ARTICLE 5 — U.S. Income Tax Treaty

Permanent Establishment

This Article defines the term "permanent establishment". This definition is significant for several articles of the Convention. The existence of a permanent establishment in a Contracting State is necessary under Article 7 (Business Profits) for the taxation by that State of the business profits of a resident of the other Contracting State. It can also be a condition for the imposition of the branch tax under Article 14 (Permanent Establishment Tax). Since the term "fixed base" in Article 15 (Independent Personal Services) is understood by reference to the definition of "permanent establishment", this Article is also relevant for purposes of Article 14. Articles 10, 11 and 12 (dealing with dividends, interest, and royalties and fees for included services, respectively) provide for reduced rates of tax by the source State on payments of these items of income to a resident of the other State only when the income is not attributable to a permanent establishment or fixed base which the recipient has in the source State.

This Article differs in several significant respects from the U.S. and OECD Model provisions, principally by requiring a lesser nexus with a country before a permanent establishment is determined to exist there. This Article is similar in many respects to Article 5 of the U.N. Model, and to the permanent establishment definition in U.S. treaties with some other developing countries.

Paragraph 1 provides the basic definition of the term "permanent establishment". As used in the Convention, the term means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

Paragraph 2 contains a list of fixed places of business (or in the case of subparagraph (l), an activity) which will constitute a permanent establishment. The list is illustrative and nonexclusive. According to subparagraphs (a) through f) of paragraph 2, the term permanent establishment includes a place of management, a branch, an office, a factory, a workshop, and a mine, quarry or other place of extraction of natural resources. These are all found in the U.S. Model.

Subparagraphs (g), (h), and (i) provide that an enterprise's warehouse which provides storage facilities to others, a farm or similar agricultural facility, and a store or other sales outlet also constitute permanent establishments. While these are not specifically provided for in the U.S. Model, as "fixed places of business through which the business of an enterprise is carried on" they are fully consistent with the principles of the Model, and are, therefore, implicitly contained within the permanent establishment definition in the Model.

Under subparagraph (j), a drilling rig or other installation or structure used for the exploration or exploitation of natural resources constitutes a permanent establishment only if the

facility is used for an aggregate period exceeding 120 days in a twelve-month period. (See explanation below of Ad Article 5 of the Protocol for a description of the rule applicable when the 120 day time period extends over two taxable years.)

Subparagraph (k) provides rules to determine when a building site or a construction, assembly or installation project constitutes a permanent establishment. Only if the site, project, etc. lasts for more than 120 days in a twelve-month period does it constitute a permanent establishment. The time spent on supervisory activities connected with the project or activity is included in determining whether the 120-day test has been met. A series of construction sites or projects are to be combined for purposes of applying the time threshold test. The 120-day period begins when work physically begins in a Contracting State. (See explanation below of Ad Article 5 of the protocol for a description of the rule applicable when the 120 day time period extends over two taxable years.)

Subparagraph (l) provides the rule for determining the conditions under which the activity of furnishing services, through employees or other personnel, constitutes a permanent establishment. These rules apply only to the provision of services which are not considered to be "included services", as the term is defined in Article 12 (Royalties and Fees for Included Services). Under the subparagraph, the furnishing of services gives rise to a permanent establishment if either the activity continues for an aggregate of more than 90 days in a twelve month period, or the services are performed for a person related to the enterprise providing the services. In the latter case, no time threshold test must be met for a permanent establishment to exist. The determination of whether persons are related for purposes of this test is made in accordance with the rules of Article 9 (Associated Enterprises). Under the U.S. Model such activities would constitute a permanent establishment only if they are exercised through a fixed place of business or by a dependent agent. (See explanation below of Ad Article 5 of the Protocol for a description of the rule applicable when the 90 day time period extends over two taxable years.)

Paragraph I of the Protocol (Ad Article 5) provides a rule which applies with respect to subparagraphs; (j), (k) and (1) of paragraph 3, all of which include time tests for the existence of a permanent establishment. The Protocol rule deals with cases in which the time threshold specified in the particular subparagraph has been met, and that time period extends over two taxable years. The Protocol article states that a permanent establishment will not be considered to exist in any year in which the facility is used or the activity is carried on for a period of less than 30 days in that year. A permanent establishment will exist in the other taxable year and the enterprise will be subject to tax in that year, in accordance with the provisions of Article 7 (Business Profits), but only with respect to income arising in that other year.

For example, subparagraph (l) provides that a U.S. enterprise will have a permanent establishment in India if it provides the services of its employees in India for a period of more than 90 days in a 12-month period. If employees are performing services in India from December 20, 1989 through March 20, 1990, that activity will constitute a permanent establishment because it continues for 91 days in a twelve-month period. Since the 91 days span two calendar years and fewer than 30 days are in one of those years, absent the rule in Ad Article 5 of the protocol, there would be a permanent establishment in both years. Under the Ad Article 5 rule, while the period

from December 20 through December 31, 1989 would be counted to determine that the 90 day threshold test has been net, for purposes of subjecting the enterprise to tax a permanent establishment will be deemed to exist only in 1990. Thus, there will be no Indian tax on the income attributable to services performed in 1989, and if the enterprise performs similar services in India during 1989 independent of the permanent establishment, the U.S. enterprise will not be subject to Indian tax on any income attributable to those services under the limited force of attraction rule of subparagraph (c) of paragraph 1 of Article 7.

Paragraph 3 contains exceptions to the general rule of paragraph 1 that a fixed place of business through which a business is carried on constitutes a permanent establishment. The paragraph lists a number of activities which may be carried on through a fixed place of business, but which, nevertheless, will not give rise to a permanent establishment. The use of facilities solely for storage, display or occasional delivery of merchandise belonging to an enterprise will not constitute a permanent establishment of that enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the purpose of storage, display, or occasional delivery, or solely for the purpose of processing by another enterprise will not give rise to a permanent establishment of the first-mentioned enterprise. The maintenance of a fixed place of business solely for purchasing goods or collecting information for the enterprise, or solely for activities that have a preparatory or auxiliary character for the enterprise such as advertising, the supply of information, or scientific activities, will not constitute a permanent establishment of the enterprise. A combination of these activities will not give rise to a permanent establishment. The use of facilities or the maintenance of a stock of goods solely for regular delivery of goods or merchandise may, however, under the Convention, constitute a permanent establishment since, unlike the U.S. Model, it is not specifically excluded.

Paragraphs 4 and 5 specify when the use of an agent will constitute a permanent establishment. Paragraph 4 specifies three conditions in which a dependent agent will constitute a permanent establishment. Only the first of these is found in the U.S. Model. Under subparagraph 4(a), a dependent agent of an enterprise of a Contracting State will give rise to a permanent establishment of the enterprise in the other Contracting State, if the agent has and habitually exercises in that other State an authority to conclude contracts in the name of that enterprise, and his activities are not limited to those activities specified in paragraph 3 which would not constitute a permanent establishment if carried on by the enterprise through a fixed place of business.

Under subparagraph 4(b), even if the agent has no authority to conclude contracts, he will give rise to a permanent establishment for the enterprise if he habitually maintains a stock of goods or merchandise in the other State on behalf of the enterprise and regularly makes deliveries from that stock, and there have been some additional activities carried on in that other State on behalf of the enterprise which have contributed to the sale. It is not necessary that these sales activities be carried out by the agent. They may be carried out by the enterprise itself or by another agent.

Subparagraph 4(c) contains a rule not found in other U.S. treaties. It provides that an agent who habitually secures orders wholly or almost wholly for an enterprise of a Contracting State will constitute a permanent establishment of the enterprise in the other Contracting State.

Diplomatic notes exchanged at the time of the signing of the Convention explain that in order for an agent to be treated as habitually securing orders wholly or almost wholly for the enterprise all of the following tests must be met:

The agent frequently accepts orders for (goods or merchandise on behalf of the enterprise.
Substantially all of the agent's sales-related activities in the other Contracting State consist of activities for the enterprise.
The agent habitually represents to persons offering to buy goods or merchandise that acceptance of an order by the agent constitutes the agreement of the enterprise to supply goods or merchandise under the terms or conditions specified in the order.
The enterprise takes actions that give purchasers the basis for a reasonable belief that such person has authority to bind the enterprise.

Under paragraph 5, as a general rule, an enterprise will not be deemed to have a permanent establishment in a Contacting State merely because it carries on business in that State through an independent agent, including a broker or general commission agent, if the agent is acting in the ordinary course of his business. If, however, the agent's activities are devoted wholly or almost wholly on behalf of the enterprise, and transactions between the agent and the enterprise are on other than an arm’s length basis, the agent will not be considered an independent agent.

Paragraph 6 clarifies that a company which is a resident of a Contracting State will not be deemed to have a permanent establishment in the other Contracting State merely because it controls, or is controlled by, a company that is a resident of that other Contracting State, or that carries on business in that other Contracting State. The determination of whether or not a permanent establishment exists will be made solely on the basis of the factors described in paragraphs 1 through 5 of the Article. Whether or not a company is a permanent establishment of a related company, therefore, is based solely on those factors and not on the ownership or control relationship between the companies.