ARTICLE 5

Permanent Establishment

The rules 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 that concept in general terms and the following paragraphs give some specific illustrations.

Where a resident of one Contracting State furnishes the services of personnel or employees in the other State, the resident will be considered to have a permanent establishment in the latter State if the services continue at the same or a connected project for more than 120 days in a twelve-month period. If such services are rendered for less than 30 days in any taxable year, a permanent establishment will not exist for that year, although the 30 days will count toward the threshold of 120 days in twelve months.

These 120-day thresholds are shorter than the minimum of 183 days preferred by the United States in Conventions with developing countries. (The U.S. Model provides a 12-month threshold for construction sites and drilling rigs and no special rule for services.) They represent a compromise with the Indonesian position that the threshold for such activities should not exceed 90 days. In the absence of the Convention, the liability to taxation in Indonesia would generally begin on day one. In some other U.S. Conventions with developing countries the thresholds vary from 90 to 183 days for different activities; here the solution was to adopt a standard 120-day test for all such cases.

Paragraph 3 enumerates certain activities which may be undertaken, singly or in combination, without creating a permanent establishment. Those activities include using facilities or maintaining a stock of goods solely for the purposes of storage or display or, as indicated in the Protocol, for the purpose of occasional delivery. A permanent establishment does exist if deliveries are made on a regular basis from a warehouse or other storage facility.

The other activities which do not constitute a permanent establishment when carried on in a Contracting State by a resident of the other State are: maintaining goods belonging to the resident solely for the purposes of processing by another person; maintaining a fixed place of business solely for the purpose of purchasing goods or collecting information for the resident; and maintaining a fixed place of business solely for preparatory or auxiliary activities of the resident, such as advertising, supplying information, or scientific research.

Paragraphs 4, 5 and 7 describe the permanent establishment implications of employees and agents. An independent agent, as explained in paragraph 5, does not constitute a permanent establishment of the enterprises using his services. Paragraph 4 provides that a person other than an independent agent who acts in one of the Contracting States on behalf of a resident of the other State is considered a permanent establishment of that resident if he either

(a) habitually concludes contracts for the resident, unless his activities are limited to those described in paragraph 3, or

(b) does not have the authority to conclude in that State contracts but habitually maintains a stock of goods belonging to the resident from which he regularly fills orders or makes deliveries on behalf of the resident and additional activities conducted on behalf of the resident contributed to the sale.

Paragraph 7 provides a special rule for insurance companies. It comes from the U.N. model and was included at the request of Indonesia. An insurance company which is a resident

of one of the Contracting States and which receives premiums from or insures risks in the other State through a person other than an independent agent described in paragraph 5 is considered to have a permanent establishment in the other State; i.e., such a person constitutes a permanent establishment of the insurance company even though he does not have the authority to conclude contracts on its behalf. Paragraph 7 does not apply with respect to reinsurance activities.

Paragraph 6 states that control of one company by another does not of itself cause either company to be a permanent establishment of the other.