ARTICLE 5

Permanent Establishment

The rule governing the taxation by a Contracting State of business income derived by a resident of the other State utilize the concept of a "permanent establishment." Paragraph 1 of this Article defines in general terms the "permanent establishment" concept, and the following paragraphs give some specific illustrations of the meaning of the term.

A place of management, branch, office, factory, workshop and a place of extraction of natural resources, such as a well or quarry, are examples of a permanent establishment. Since a place of management would in most cases require an office, which is specifically noted in paragraph 2, the addition of that term will not generally cause a permanent establishment to exist where there would not otherwise be one.

A building site or construction or installation project will only be considered a permanent establishment if it lasts longer than 9 months, and an installation, drilling rig or ship used for dredging or exploring or exploiting offshore natural resources is a permanent establishment only if so used for at least 6 months in any 24-month period. In such a case, the site, project, installation, rig or ship constitutes a permanent establishment from the first day when work physically begins within the territory of a Contracting State. A series of contracts or projects which are interdependent both commercially and geographically are to be treated as a single project for the purpose of applying the 9- month and 6-month tests.

Paragraph 3 enumerates certain activities which may be undertaken singly or in

combination without creating a permanent establishment. Although subparagraph (f) of this paragraph of the U.S. Model was deleted, the same effect is obtained by the insertion of the reference to "one or more" in the introductory language of paragraph 3.

Paragraphs 4(a) and 5 consider the use of agents. A dependent agent who habitually exercises an authority to conclude contracts in the name of an enterprise is deemed to be a permanent establishment of that enterprise except to the extent that his activities are limited to those mentioned in paragraph 3 which would not constitute a permanent establishment under that paragraph. An enterprise of a Contracting State will not be considered to have a permanent establishment in the other State merely because it uses the services of an independent agent acting in the ordinary course of business in that other State.

Subparagraphs (b), (c) and (d) of paragraph 4 specify certain activities which constitute a permanent establishment even if not carried on through a fixed place of business like those enumerated in paragraph 2. Maintaining substantial equipment in a Contracting State for rental or other purposes for longer than 12 months constitutes a permanent establishment unless the equipment is leased under a “hire-purchase” agreement. Under Australian law the lessee under a “hire-purchase” agreement (a lease accompanied by certain lessee purchase options or rights) is treated for tax purposes as the owner of the leased property. The exception for hire-purchase agreements in this Article and elsewhere in the Convention (see Article 12 (Royalties)) was inserted at the request of Australia to distinguish such agreements from leases respected as such for tax purposes. Such a distinction is also made in the Commentary to Article 12 of the OECD Model Convention. Similarly, under the Internal Revenue Code, the terms of a “lease” may be such that for U.S. income tax purposes the lessee is treated as the owner of the property. For purposes of United States tax the exception for “hire-purchase” agreements simply confirms such treatment, which would also apply in the absence of such an explicit exception. See paragraph 2 of Article 3 (General Definitions). Engaging in supervisory activities at a building site or construction, assembly or installation project for more than 9 months in a 24-month period constitutes a permanent establishment. And, an enterprise which maintains goods in the other Contracting State which goods were either purchased there (and not previously processed elsewhere) or produced there by it or in its behalf, and are then substantially processed there by a related enterprise is deemed to have a permanent establishment in that other State. This provision was added at the request of Australia to permit it to tax a portion of the sale profit when goods are produced or purchased in Australia, processed there at cost by a related enterprise, and then sold. It is an alternative approach to allocating part of the profit to the processing operation in such a case, as the United States could do under section 482.

Paragraph 6 provides that control of one company by another does not of itself constitute either company a permanent establishment of the other. The determination as to whether a subsidiary is a permanent establishment of its parent corporation, or the converse, or whether two or more subsidiaries of the same corporation are permanent establishments of the parent or of each other is made by reference to the tests set out in paragraphs 1 through 5.

These same principles apply in determining whether an enterprise of a Contracting State has a permanent establishment in a third State or whether an enterprise of a third State has a

permanent establishment in a Contracting State. Such a determination may be relevant, for example, in deciding the source of interest (paragraph 7 of Article 11 (Interest)) or royalties (paragraph 6 of Article 12 (Royalties)).