, so as for it to obtain the right to tax.
    39. Giuseppe Tomasi di Lampedusa, The Leopard, William Collins Sons Company and Pantheon (1st edition), 1960.
    40. The initial purpose of the Base Erosion and Profit Shifting (BEPS) Project was the realignment of taxation with economic activities and value creation. The ideal goal was to achieve a holistic approach that would take into account the differentiated economic climate of our days and restore a fair balance between source and residence taxation. However, a more modest goal i.e. this of the prevention of ‘artificial avoidance’, ended to be the aspiration of Action 7 of the BEPS Action Plan concerning the PE. Nevertheless, small repairs of Art. 5 MC, on the mere purpose of updating the already existent yet still obsolete basic idea, in order just to bar artificial avoidance, can - at best - restore the source State taxation in accordance with a proxy (the PE concept) which is nonetheless inherently unapt to provide a fair allocation of taxing rights under the modern business models. The existing definition of PE remains consistent with the underlying principles on which it was based. Drawing on the existing concept prevailed against rethinking the nexus. See J. Eisenbeiss, supra n. 2, at 482, 502.

    Giannis is a tax lawyer in Greece, (LLM in Civil Law | LLM in Tax Law - University of Athens) and a grant holder of the Alexander S. Onassis Public Benefit Foundation for postgraduate studies in Tax Law. This is a modified version of his thesis for the degree of Master of Laws at the University of Athens under the supervision of Dr. Tsourouflis Andreas, entitled ‘The PE concept and the attribution of profits after the finalization of the BEPS project’. He may be contacted at psarj1@yahoo.gr.

    The author does not contribute this article in his capacity as tax advisor of PwC Greece. Hence, this contribution is based on his very own point of view as regards this topic.

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