Permanent establishment is a very important concept in the world of corporate taxation and a key determinant for the application of corporation tax.
As discussed in our previous article, we pointed out that with few exceptions, tax residents would be subject to corporation tax (CIT) on their worldwide income while non-residents would be subject to CIT on the taxable income from their permanent establishment (PE) in the UAE; and income from the United Arab Emirates.
Permanent establishment is a very important concept in the world of corporate taxation and a key determinant for the application of corporation tax. The PE is generally a fixed place of business, other than a subsidiary in any other country or state, and the income of the PE is generally subject to tax in the same state or jurisdiction from which it arises. income.
The original concept of PE dates back to Germany. In 1845 the concept was first seen in the Prussian Industrial Code, but it was not used for tax purposes at the time. Later in 1869, Prussia and Saxony (two German states) entered into the first-ever tax treaty, which specified the terms of taxation as stehendes Gewerbe (permanent operation).
According to Article 2(1) of the treaty signed between two German states, a non-citizen was taxable in a state where a company used a gewerblichen oder Handels-Anlage (business establishment).
The Prussian concept of a permanent operation was a general limitation on state taxation of source, and two conditions were required to tax the income in the state.
(i) A fixed location in the other State; and
(ii) The company intends to continue to conduct business at this location.
In 1909, the word PE was used in the German double taxation law to end double taxation between German states, and in 1928 the League of Nations developed a model to combat cross-border double taxation and combat against tax evasion. Since then, extensive work has been done on tax treaties under the OECD Model Tax Convention on Income and on Capital (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 3,000 tax treaties.
The United Arab Emirates, being a member of the 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 for determining 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 outlined in the proposed public consultation document.
Fixed place of business test
The proposed documents state 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 carried on in whole or in part.”
The fixed establishment includes a head office, a branch, an office, a factory, a workshop, real estate and construction sites where the 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.
As a rule, preparatory or auxiliary activities such as limited marketing and promotional activities, carrying out market research and attending seminars or conventions, etc. do not fall under the definition of PE. The fixed place where the property of the foreign company is used to store, display and deliver or make it available to another person for processing cannot be considered as the PE of the foreign company.
Dependent agent test
There is a risk that foreign companies derive their income from any country without establishing fixed establishments there, such as appointing an agent and processing all transactions through the agent. To counter this risk, the concept of “dependent agent” was introduced.
When the “fixed establishment” criterion fails, the PE can also be established based on the dependent agent. It would be assumed that the dependent agent test is met where the business traveler or the UAE-based person is acting on behalf of the foreign company in the UAE and ordinarily exercises authority to enter into contracts on behalf of a foreign company. If a person enters into contracts in the UAE on behalf of the foreign company without material intervention from the foreign company, he can form a PE in the UAE.
However, if the person is working independently and carrying on the business of the foreign company in the UAE as in the normal course of business, this will 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 will become a permanent establishment. If the individual is acting in the UAE on behalf of the foreign company and performing contracts usually on behalf of the foreign company, then the individual would constitute a PE of the foreign company in the UAE.
If you are in doubt about the presence of PE in the UAE, you should seek professional advice. Depending on the circumstances, you would be advised to create a subsidiary or enter into a short-term contract to avoid inadvertently creating a PE.
Mahar Afzal is Managing Partner at Kress Cooper Management Consultants. The above is not an official, but a personal opinion of the author. For any questions/clarifications, please write to him at [email protected].
