Evolution of the permanent establishment concept under Covid-19
By Euney Marie Mata-Perez on December 9, 2021
In cross-border transactions, the allocation of the power to tax between taxing jurisdictions over buyers and sellers of tangible or physical goods is crucial. In the pre-internet age, the buyer’s and seller’s actual geographic location was critical.
Most existing income treaties, which are modeled after the Organization for Economic Cooperation and Development’s (OECD) Model Tax Convention on Income and on Capital, state that “an enterprise in one state shall not be subject to a direct tax on its business profits based on net income in the other state unless it carries on business in that other state through a permanent establishment (PE) located in the other state.” The OECD treaty cites three types: * a fixed place of business PE such as an office, branch, warehouse or mine site; * a construction or project PE, which is generally a building site or construction or installation that lasts more than a specified length of time (the time period varies per treaty); and * an agency PE through the actions of a dependent agent.
The United Nations Model Tax Convention, which gives greater consideration to developing countries, adds what is known as a service PE. A service PE is deemed to exist for an enterprise of one country performing services in the other country for more than a specified length of time.
The advent of the internet, and especially the proliferation of e-commerce, has led many to question the use of the PE as the defining nexus by which a country taxes the business profits of a nonresident entity. Physical presence is no longer relevant since buyers and sellers may conduct cross-border business without ever establishing a physical presence in a non-resident state. (See Hoffart, “Permanent Establishment in the Digital Age: Improving and Stimulating Debate Through an Access to Markets Proxy Approach”, Northwestern Journal of Technology and Intellectual Property, Vol. 6 ) The use of the permanent PE concept was further affected by the Covid-19 pandemic where people, including those belonging to the top management of corporations, work from home or are restricted from traveling because of government-imposed restrictions. The OECD Secretariat, recognizing the profound impact of the pandemic, released its “Analysis of Tax Treaties and the Impact of the Covid-19 Crisis” on April 3, 2020 and updated it on January 21, 2021. The analysis was based on the OECD Model Treaty but also included one reference to the UN convention.
In a nutshell, the OECD guidance provides that for a home office PE, individuals teleworking from home as a result of a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved to prevent the spread of Covid-19 does not create a fixed place of business PE for the business or employer. It was recognized that work-from-home arrangements lack a sufficient degree of permanency or continuity because the home office is not at the disposal of the enterprise.
However, if the individual keeps working from home after the public health measures are no longer applicable, the home office can be considered to have a certain degree of permanence. For this change or permanence to give rise to a PE, however, a further examination of the facts and circumstances is required to determine whether the home office can then be considered to be at the disposal of the enterprise.
Meanwhile, an employee’s or agent’s working from home during the pandemic is unlikely to constitute an agency PE if the employee/agent does not habitually conclude contracts on behalf of the enterprise. The employee’s or agent’s activity should not be regarded as ”habitual” if they have exceptionally begun working from home as a result of a public health measure imposed or recommended by the government and provided the individual does not continue those activities after the public health measures cease to apply.
Lastly, a construction site PE will not be regarded as ceasing to exist when work on the site is temporarily interrupted. However, jurisdictions may consider, in light of the extraordinary circumstances of the pandemic and based on the facts and circumstances, that certain periods where operations are prevented as a public health measure imposed or recommended by the government where the site is located to reduce the spread of Covid-19 constitute a type of interruption that should be excluded from the calculation of time thresholds for construction site PEs.
The OECD guidance also provides that a temporary change in location of board members or other senior executives because of their inability to travel due to pandemic restrictions is an extraordinary and temporary situation and should not trigger a change in treaty residence or change in the “place of effective management” of a company.
The Covid-19 pandemic has indeed profoundly impacted lives and economies around the world. It has also led to changes in interpretation or application of international tax concepts or rules.
Euney Marie J. Mata-Perez is a CPA-lawyer and the managing partner of Mata-Perez, Tamayo & Francisco (MTF Counsel). She is a corporate, M&A and tax lawyer and has been ranked as one of the top 100 lawyers of the Philippines by the Asia Business Law Journal. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. If you have any questions or comments, you can email the author at firstname.lastname@example.org or visit the MTF website at www.mtfcounsel.com.